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Article | Executive Pay Memo North America

How would your company respond to a CEO pay ratio-related shareholder proposal?

Executive Compensation|Governance Advisory Services

By Steve Seelig , Rich Luss and Jim Kohler | January 25, 2019

Keen interest in CEO pay ratio disclosure continues and could ramp-up this year with more shareholder proposals on the horizon.

Late last year, New York State Comptroller Thomas P. DiNapoli announced that the New York State Common Retirement Fund (NYSCRF) has reached agreements with Microsoft Corp., CVS Health Corp., Macy's Inc., the TJX Companies, Inc. and “to reexamine their CEO and executive pay and adopt policies that take into account the compensation of the rest of their workforces.” Each company agreed to provide more details in their proxy disclosure about how they are tackling this goal. In exchange, the NYSCRF withdrew shareholder proposals that would have required those companies to take these actions. The State Comptroller’s press release indicates the NYSCRF intends to file similar proposals with other companies this year.

This follows a letter sent to Fortune 500 companies (see “Shareholder letter may prompt more descriptive CEO pay ratio disclosures”, Executive Pay Matters, January 9, 2019), and raises additional questions about whether companies should consider altering their Year 2 proxy disclosures under Securities and Exchange Commission rules.

How companies responded

We haven’t seen the actual shareholder proposals themselves, but believe it likely they were similar to the one received by BB&T Corporation, the subject of a no-action letter” request denied by the SEC Corporate Finance Division in 2017.  Each company that received the proposal during 2018 took a different approach to their settlement and disclosure that reflect the diverse viewpoints over how workforce compensation fits in to the executive pay setting process. 

We provide the following as examples of how companies have responded and, as is our policy, offer no endorsement or criticism of the approaches taken.

1. Include a statement within the Compensation Discussion and Analysis (CD&A)

Macy’s agreed to include the most expansive disclosure that described its overall compensation philosophy and how it extends beyond senior executives to its broader workforce. It described how Macy’s pays most employees some form of variable pay — creating a shared pay-for-performance philosophy across the organization to align broad groups of employees with the interests of its shareholders — and how the compensation committee’s reach includes both executives and directors. It also depicts that its internal pay setting process for all job levels balances internal and external pay fairness for each job classification within the organization. Finally, the disclosure notes that Macy’s provides a wide variety of job opportunities in multiple disciplines, where workers can build their careers or simply earn extra money.

TJX agreed to include a brief declaration that executive pay issues are advised by the same framework for total rewards as the entire workforce. 

Despite the inclusion in the CD&A, neither statement obligates the compensation committee to consider the impact of workforce pay or the median paid employee on the activity of setting compensation levels for the CEO. 

2. Include a statement outside the CD&A 

Microsoft kept the discussion in the corporate governance section of the proxy possibly reflecting the intent to leave the compensation committee’s current remit unchanged. Its statements reflected the compensation committee’s existing practices including human capital-related discussions about succession planning, compensation and benefits, recruiting, retention and diversity, plus its review of sales force compensation and the compensation risk assessment presented to it by management. These activities are typical of how most compensation committees we work with operate.

We also note that Microsoft included market analysis and pay setting language in its settlement that seems fairly typical of CD&A discussions about the compensation setting process. 

What was unique in its disclosure was a reference to an employee survey that reflected a high level of job satisfaction. This reference from the settlement ultimately made its way into the CD&A discussion that covered the qualitative elements of the CEO’s annual cash incentives, and also described his continued efforts to improve diversity and inclusion supported by impressive ratings from third-party assessments. included a statement in a section of its proxy entitled “Sustainability, Equality and Philanthropy” that appears outside the CD&A in a discussion about promoting equal pay, equal advancement, equal opportunity and equal rights for employees, and included an affirmative statement about having adjusted pay practices to eliminate statistically significant gender-associated differences in pay. It has pledged to continue to evaluate that employees performing similar work at the same level are paid consistently. has also affirmatively stated that “the fiscal 2018 CEO pay ratio has been reviewed with our Compensation Committee and is among the factors it expects to consider when making future executive compensation decisions.”

3. Provide other pay/benefit enhancements without mentioning in the proxy 

CVS Health explained how it gave back some of the tax savings it received from the Tax Cuts and Jobs Act of 2017 by promising increases in hourly pay, holding health insurance premiums steady and creating a new parental leave program. No mention was made of any other actions by the compensation committee to connect executive and workforce pay.

The data alternative

The lack of focus on the subject of the initial shareholder proposals — pay grades and salary ranges — is curious, as it details how the compensation committee determines pay, employees’ potential productivity, and how pay fits within the company strategy.

However, valuable information can be found by analyzing a combination of publicly available information from the financial and CEO pay ratio disclosures of the organization and its peers. Companies may not want to disclose such information in their pay ratio disclosure, but we recommend they consider an internal analysis to provide more insight to their board.

The resulting disclosures (or response to a shareholder proposal) could be more reassuring in nature, detailing how the company efficiently manages its human capital function or that the pay at the organization is well aligned with employee productivity.

This information would fall under three categories:

1. Industry- or sector-specific information: Across industries, there are substantial differences in the mix of assets, including human capital (e.g., the prevalence of skills and education among employees and the types of employees hired); physical assets (e.g., those acquired through investments that have not yet been fully depreciated); and intangible assets (e.g., brand value or intellectual capital — assets acquired through investments in R&D, advertising or M&A). The incremental value created through the use of these assets will differ depending on the industry or sector considered. 

In some industries, investments in physical assets (such as the acquisition of new technologies or machinery) can generate large increases in employee productivity, while in other industries the creation of intangible assets is more likely to drive productivity differences. Other differences include the proportion of value created that typically goes to employees and the expected shareholder ROI. 

2. Company-specific information in financial statements: This information includes measures of productivity and capital intensity of production within the organization. It can be used to determine the value generated per employee (i.e., what the return for each employee hired is relative to the return on capital employed).

3. Company-specific information provided in the CEO pay ratio disclosure: This information includes employee counts, whether the de minimis exclusion was used, and whether health and wellness benefits were included in the median pay. It helps control variations generated by process differences and can provide a rough indicator of the distribution of employees across higher and lower paying countries. For example, organizations with more employees in lower paying positions in lower paying countries are more likely to use the de minimis exception and to exclude more employees (or to exclude up to the 5% maximum).

Collectively, we have found that this information explains a substantial portion of the variation in the median pay across a broad cross-section of organizations. While other factors such as those mentioned in the institutional shareholder letter may explain more and increase understanding of a company’s pay practices, a robust analysis of the information already available can help identify those organizations that appear to be paying more (less) than their peers relative to the value being created by employees.

How would your company respond?

There is no set playbook for how companies respond to shareholder proposals. Some responses are minimalist, while others provide a lot more information about how the company manages its workforce and recent steps taken to ensure pay equality across the workforce. Most piggybacked their responses to planned or completed activities to enhance workforce pay and benefits. It is noteworthy that only one company responded by affirmatively stating that their compensation committee would consider workforce pay levels in establishing CEO pay.

Three key considerations should frame your company’s disclosure:

  • What to include
  • Where to include it to clearly reflect your compensation committee’s mandate
  • How you’ll tell your story so investors truly understand how your organization values its employees

Any shareholder proposal response will require close consultation among SEC counsel, the board and the compensation committee, shareholder relations and human resources.

Disclosure could potentially include completed or intended actions on gender pay equity, job leveling and assessment, better employee communication/education about pay and how it’s determined, and compensation and benefit enhancements. Potential proxy disclosures could include the results of employee surveys that help portray attitudes about pay fairness and worker satisfaction. Finally, companies should consider data assessments that we detailed in the prior section.

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