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Article | Executive Pay Memo North America

The Do’s and Don’ts of CEO Pay Ratio Communications

Executive Compensation

By Jim Kohler and Steve Seelig | September 12, 2017

You’re probably well on your way to calculating your CEO pay ratio, but have you begun to think about the difficult task of communicating it to internal and external audiences? In this article we share our point of view on how best to communicate your message to not only meet legal requirements but to address the potential concerns of employees and external stakeholders.

You’re probably well on your way to calculating your CEO pay ratio, but have you begun to think about the difficult task of communicating it to internal and external audiences? Or, is your plan to just address it through your proxy disclosure? We thought it would be helpful to share our point of view. As you read on, keep in mind that having a set of well-crafted messages to apply across all your communications will serve you well.

External messaging in the proxy and elsewhere

The required disclosure itself: SEC guidance uses the phrase “briefly describe” six times in connection with required disclosure. Anyone that has written proxies knows that this isn’t always easy because of “paragraph creep” due to the many voices that contribute to the drafting process. However, in this case we believe it’s beneficial to be brief. We are working with companies to craft their pay ratio disclosure — even global companies that are using statistical sampling — so that the message fits within a single paragraph. 

But within that paragraph, some detail is helpful. Some readers may tend to believe that a certain worker category would be your typical employee, like a letter carrier might be for the U.S. Postal Service. In this case, disclosing the median worker’s job title helps personalize a company’s brand and may be worthwhile to consider for an organization in a single line of business.

Explaining the economics of setting pay for the CEO: Of course the disclosure is fraught with social justice questions that cannot be minimized when considering the function of capital markets and broader economic considerations. There is no doubt this was the reason the disclosure was included in the Dodd Frank Act; to create debate and hopefully foster changes in pay structures for the rank-and-file. Despite these larger issues, our view is that for most companies, proxy disclosure is not the place to be re-litigating the question of why CEOs are paid what they are because of the scarcity of qualified talent, and then contrasting that with median worker pay for those whose skills are more common.

Contrasting your median pay to peers and other industries: Those who work in the world of executive compensation know the need for a sound peer group, with CEO pay setting being tied directly to it. The economics of competing for talent at all levels are based on this notion. It is no different when thinking of median pay levels that will vary greatly by industry, global reach, number of employees and business lines. It’s worthwhile to consider these issues and how you compare to industry peers (e.g., global vs. domestic, vertically integrated vs. stand-alone). This could lead to a discussion of median pay level comparability, both for the external audiences as well as for your workforce. 

It’s trickier to decide whether or not to provide a peer comparison for the CEO pay ratio disclosure as you factor in CEO pay at peers. Our sense is that it will be difficult to anticipate what pay ratios will be at peer companies, which will make it a riskier proposition because of the potential variability of CEO pay at those peers.

Getting ahead of the media: Some disclosures will inevitably make headlines in local and national news, and our research shows that workers don’t understand these ratios. Therefore, it’s worthwhile to draft messages that incorporate your employee value proposition, helping you frame your company’s narrative. The media may want to know why your ratio is as high as it is. Consider the quote you’d want to see in that article. Your goal should be to have your messages prepared so that you can present information that will hopefully lead to a more balanced view.

Messaging to internal stakeholders

What to tell the CEO and compensation committee: You should expect to be asked how your ratio compares with other companies. Be careful how you answer. Until published, you can have no certainty of what median pay might be at a peer organization, and our strong advice is to avoid speculation. A better approach is to compare your median employee pay to the CEO’s summary compensation at a peer.

Focus on the median employee versus discussing pay fairness: We have heard from many companies that given the flexibility provided in the regulations, they would rather find a median employee whose pay level is lower rather than seeking a higher median pay level that will yield a more favorable pay ratio. The logic is that they would prefer to have fewer workers find they are paid below that level. However, our view is that this approach will have a nominal impact. The more important question will come even from those paid above median: am I being paid fairly when our pay ratio seems so large?

We believe a better focus for companies is to use more robust communications about their employee value proposition to get ahead of the question of pay fairness. When we asked employees in our Willis Towers Watson 2016 Global Workforce Study (over 31,000 employees across 29 countries) if they understood how their compensation compares to their organization’s CEO, only 37% agreed. And only 44% agreed that they understood how their compensation compares to employees at organizations like their own. Clearly, a large percentage of companies have work to do to enhance the perception of pay fairness.

It may not be possible control the press reports of exorbitant CEO pay at your company, but it’s possible to educate your workforce on how their total compensation is determined and how it might compare to the marketplace. With six months until the first disclosures, we would suggest focusing on five activities to build employees’ understanding of pay (there is much more that should be done to build trust and appreciation of your pay equity following your disclosure):

  • Help employees understand why their pay is fair and competitive… it’s just one element of their total rewards.
  • Explain how pay ranges are set using a competitive analysis and how employees’ positions within the ranges influence pay decisions.
  • Define what median means and how it affects calculation of the ratio.
  • Train managers to have effective pay discussions.
  • Help senior leadership know what the pay ratio means, how it compares to other organizations and how to respond to questions without being defensive or dismissive.
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