Pay ratios: new reporting requirements

By Adrian Martin and Deborah Bulman

Under the draft legislation, UK listed companies with more than 250 employees will be required to publish the pay difference between their chief executive and their average UK worker annually. The draft legislation will also force these companies to also justify the gap, known as the pay ratio.

Subject to parliamentary approval, the requirement to publish the pay ratio is intended to apply to the financial year of companies beginning on or after 1 January 2019. Companies will therefore need to start reporting their pay ratios in 2020.

Who will be affected by pay ratio reporting?

All UK listed companies will be required to report their pay ratio if the average number of their UK employees is more than 250 in the financial year. For these purposes, an employee includes anyone ‘employed under a contract of service by the company’. However, those who work wholly or mainly outside the UK are excluded.

For parent companies, the pay ratio information will relate to the group rather than the company, and the average number of UK employees is to be calculated using the number of UK employees in the group.

What information will have to be published?

Companies will be required to publish specific pay ratio information in the directors’ remuneration report. This information is set out in the regulations and includes a pay ratio table setting out:

• the year
• the method of calculation used (see below)
• the 25^th percentile pay ratio (Y25)
• the median pay ratio (Y50)
• the 75^th percentile pay ratio (Y75).

What method of calculation must be used?

Companies must choose one of three methods to calculate Y25, Y50 and Y75 figures to use in the pay ratios:

• Option A uses the pay and benefits figures for all the UK employees.
• Option B uses the most recent hourly rate gender pay gap figures to identify three UK employees as the best equivalents of UK employees whose pay and benefits are on the 25^th, 50^th and 75^th percentile. It will then calculate the pay and benefits for each for the financial year.
• Option C uses data other than, or in addition to, the gender pay gap data to identify three UK employees as the best equivalents of UK employees whose pay and benefits are on the 25^th, 50^th and 75^th percentile. It will then use these to calculate the pay and benefits for each for the financial year.

The directors’ report will have to explain why the company chose option A, B or C as the preferred method for calculating the pay ratio and other explanations about the figures and methods used. In particular, if any component of pay and benefits are omitted from the figures this will have to be specified together with a reason for the omission.

What remuneration is to be used?

In order to calculate the ratio, the total remuneration of the director undertaking the role of the chief executive officer (CEO) is used and the UK employee full-time equivalent pay and benefits are used.

Directors’ summary

As the table of pay ratio data develops after the first year that it is reported, the directors’ report will also have to contain a summary containing specific information including an explanation of any reduction or increase in the pay ratio compared to the previous year and any trend in the median pay ratio.

Engagement with employees

In addition to the pay ratio information, if it is not the first financial year in which the threshold number of UK employees has been reached, the directors’ report will have to contain a statement describing what action the company has taken to introduce, maintain or develop arrangements aimed at:

• providing employees systematically with information on matters of concern to them as employees
• consulting employees or their representatives on a regular basis so that the views of employees can be taken into account in making decisions which are likely to affect their interests
• encouraging the involvement of employees in the company’s performance through an employees’ share scheme or by some other means
• achieving a common awareness on the part of all employees of the financial and economic factors affecting the performance of the company.

It must also summarise:

• how the directors have engaged with employees
• how the directors have had regard to employee interests, and the effect of this, including on the principal decisions taken by the company during the financial year.

What to do now?

The regulations are subject to parliamentary approval so some of the detail may change, but given the government’s commitment to ensure that large organisations are transparent and accountable to their employees and shareholders, the regulations look likely to come into force on 1 January 2019.

Many organisations underestimated the amount of work required to report on their gender pay gap data and so if your organisation is likely to be caught by the requirement to report pay ratio data, it is sensible to prepare early for the change. The amount of work may be more or less difficult depending on the make-up of your workforce, your methods of remuneration and the payroll systems in place.

In particular, affected employers should:

• allocate a person or team to take responsibility for compliance with this new requirement
• identify their 'relevant employees'
• familiarise themselves with the required approach to the calculation of the pay and benefits of UK employees to ascertain how these calculations can be undertaken
• consider conducting an initial audit and risk assessment to identify potential problem areas
• prepare an employee communication plan in advance of the publication date.

How Burges Salmon can help

• Tailored advice for your organisation: We can provide specific advice on the regulations as they apply to your organisation including advice in identifying who is an 'employee' and other difficult areas.

• Reviews and analysis: We can help with reviews and analysis of data gathered, building a practical action plan to prepare for reporting and a plan to address any potential problem areas identified. Information gathered for the purposes of obtaining legal advice may be subject to legal advice privilege.

• Strategic input: Most companies will want to provide some explanation of their figures and to publicise any steps that are being taken to address any issues disclosed. We can help prepare that narrative and accompanying employee communications plans.

If you would like help or advice on this subject, please contact Adrian Martin.