January 7, 2019

CEO pay ratio reporting – are you prepared?

For the first time, all UK listed companies with more than 250 UK employees will have to publish and explain every year the differences in pay between their chief executive and staff. The below sets out a summary of the requirements which will require action in 2020 for financial years starting in 2019.

We can help by explaining the rules in more detail, and assisting with “test runs” this year for previous financial years to plan for the disclosures required next year.

Why has CEO pay ratio reporting been introduced?

The government has introduced CEO pay reporting because of concerns raised in recent years that some chief executives' pay may have been out-of-step with company performance. These new rules are part of a wider package of corporate reforms which the government hopes will "hold big businesses to account for the salaries they pay, while giving employees a greater voice in the boardroom."

Which companies does it apply to?

The new rules apply to UK incorporated companies that are listed on the London Stock Exchange, an exchange in an EEA member state, the New York Stock Exchange or NASDAQ, and have an average number of UK employees above 250 in their group. There are set rules for how to work out the average number of employees and which employees are included in this.

If the listed company is a parent company, the number of UK employees within group companies must also be included, and pay ratio information must relate to the group not just the company.

What do companies have to do?

Companies subject to the new rules will need to include a table – in a specified form - in their directors' remuneration report, setting out the ratio of the CEO's total remuneration to the 25th, median and 75th percentile of UK employees' pay.

The 25th, median and 75th percentile pay ratios are based on the pay of a representative employee who falls on these pay percentiles. They are called “P25”, “P50” and “P75”. Employee pay in this context means the employee’s full-time equivalent pay and benefits. 

CEO pay is the total remuneration paid to the director carrying out the role of CEO in the relevant financial year. This is to be based on the “single figure” in the directors’ remuneration report, and must include all elements of remuneration including salary, fees, benefits, bonuses, share schemes and pension benefits. If more than one person undertakes the role of CEO in the financial year, the total remuneration paid to all those who held the role must be calculated. 

The new rules give companies three options on how to work out the ratios:

  • Option A - is to calculate the pay and benefits of all UK employees for the relevant financial year in order to identify P25, P50 and P75, and then use those figures;
  • Option B - is to use the most recent hourly rate gender pay gap information for all UK employees of the company to identify three UK employees as the best equivalents of P25, P50 and P75;
  • Option C - is to use pay data other than, or in addition to, gender pay gap information to identify three UK employees that are the best equivalents of P25, P50 and P75. The data used must not relate to any year prior to the previous financial year or be less up-to-date than the gender pay gap information.

The report must also include certain other information, including:

  • an explanation of why the company chose the method of calculating the pay ratios for the relevant financial year that it did, along with certain specific information related to the ratio calculation methodologies used and an explanation for any change in the methodology used from the previous year;
  • clarification of any deliberate omissions of any component of pay or benefits (as companies have some flexibility around this) and the reasons for them;
  • a brief explanation of any assumptions or statistical modelling used to determine full-time equivalent remuneration;
  • an explanation for any increase or decrease in pay ratios from a previous year, with an explanation of whether this is due to a change in CEO or employee pay, employment models or the method of calculation;
  • any trend in the median pay ratio over the number of years covered in the table;
  • for the median ratio, whether, and if so how, the ratio accords with the company's wider pay, reward and progression policies.

In each year’s report, companies will be required to report the same ratios for up to nine financial years immediately preceding the relevant financial year. This means the table will build up over time to a 10 year record of pay ratios, making it easy to see at a glance whether a company’s CEO pay ratio is getting bigger or smaller.

Companies must also report on how their directors take employee and other stakeholder interests into account. Specifically, the directors’ report for the financial year will need to include a statement describing the action that has been taken during that year to:

  • introduce, maintain or develop arrangements aimed at providing employees systematically with information on matters of concern to them as employees;
  • consult employees or their representatives on a regular basis so that the views of employees can be taken into account in making decisions which are likely to affect their interests;
  • encourage the involvement of employees in the company’s performance through an employees’ share scheme or by some other means;
  • achieve a common awareness on the part of all employees of the financial and economic factors affecting the performance of the company.

There is no requirement to disclose information about impending developments or matters in the course of negotiation if this would, in the opinion of the directors, be seriously prejudicial to the interests of the company.

Directors will also be required to show what effect an increase in share prices will have on executive pay, in order to inform shareholders when voting on long-term incentive plans.

When do they have to do it?

The new rules came into effect on 1 January 2019. The first pay ratio reports will appear in director remuneration reports in 2020, for financial years starting on or after 1 January 2019.

Preparing for CEO pay ratio reporting

It is likely that the process of calculating, presenting and justifying the pay ratios between CEO and staff will be time-consuming for companies, and require careful planning and consideration.

Companies may want to consider doing a test run for the 2018 reporting year. From a practical perspective, this will help them check they have access to the necessary pay data and that they will have it in time to meet the relevant reporting deadline. It will also give them time to look at whether their choice of option for calculating employees’ pay is practical, suitable and workable, and any omissions from the components of pay and benefits that will be made - and how these will be justified.

There are also some anomalies for companies to work through. For example, the definition of an employee (someone who works under a contract of service) is different from that used in gender pay reporting, which is a wider definition used in equality legislation and includes workers and some self-employed contractors. So it may not be straight-forward to safely rely on gender pay gap data if the company uses contractors as well as employees.

Perhaps most importantly though, careful planning will give companies time to consider and plan for how best to present and explain their pay ratios, and manage how this may impact on employee, public and investor relations and the company's reputation.

What's next for pay equality in the UK?

With gender pay gap reporting already in effect, CEO pay gap reporting set to start in 2020 and a government consultation on whether to introduce ethnicity pay reporting, it seems the focus on equality and fairness in pay is here to stay. For more information, please contact Chris Holme or your usual contact at Clyde & Co.

How can we help?

Contact us for more details, or to arrange a “test run” this year to see how your data looks and to plan for disclosures which will be required next year.

Department for Business, Energy & Industrial Strategy Guidance: Corporate Governance – the Companies Miscellaneous Reporting Regulations 2018