In August 2015, the SEC, by the narrowest of margins (3 votes for, 2 against), adopted the long-awaited and politically charged rule requiring large U.S. public companies to disclose the ratio of their CEOs’ annual compensation to that of their median-compensated employees. The rule, often referred to as the “pay ratio rule,” implements section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 by amending Item 402 of Regulation S-K, Executive Compensation.

Highlights of the Final Rule

The pay ratio disclosure requirements apply generally to all U.S. public companies except emerging growth companies, smaller reporting companies, and foreign issuers. The rule requires the following information to be disclosed in annual reports on Form 10-K, registration statements under the Securities Act of 1933 and the Securities and Exchange Act of 1934, and proxy and information statements covering the first full fiscal year beginning on or after January 1, 2017: 1) the median amount of the annual total compensation of all employees (i.e., the “median employee”), except that of the CEO; 2) the total amount of the CEO’s annual compensation; and 3) the ratio of the two amounts, which may be expressed either with the median employee’s compensation equal to one, or in terms of the multiple that the CEO’s total compensation bears to the median compensation. For example, if the median total annual compensation is $50,000 and the CEO’s annual compensation is $500,000, the ratio could be expressed as “1 to 10” or as “the CEO makes 10 times as much as the median employee.” The median employee’s annual total compensation may not, however, be expressed as a percentage of the CEO’s compensation (e.g., the median annual compensation could not be expressed as 10% of that of the CEO).

The term “all employees” encompasses all U.S. and foreign full-time, part-time, seasonal, or temporary workers who were employed by the company or any of its consolidated subsidiaries within the last three months of the entity’s latest fiscal year. Independent contractors, “leased” workers, or other temporary workers employed by a third party are not covered. With certain conditions, the rule provides the following two exclusions from the definition of “all employees:”

  • Individuals employed in a foreign jurisdiction in which the laws or regulations governing data privacy are such that, despite its reasonable efforts to obtain or process the information necessary for compliance, the company is unable to do so without violating the data privacy laws or regulations.
  • Foreign employees accounting for 5% or less of the total of all of the company’s U.S. and foreign employees.

The term “annual compensation” is defined as total compensation for the company’s last completed fiscal year. Total compensation for the median of all employees and for the CEO should be consistent with column (j) of the Summary Compensation Table in Item 402(c) of Regulation S-K, which is the total dollar value of compensation for the year. The rule does not require a specific method for calculating the median amount of annual total compensation; a company is permitted to use its entire employee population, statistical sampling, or any other reasonable approach in determining the employees from which the median employee is identified. The median employee may be identified using any consistently applied compensation measure, including information from tax or payroll records. The median employee is required to be identified only once every three years, provided that there have been no changes in employee compensation or the employee population that the company reasonably believes would significantly affect the pay ratio. A cost-of-living adjustment may be made to the compensation of employees in jurisdictions other than that in which the CEO resides (i.e., so that compensation is adjusted to the cost of living in the jurisdiction in which the CEO resides).

Controversy from the Very Beginning

It took more than five years from the enactment of Dodd-Frank for the SEC to issue a final rule implementing section 953(b), and it took nearly two full years from the date it was initially proposed in September 2013. As an indication of interest on the topic, the SEC received nearly 300,000 comment letters on the proposed rule, although the overwhelming majority were form letters generated by special-interest organizations on one side of the issue or the other. Citing a study by the Economic Policy Institute (Lawrence Mishel and Alyssa Davis, “Top CEOs Make 300 Times More than Typical Workers,” June 21, 2015,, which showed that average CEO compensation in 2014 was more than 300 times that of an average employee compared to just 20 times in 1965, some proponents of the rule contended that the pay ratio disclosure could allow boards of directors to take account of internal pay inequity when setting CEO compensation. Opponents argued that the ratio would be overly costly and complicated to compute relative to the minimal value it would provide for investors. Even Congress got involved, with Republicans seeking unsuccessfully to repeal the provision, and then to delay the SEC’s implementation of it, and Democrats pushing for accelerated application.

Commissioners’ Dissents

The SEC, for its part, attempted to mitigate the compliance costs and practical difficulties associated with the proposed rule. Nevertheless, the controversy did not die down. Indeed, it may intensify following adoption of the final rule as the January 1, 2017 compliance date draws ever nearer. Among the strongest opposition to the final rule is that from the two SEC Commissioners who voted against it. Commissioners Michael S. Piwowar and Daniel M. Gallagher, the two Republican members of the SEC, each issued strong dissents. Commissioner Piwowar dissented in large part because, in his view, section 953(b) of Dodd-Frank—and by extension the SEC rule implementing it—has nothing to do with the SEC’s core mission of protecting investors, ensuring fair, orderly, and efficient markets, or facilitating capital formation. Moreover, Commissioner Piwowar asserted that, because the proposing release did not identify any objective, goal, or benefit that the SEC believed the rule was intended to accomplish, constituents were prevented from making a proper evaluation of its merits. This, Commissioner Piwowar noted, is a violation of the Administrative Procedure Act of 1946 [5 USC 553(b)-(c)], which requires an agency to make its views known to the public in a concrete and focused way in order to make criticism or formulation of alternatives possible (“Dissenting Statement at Open Meeting on Pay Ratio Disclosure,” August 5, 2015,

Commissioner Gallagher dissented because, in his opinion, the rule will produce so few benefits for shareholders that the information seems likely to be useless for anything but “naming and shaming.” Commissioner Gallagher also believed that the rule improperly compels corporate speech, and he thus raised the issue of whether it is even constitutional. He, along with many other opponents, also objected to the inclusion of foreign workers in the computation; Commissioner Gallagher pointed out that the SEC, under its definitional, interpretive, and exemptive authority, could have limited the scope of the rule to full-time U.S. employees, especially given that the statute itself provides no definition of the term “employee.” Commissioner Gallagher also dissented because of the high costs of compliance; he cited the SEC’s own economic analysis, which estimates initial costs to be more than $1.3 billion and ongoing costs approximately $526 million. Commissioner Gallagher pointed out that, had the scope of the rule been limited to full-time U.S. employees, compliance costs would be reduced by nearly half. Finally, Commissioner Gallagher dissented because neither the law itself nor its legislative history identifies the purpose of the rule or the benefits the rule would achieve. In his view, there is no credible evidence that a reasonable investor would actually find the pay ratio useful (“Dissenting Statement at an Open Meeting to Adopt the ‘Pay Ratio’ Rule,” August 5, 2015,

The Lack of Comparability Apparently Doesn’t Matter

In the final rule, the SEC intentionally provided companies with a good deal of flexibility in determining the median employee’s compensation, including 1) foreign employee exemptions, 2) the use of statistical sampling or any other reasonable method for identifying the median employee, and 3) the option to choose a measurement date. These accommodations, together with the uncertainty of judgments and estimates inherent in the convoluted process, will likely render pay ratio comparability across companies—even those within the same industry—virtually unachievable. Even the SEC acknowledges this, but it maintains that comparability isn’t really the point of the rule. Rather, the SEC notes that it is just another company-specific metric to be used by investors in assessing CEO compensation.

Perhaps comparability across companies isn’t the point. Yet it seems naive to believe that comparing ratios among companies will not be precisely the way it will be used, particularly by those with a specific social objective. Like it or not, there is little doubt in my mind that activists will bring pressure to bear on boards of companies with high CEO pay ratios, using the rule to “name and shame.” Still, depending on the strength of continuing opposition to the final SEC rule, legislation could be enacted that repeals or modifies it. Litigation is also a possibility. And because pay ratio disclosure is not required until 2018 to cover the 2017 calendar year, there is enough time for those opposing the rule to forge ahead with plans to eliminate it entirely or substantially dilute its requirements.

Allan B. Afterman, PhD, CPA is the author of numerous treatises on financial reporting and SEC practice and has consulted with governments on the establishment of national securities laws and financial reporting standards. He is a former adjunct professor in the Booth School of Business at the University of Chicago, and was assistant to the national director of SEC practice at a major public accounting firm.