Global menu

Our global pages

Close

CEO pay ratio reporting: mind the gap

  • United Kingdom
  • Employment law

07-01-2020

The High Pay Centre has published figures which indicate that by 5pm on Monday 6 January 2020 (the third working day of the year) pay for the typical FTSE 100 CEO surpassed the amount the average UK worker earns in an entire year. The High Pay Centre report notes: ‘CEOs are paid extraordinarily highly compared to the wider workforce, reflecting an approach to business that has made the UK one of the most unequal countries in the developed world’.

The publication of the figures has already led to significant press coverage, suggestive of the media interest that will follow the publication of CEO pay ratios this year.

The CEO pay ratio reporting requirements

The Companies (Miscellaneous Reporting) Regulations 2018 (the 2018 Regulations) amend company reporting requirements to include information on the ratios between CEO and average staff pay for financial years beginning on or after 1 January 2019. First reporting will therefore take place this year. Under the 2018 Regulations, relevant companies must publish, as part of their directors’ remuneration report, the ratio of their CEO’s total remuneration to the median (50th), 25th and 75th percentile full-time equivalent remuneration of their UK employees.

To whom do the 2018 Regulations apply?

The requirement to report on the gap between CEO and average employee pay applies to quoted companies with more than 250 UK employees. The term ‘employee’ for the purposes of calculating the ratio is defined more narrowly than for gender pay gap reporting purposes as ‘a person employed under a contract of service by the company other than a person employed to work wholly or mainly outside of the UK’.

The definition of employee is unlikely to include individuals who work on an agency or consultancy basis but it will include, for example, part time staff who meet the definition of employee. Each relevant company must examine whether, on the facts, an individual is an employee working under a contract of service.

The relevant company must calculate the number of employees employed in the UK across the group as a whole. The BEIS Q&A makes clear that where a quoted parent company has fewer than 250 UK employees but the group as a whole has more than 250 UK employees it is required to report its CEO pay ratio.

How is the ratio calculated?

Three options for calculation have been included to address concerns that some companies would face particular challenges in following the preferred method of calculation (Option A). Option A requires a company to calculate the total full-time equivalent pay and benefits of all its UK employees for the relevant financial year (using the same methodology as for CEO pay) in order to identify and rank the 25th, 50th and 75th percentiles. These three pay ratios are then calculated against the CEO’s single total figure of remuneration (STFR) (which is already part of the directors’ report, calculated according to existing regulations). Whilst Option A is the most statistically accurate method of calculation it is likely to be too onerous for many companies unless they have high quality data or a limited UK employee population.

The regulations therefore also include Options B and C which allow companies to identify, on an indicative basis, their employees at the 25th, 50th and 75th percentiles, without having to first identify and rank the total pay and benefits of every UK employee.

Option B allows companies to rank employees using their gender pay gap information and Option C allows employees to be identified using other existing pay data if such data was gathered no later than the previous financial year. An obvious complication with using gender pay gap information is that the definition of employee for CEO pay ratio reporting is narrower than that for gender pay gap reporting.

A company may choose different methods of calculation for different financial years. Given that there are three different options of calculation, this does mean that cross comparison with other companies in the same sector will be problematic.

Supporting information

Supporting information must be published for the relevant financial year which states the methodology used and explains any reduction or increase in the ratio from year to year and whether such change is attributable to

  • A change in the CEO’s remuneration or the company’s UK employees’ pay and benefits as a whole or
  • A change in the company’s employment models or
  • The use of a different calculation method (Options A, B or C).

Changes in ratios, trends and explanations apply from the second year of disclosure under the 2018 Regulations. The company must also state whether, and if so why, it believes the company’s median pay ratio for the relevant financial year is consistent with the pay, reward and progression policies for the company’s UK employees taken as a whole.

The 2018 Regulations also require companies to provide a top level summary of the employee pay and benefits used to calculate each of the three pay ratios.

The 2018 Regulations do not state how long or short the explanation should be but investors will be interested in meaningful and relevant explanations. Companies might provide more detailed explanations in certain years; for example, where there have been significant changes to pay ratios compared to the previous year.

What if all employee benefits cannot be calculated in time for reporting?

Options B and C may be considered as alternatives to A. The regulations also allow for one or more components of pay and benefits (apart from salary) to be omitted from the annual report but the reason for omitting this component should be explained in the supporting information.

When using Option B or C, a company can also provide an estimate of a non-salary component, provided that this is stated and the basis for the estimate is explained. A company can explain the extent to which it believes this has impacted on the company’s reported pay ratios in that year.

However, if a component is omitted, a company cannot omit the same or equivalent component of the CEO’s STFR, which could lead to a less favourable pay ratio. The BEIS Q&As state ‘it is not permittable in any circumstances to use anything other than [the CEO’s] STFR reported each year, for the purpose of calculating the pay ratios’.

Problems and challenges

Due to the nature of variable pay, a CEO may receive incentive payments some time after they are ‘earned’ which means that fluctuations in pay and vesting under LTIP and other incentive schemes will require explanation as the figures may appear skewed from year to year.

Careful communication around the resulting pay ratio will be important because, as critics have pointed out, commentators will just look at the headline figures. Effective external and internal communications will be key. It is clear from gender pay gap reporting that employers are likely to benefit from directly reporting and explaining the results to staff.

The 2018 Regulations require a STFR figure for CEO pay, which means that where there is a change of CEO in the reporting year, the figures should be aggregated. The STFR looks at the role rather than the individual. There may be some artificial inflation in some years where the STFR includes termination packages or buy-out awards. This should be explained in the explanatory information section.

What are the sanctions for non-compliance?

In situations where directors knowingly fail to comply or are reckless as to non-compliance, such non-compliance will be treated as an offence. This means that each director may be found to be criminally liable and subject to a fine.

Of course, the most likely and immediate consequence for a company publishing a large CEO pay ratio gap is bad press coverage.

Looking ahead

In March 2019 BEIS published a report on executive remuneration which recommended that pay ratio reporting should:

  • be extended to all organisations with over 250 employees;
  • include a requirement to publish the ratio between CEO pay and the lowest pay band, as well as the bottom quartile.

The government responded that before considering any extension it intends to monitor the impact of the new reporting requirement. So, watch this space!

For more information contact

< Go back

Print Friendly and PDF
Subscribe to e-briefings