CEO Pay Ratio Disclosure: Calculation Methodology Guide

CEO Pay Ratio Disclosure: Calculation Methodology Guide

If your company files a DEF 14A and isn't a smaller reporting company, emerging growth company, foreign private issuer, or MJDS filer, you must disclose a CEO pay ratio under Item 402(u) of Regulation S-K. The rule has been in force since 2018 proxy statements and remains active law in 2026. What the SEC gave you alongside the mandate is significant methodological flexibility, and that flexibility is where the real compliance work lives.

The top-ranking guides describe the options. This one helps you choose among them, sequence the work, and produce proxy disclosure that holds up to SEC staff review.

Key takeaway: The SEC's intentional flexibility in the pay ratio rule creates at least a dozen discrete methodology decisions. Each has compliance, reputational, and comparability consequences. Getting the sequencing right, and documenting every choice, is what separates a defensible disclosure from an SEC comment letter.

What Is the CEO Pay Ratio Disclosure Requirement?

The pay ratio rule, codified in Item 402(u) of Regulation S-K, requires three disclosures: the median annual total compensation of all employees excluding the principal executive officer (PEO); the PEO's annual total compensation; and the ratio between the two. The ratio may be expressed numerically ("50:1" or "50 to 1") or narratively ("the CEO's annual total compensation is 50 times that of the median employee").

The requirement derives from Section 953(b) of the Dodd-Frank Act of 2010. The SEC adopted final implementing rules in August 2015, effective for fiscal years beginning on or after January 1, 2017. Calendar-year companies first disclosed in their 2018 proxy statements.

The rule attracted over 187,000 comment letters during rulemaking, and the Commission adopted it by a 3-2 vote, with two commissioners strongly dissenting. Initial aggregate compliance costs were estimated at $1.3 billion, with ongoing annual costs of $526 million. Despite periodic political pressure, including a House-passed repeal attempt in 2017 that failed in the Senate, the requirement remains in force as of 2026.

Step 1: Confirm Coverage and Set the Employee Population

Before any calculation, confirm your company is a covered registrant and define exactly who counts as an "employee" for this purpose.

Who Is Covered

The rule applies to any SEC reporting company required to file executive compensation disclosure under Item 402, with four exemptions:

• Smaller reporting companies (SRCs)
• Emerging growth companies (EGCs)
• Foreign private issuers
• MJDS filers

Companies transitioning out of SRC or EGC status do not need to provide pay ratio disclosure until after the first full fiscal year following their exit from that status.

Who Counts as an Employee

The employee population includes all full-time, part-time, seasonal, and temporary employees of the registrant and its consolidated subsidiaries worldwide. Consolidated subsidiaries are determined by accounting consolidation rules, generally requiring ownership of more than 50% of outstanding voting shares. Employees of unconsolidated subsidiaries, equity method investees, and unaffiliated third-party staffing agencies are excluded. Independent contractors and leased workers whose compensation is set by a third party are also excluded.

Newly Acquired Company Relief

Employees of a newly acquired company do not need to be included in the pay ratio calculation for the fiscal year in which the acquisition becomes effective. This is a one-year transition only. In subsequent years, those employees must be included, and a significant acquisition may trigger a mandatory median employee redetermination (see Step 4).

Choose Your Determination Date

You may select any date within the last three months of your most recently completed fiscal year as the employee population determination date. For a calendar-year company, that means any date from October 1 through December 31. This flexibility lets you avoid seasonal workforce peaks, payroll processing cycles, or administrative complexity. The date must be disclosed, and if you change it from the prior year, you must explain why.

Step 2: Choose Your Consistently Applied Compensation Measure (CACM)

The CACM is the compensation measure you use to rank employees and identify the median. It is not the same as the full Summary Compensation Table (SCT) calculation, and choosing the right one is the single most consequential methodology decision you will make.

The SEC's final rule explicitly permits any measure that reasonably reflects annual compensation, applied consistently across the workforce. Common CACMs include:

The full SCT-equivalent calculation is only required once you have identified the median employee. At that point, you must calculate that individual's annual total compensation using the same methodology as the SCT.

Practical guidance on CACM selection: W-2 wages or total cash compensation are the most commonly used CACMs in practice because they are extractable from standard payroll systems (Workday, SAP SuccessFactors, ADP) without significant data engineering. If your company distributes equity broadly below the senior leadership level, total cash will understate the compensation of higher-paid employees and may produce a misleading median. In that case, total direct compensation is more appropriate, but expect meaningful data work to pull grant-date fair values at scale.

The SEC's September 2017 interpretive guidance (Release No. 33-10415) confirmed that companies may also use reasonable estimates when applying the CACM, not just for identifying the median employee but also for calculating the median employee's annual total compensation, provided the estimates are reasonable and disclosed.

Step 3: Decide Between Census and Statistical Sampling

Statistical sampling is explicitly permitted under the SEC's final rule and its 2017 interpretive guidance. For large or geographically dispersed workforces, it is often the only practical approach.

When to Use a Full Census

A full census works well when:

• Your workforce is concentrated in one country or a small number of locations
• Your HRIS is fully integrated and can produce a single compensation extract
• Your total employee count is manageable (generally under 5,000)

When to Use Statistical Sampling

Sampling is appropriate when:

• You have a large, geographically dispersed workforce with fragmented HRIS systems
• Pulling exact compensation data for every employee would require disproportionate effort
• Your workforce has identifiable compensation clusters (e.g., by grade level, job family, or geography) that allow stratified sampling

As Deloitte DART summarizes from the SEC's rulemaking analysis: "Under the assumptions used in the analysis, the appropriate sample size for a registrant with a single business line or geographical unit varied between 81 and 1,065 employees, with an average of 560, depending on the industry."

You may also use different sampling techniques for different populations. For example, a random sample for US employees and a stratified or cluster sample for non-US employees where pay variation is wide. The SEC's 2017 guidance explicitly endorses this approach.

One practical efficiency: once you have identified the approximate median band, you do not need to calculate exact compensation for every employee in the sample. Employees whose compensation clearly falls well above or below the median can be handled with reasonable estimates.

Key takeaway: If your workforce is more than 80% concentrated in one country with an integrated payroll system, a full census is simpler and eliminates sampling methodology risk. If you are multinational with fragmented HRIS data, stratified sampling is both permissible and more practical.

Step 4: Apply Exclusions for Non-US Employees

Two exclusion mechanisms are available for non-US employees. Using them correctly, and disclosing them properly, is a frequent source of SEC comment letters.

De Minimis Exclusion

If your non-US employees represent 5% or less of your total worldwide workforce, you may exclude all of them. If non-US employees exceed 5%, you may still exclude up to 5% of your total workforce, selecting which non-US jurisdictions to exclude, but you must exclude all employees from any jurisdiction you choose to exclude (not a subset).

Important: employees excluded under the data privacy exemption (below) count toward your 5% de minimis limit.

Data Privacy Exclusion

If obtaining compensation data from a specific non-US jurisdiction would violate that jurisdiction's data privacy laws, you may exclude those employees. The requirements are demanding, per Deloitte DART's summary of SEC guidance:

1. Identify each excluded jurisdiction and the specific data privacy laws at issue
2. Explain how compliance with Item 402(u) would violate those laws
3. Document efforts to obtain an exemption under local law
4. Exclude ALL employees in that jurisdiction (no partial exclusions)
5. Disclose the estimated number of excluded employees per jurisdiction
6. File a legal opinion as an exhibit confirming the inability to collect data without violating local law

In practice, most companies have relied on the de minimis exclusion rather than the data privacy exemption, given the legal opinion requirement and the difficulty of satisfying all conditions.

Step 5: Decide on Cost-of-Living Adjustments

COLA adjustments for non-US employees are permitted but not required. A company may adjust the compensation of employees in non-CEO jurisdictions using a COLA to make international pay more comparable. This can meaningfully affect the median employee's location and the resulting ratio.

If you use COLA, you must disclose:

• That a COLA adjustment was applied
• The country of the median employee (if different from the CEO's country)
• The median employee's annual total compensation both with and without the COLA adjustment

The disclosure requirement for COLA is more burdensome than the adjustment itself. For companies where the median employee is almost certainly in the US regardless of COLA (e.g., a retailer with 60% of its workforce as US part-time store associates), the adjustment adds complexity without changing the result. For companies with large, lower-cost international workforces, COLA can shift the median employee to a different country and produce a materially different ratio.

Step 6: Handle Part-Time, Seasonal, and Temporary Employees

This is the methodology choice with the most direct impact on your disclosed ratio, and it is widely misunderstood.

The rules on annualization differ by employee type:

This is a genuine strategic decision. A company with a large part-time workforce, such as a retailer, will find its median employee almost certainly among part-time workers. Compensation Advisory Partners illustrates this: a company with 47,000 total employees including over 27,000 US part-time store associates earning approximately $12,000 annually (20 hours per week at $12 per hour) will find its median employee in that part-time population almost by definition.

If you annualize part-time employees' compensation, you raise the effective median and reduce the ratio. If you do not, the ratio is higher. Both approaches are permissible; the choice must be disclosed and applied consistently.

Some companies provide supplemental pay ratio figures alongside the required disclosure, such as a ratio excluding part-time workers, to give additional context. This is permissible provided the supplemental figures are clearly identified as supplemental, not misleading, and not presented more prominently than the required ratio.

Step 7: Handle CEO Transitions During the Year

If your company had more than one PEO during the fiscal year, two approaches are permissible under the SEC's final rule:

1. Combine the total compensation of all individuals who served as PEO during the year
2. Annualize the compensation of the PEO who was in the role on the date selected to identify the median employee

The PEO's compensation used in the ratio must be calculated using the same SCT methodology as the annual total compensation reported in the proxy's Summary Compensation Table. The approach chosen must be disclosed.

Note that the rule applies to the "principal executive officer" as defined under existing SEC rules, not necessarily the person with the title "CEO." If your company's PEO is a President or Executive Chairman, that individual's compensation is what goes into the ratio.

Step 8: Apply the Three-Year Redetermination Rule

You do not need to identify a new median employee every year. The SEC's final rule permits companies to use the same median employee for up to three years, unless a change in the company's employee population or compensation arrangements would reasonably be expected to result in a significant change to the pay ratio.

If you use a previously identified median employee, you must disclose that fact and explain why you believe that individual remains an appropriate median employee.

What Triggers an Earlier Redetermination?

The SEC did not define "significant change" precisely, which creates judgment calls. Events that should prompt a reassessment include:

• A material reduction in force (mass layoffs)
• A significant acquisition that adds a large new employee population
• A major outsourcing arrangement that removes a substantial employee group
• A spin-off that separates a significant portion of the workforce
• A broad-based compensation restructuring (e.g., shifting from cash to equity for a large employee group)
• A significant geographic expansion or contraction

If any of these events occur, run a preliminary analysis to assess whether the prior median employee is still likely to be near the median. Document that analysis for your audit committee. If the answer is uncertain, redetermining is lower-risk than defending a stale median employee to SEC staff.

Step 9: Draft the Required Methodology Disclosure

The proxy disclosure must be sufficient for a reader to understand how the ratio was calculated. Per Compensation Advisory Partners' implementation guide, the disclosure must describe:

• The methodology used to identify the median employee
• Any material assumptions, adjustments (including COLA), or estimates used
• If statistical sampling was used: the sample description and methodology
• If the de minimis or data privacy exemption was used: the jurisdictions excluded and approximate employee counts
• Whether a previously identified median employee was used, and why
• The determination date used for the employee population

SEC comment letters since 2018 have consistently flagged these deficiencies:

1. Insufficient CACM description. Saying "we used a consistently applied compensation measure" without specifying what it was is not enough. Name the measure (e.g., "W-2 Box 1 wages") and explain why it reasonably reflects annual compensation for your workforce.
2. Failure to explain why the methodology is reasonable. The SEC expects a brief explanation of why the chosen approach is appropriate given your workforce structure, not just a recitation of what you did.
3. Inadequate disclosure of material assumptions. If you used estimates, annualization, or COLA, each must be disclosed as a material assumption.
4. Unclear treatment of part-time and international employees. State explicitly whether part-time employees were annualized and which non-US jurisdictions, if any, were excluded.
5. Missing median employee context. While you must not disclose personally identifiable information, the SEC has pushed back on disclosures that provide no context about the median employee's role or location.

For guidance on responding to SEC comment letters on executive compensation disclosures more broadly, see How to Respond to an SEC Comment Letter: An Annotated Example.

Step 10: Document Methodology Choices for Internal Governance

The proxy disclosure is the public output. The internal documentation is what protects you.

Your audit committee and compensation committee need a methodology memo that captures:

• The determination date selected and the rationale
• The CACM chosen, why it was selected, and why alternatives were rejected
• Whether a census or sampling was used, and if sampling, the technique, sample size, and rationale
• How non-US employees were handled (included, de minimis exclusion, or data privacy exclusion)
• Whether COLA was applied and to which jurisdictions
• Whether part-time employees were annualized
• How the median employee was identified and their compensation calculated
• Whether a previously identified median employee was used or a new determination was made
• The three-year redetermination schedule and any events that were assessed as potential triggers

This memo should be reviewed by the compensation committee before the proxy is filed. It creates the evidentiary record that supports both the proxy disclosure and any SEC staff inquiry. For AI-assisted disclosure drafting workflows that include governance checkpoints, see AI Footnote Disclosure Drafting for SEC Filings: 2026 Practitioner Walkthrough.

Supplemental Pay Ratios: When and How to Use Them

Companies may provide supplemental pay ratio figures alongside the required disclosure. This is a legitimate tool for companies whose required ratio is likely to be misread, particularly those with large part-time or international workforces.

Common supplemental disclosures include:

• A ratio excluding part-time or seasonal employees
• A ratio calculated using a different CACM to show an alternative view
• A ratio using a different geographic scope

The rules are clear: supplemental figures must be clearly identified as supplemental, must not be misleading, and must not be presented more prominently than the required ratio. Presenting a supplemental ratio that is more favorable without adequate explanation of the difference is exactly the kind of disclosure that draws SEC comment letters.

FAQ

Do we have to use the full SCT methodology to identify the median employee? No. You may use any consistently applied compensation measure (CACM) to identify the median employee. The full SCT-equivalent calculation is only required once you have identified the median employee and need to calculate that individual's annual total compensation for the disclosure.

What sample size is defensible for statistical sampling? The SEC has not prescribed a minimum. Analysis submitted during the rulemaking process showed appropriate sample sizes ranging from 81 to 1,065 employees (average 560) for a single business line or geography. The key is that the sample size and technique must be reasonable given your workforce's size, geographic distribution, and compensation structure, and must be disclosed.

How often do we need to redetermine the median employee? At most every three years, per the SEC's final rule. An earlier redetermination is required if you reasonably believe a change in your employee population or compensation arrangements would result in a significant change to the pay ratio. Document the assessment either way.

Can we exclude all non-US employees? Only if they represent 5% or less of your total worldwide workforce. If non-US employees exceed 5%, you may exclude up to 5% of total employees by selecting specific non-US jurisdictions to exclude, but you must exclude all employees from any jurisdiction you choose.

What happens if we had two CEOs during the year? You may either combine the total compensation of all individuals who served as PEO during the year, or annualize the compensation of the PEO who was in the role on the median employee determination date. Disclose which approach you used.

Can we provide a supplemental ratio that excludes part-time workers? Yes, provided it is clearly labeled as supplemental, not misleading, and not presented more prominently than the required ratio. Many companies with large part-time workforces use this to provide context for an otherwise high ratio.