Risk & Compliance

Pay Ratio Disclosures Mislead Investors

The first round of proxy statements after the new pay ratio rule took effect underscores inherent flaws in the rule.
David McCannMarch 14, 2018
Pay Ratio Disclosures Mislead Investors

An early tabulation of companies’ first reported CEO pay ratios confirms what many observers had been expecting: taken as a whole, the disclosures are rife with misleading information — although it’s not necessarily the fault of the reporting companies.

The ratios — disclosed under an SEC rule that was mandated by the Dodd-Frank Act and effective for public companies with fiscal years ending on or after December 31, 2017 — compare each company’s CEO compensation with that of its median-paid employee.

Compensation Advisory Partners (CAP) looked at the disclosures of 150 companies that filed their 2018 proxy statements or preliminary proxies by March 9.

The rule is intended to provide investors with more information with which to evaluate CEO compensation. However, in many cases the disclosures do no such thing.

Such examples demonstrate some of the flaws in the pay ratio rule. Most damning as to its lack of efficacy are instances of companies reporting what seem at first glance to be dubiously low ratios. Two of the three most extreme such disclosures were made by private equity giants Apollo Global Management and The Carlyle Group.

Apollo reported that the total annual compensation of CEO Leon Black was $251,888. That was almost identical to the $249,750 paid to the firm’s median employee. Thus, Apollo’s ratio was 1:1.

Similarly, Carlyle provided total compensation of $281,750 to each of three “co-principal executive officers” and co-founders of the firm: David Rubenstein, William Conway, and Daniel D’Aniello. The firm’s median employee received $201,315, creating a ratio of 1.4:1.

However, both Apollo and Carlyle are structured as limited partnerships, where the partners who act as top executives derive the vast majority of their income from dividends on their equity in the partnership. The pay ratio rule does not require such income to be included in the calculation of CEO pay. Thus, as reported by Bloomberg Law, the $191.3 million in dividends that Apollo’s Black reaped last year did not count.

Nor did the $66.3 million worth of dividends that went to Rubenstein or the $62.7 million dividend income for both Conway and D’Aniello.

In a statement to CFO, an Apollo spokesperson said, “To be clear, Apollo has not misled its investors, and dividend income is not characterized as a form of compensation. Apollo is entirely transparent in how it calculates and discloses Mr. Black’s total annual compensation and the ratio of that figure to the median employee’s total annual compensation.”

The spokesperson added that Black receives “the same per-share amount given to public shareholders. As such, Mr. Black’s long-term, fully vested interests are in complete and total alignment with all of the firm’s other shareholders.”

Carlyle, for its part, did note that going forward, it expects its CEO pay ratio to be substantially different from the 2017 figure as a result of appointing Kewsong Lee and Glenn Youngkin as co-CEOs, effective Jan. 1 of this year.

However, in the section of its proxy statement where the pay ratios were disclosed, Carlyle, like Apollo, avoided any mention of its executives’ dividend income. “Historically, the annual total compensation received by our former co-principal executive officers has been limited solely to an annual base salary and 401(k) matching contributions in light of their unique status as founders of our firm,” Carlyle stated.

The same statement would have been applicable had Rubenstein, Conway, and D’Aniello chosen to work only for their comparative base-salary peanuts and received no dividend income.

Meanwhile, neither Apollo nor Carlyle took home the title of lowest CEO pay ratio. That distinction went to Dorchester Minerals, another limited partnership, whose recent preliminary proxy statement reported that total 2017 compensation for CEO William McManemin was $96,000. As the median employee’s pay was calculated as $106,385, the reported ratio was 0.9:1.

CFO was unable to confirm by press time whether McManemin received dividend income on his equity in Dorchester. It may or may not be notable that in recent years Dorchester’s per-share dividend payouts have far surpassed its per-share earnings. In other words, the company is not making enough money to cover its dividends.

At the other end of the pay-ratio spectrum, the company reporting the highest ratio so far is Fresh Del Monte Produce, at 1,465:1. The components of the eye-popping statistic: total compensation of $8.54 million for CEO Mohammad Abu-Ghazaleh versus median company-wide compensation of just $5,833.

The company disclosed that its employee population consists of “full-time, part time, temporary, and seasonal employees,” 80% of whom are from Costa Rica, Guatemala, Kenya, and the Philippines.

What are investors to make of Fresh Del Monte’s pay ratio? With its employees concentrated in low-wage countries and consisting of many less-than-fulltime workers, does the fact that its pay ratio is the highest reported so far have any real meaning?

“As more companies continue to file their proxy statements in the coming weeks, we will likely see larger pay ratios, particularly as companies with a significant part-time workforce begin to disclose their ratios,” CAP said in its report.

Add to that the fact that, as allowed under the SEC’s rule, Fresh Del Monte used a statistical sampling methodology to identify its median-paid employee. The method considered a “representative sampling” of employees in each country where the company operates. As a result, while Fresh Del Monte said it had 39,089 employees, the total sample size was a mere 217.

In addition, various sampling methodologies are allowed, and two competitors can choose different ones. How does that help investors?

According to CAP, approximately one-third of the companies reporting so far have excluded a portion of their workforce when determining the median employee. The most common rationale has been the “de minimus” exemption provided in the SEC rule, whereby a company can exclude up to 5% of its non-U.S. labor force even if it doesn’t use a sampling methodology.

Companies also commonly cited recent acquisitions as a reason for not including workers acquired in the deals.

And, many others cited a “corporate not responsible for setting pay” provision, which allows them to exclude independent contractors. Yet, given the deepening entrenchment of the gig economy, whereby the use of contractors is fast proliferating, excluding such workers from the calculation is highly likely to skew median pay away from a level that would reasonably reflect a company’s compensation practices.

Other findings in the CAP report:

  • About 25% of the companies included language in the disclosure noting that the ratio should not be used to compare pay levels to those of other companies in their industry, region, or revenue size group.
  • The median pay ratio among the 150 companies in CAP’s sample was 87:1.
  • Median pay ratio was correlated with company size. The average ratio for companies with more than $15 billion in revenue was 218:1. That average progressed downward through several size ranges, ending up at 20:1 for companies with revenue of less than $500 million.
  • The pay ratio was typically not disclosed in the Compensation Disclosure and Analysis section of proxies, signaling to shareholders that the pay ratio is not used to determine CEO pay levels.