The Securities and Exchange Commission has approved a rule that mandates public companies disclose how much money their CEO makes compared to the average employee. The rule, part of the Dodd-Frank Act, requires companies to disclose the median of the annual total compensation of all its employees save the CEO, the annual total compensation of its CEO, and the ratio of those two amounts.

The commission has given companies broad latitude in how they decide who exactly is a median employee, as they can "select a methodology based on their own facts and circumstances." So for example, they can use existing executive compensation rules to come up with their figures or "any consistently-applied compensation measure from compensation amounts reported on its payroll tax records." In general, median employee compensation would need to be calculated every three years unless there has been a change in employee population or compensation arrangements that "it reasonable believes would result in a significant change to its pay ratio disclosure." In the event of such a compensation change, the company may choose to "use another employee with substantially similar compensation as its median employee." 

The method for calculating total compensation for the median annual employee will be the same as is currently mandated for CEO compensation disclosures as outlined in Item 402(c)(2)(x) of Regulation S-K. 

In general, companies will need to include all employees, regardless of whether they are domestic or foreign, full-time or part-time, or employed directly or as part of a consolidated subsidiary. Companies can opt, however, to omit up to 5 percent of its total non-U.S. employees, though if it does so it cannot pick and choose who to exclude: if any one non-U.S. employee in a particular jurisdiction is excluded, then it must exclude all of them in that jurisdiction. There is also an exception for non-U.S. employees who work in a jurisdiction with data privacy laws that would prevent the company from complying with the disclosure rule. Companies can also exclude independent contractors and unaffiliated third parties. They are also permitted to omit from its calculations any employees obtained in a business combination or acquisition for the fiscal year in which the transaction became effective. 

The decision to approve the rule was a contentious one. Commissioner Michael S. Piwowar, a Republican, said that it represents "nothing more than a sad example of surrendering the Commission’s agenda to politically-connected special interests and acquiescing to the bullying tactics of their political allies," namely labor unions, and is far afield of the commission's actual purpose of protecting investors, ensuring fair, orderly, and efficient markets, or facilitating capital formation.

On the other hand, Commissioner Kara M. Stein, a Democrat, said that "it will allow investors to evaluate how this metric changes from year to year for individual companies. It also will provide valuable information to investors about how a company manages human capital,"and added that this information will be valuable for the ability of investors to evaluate a company's governance as it relates to executive compensation, particularly as they relate to "say on pay" votes. 

Companies would be required to report the pay ratio disclosure for their first fiscal year beginning on or after January 1, 2017. A company that had not previously been a reporting company would be required to report the pay ratio disclosure for the first fiscal year following the year in which it becomes subject to the Commission’s reporting requirements, but not for any fiscal year commencing before January 1, 2017.