No matter how many rules regulators come up with to rein in exorbitant executive compensation, at least some corporate leaders are doing everything in their power to expand their personal coffers even as stock prices and company performance falter. Two new surveys show that companies are finding ways to skirt laws requiring full disclosure of the performance goals on which executive salary and bonuses are paid, while also continuing to issue heaps of tax-deferred nonqualified retirement options–a benefit that the Internal Revenue Service (IRS) has been fighting to eliminate through less favorable tax treatment. In a recent study by Watson Wyatt International Inc., 33% of 135 legal, compensation and human resources professionals claimed they had no plans to spell out executive performance goals–as directed by the Securities and Exchange Commission (SEC) –in their 2008 proxies for fiscal 2007. Only 42% said they would even take a crack at it. The rest checked unsure.
While the clamor over executive compensation is not new, the noise is growing louder as some executives continue to reap bundles of money even as the fortunes of their companies and shareholders flounder. That's where the SEC's insistence on performance goals is supposed to come into play. If an executive doesn't meet specific, clearly defined corporate goals, his pay is supposed to be moderated.
A loophole, however, makes disclosure requirements subjective, according to consultants interviewed for this story. The dodge is that companies that don't want to reveal this information can insist that, by so doing, they will disclose competitive secrets. The SEC hasn't defined "competitive harm" or explained how it will review such arguments. But company compensation committees could be wrong in thinking that they can get around the requirements in this, the second year for which performance goals are to be issued.
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"It might be hard to show that a company's competitive stance will be hurt, says Steve Van Putten, Watson Wyatt's executive compensation practice leader. That's especially true since the assessment goals aren't published until the fiscal year has ended, making them old news by the time the proxy comes out–belatedly revealing any corporate secrets. "But companies might say it will give their competitors' numbers than can be extrapolated to provide more up-to-date performance goals for the coming year," says Van Putten.
Corporations can glean SEC strategy from an analysis of 300 letters the agency sent out after 2007 proxies were filed asking companies for more and clearer performance goal information. While none may warrant a restatement of either the proxy or the company's 2007 10-K, they suggest a significant gap between what the SEC expected and what was filed, according to a Watson Wyatt analysis. Even companies that did not receive a letter should consider the comments relevant for future disclosures.
Many of the letters from the SEC to corporate executives asked for inclusion of a list of companies defined to be in a filer's peer group; more detail about the data used to decide each element of compensation–salary, annual incentives and long-term incentives; percentiles at which each element of compensation was targeted vs. peer and/or survey data, and that the information should be presented in plain English that any investor can understand.
Two principle themes emerged from an analysis of 2007 proxy statements, according to John White, SEC corporation finance division director, who is following industry cooperation–or not–in this area. Companies should provide more focused disclosure of how and why they made specific executive compensation decisions and they must explain it in "a more direct, specific, clear and understandable executive compensation disclosure," White has said.
"The SEC has put significant pressure on companies to disclose their goals so shareholders can determine if programs are paying for performance," says Ira Kay, Watson Wyatt global director of executive compensation consulting. "However, companies are [undecided] about whether to disclose this information."
Corporations are clinging to traditional methods of rewarding executives in other ways, as well. In a recent survey of 80 employers by Buck Consultants, 95% said they will retain their nonqualified defined contribution (DC) plans and 89% said they would retain their nonqualified defined benefit (DB) plans following clarification of Internal Revenue Service (IRS) code 409A. The rule sets out to change the ways such plans are governed. While not outright banning tax-deferred plans, the IRS hopes by changing the way in which they are introduced last year to change the way such plans are governed, they could use tax laws to avoid abuses, such as those in the Enron scandal.
IRS ruling 409A would have prohibited Enron executives from withdrawing millions in funds from deferred compensation programs in November of 2001, a scant two weeks before the notorious Dec. 2 bankruptcy filing. For the less pernicious, adjusting withdrawal dates could merely reflect an executive's desire to withdraw funds for a child's college education or, perhaps, when the tax benefits make withdrawal in one year more appealing than in another year. "409A eliminated the role of discretion in accelerated payment," says Robert Alpern, a principal at compensation consultant Frederic W. Cook & Co.
The new interpretation specifies that notice must be given literally six years in advance of on any unscheduled payout. "It doesn't eliminate these tax-deferred plans," says Alpern. "But in sum and substance, it makes them less attractive." Especially since the executive will have to pay an additional 20% penalty if the rules are violated.
Companies told Buck Consultants that they plan to abide by the rules, while seeking methods to continue the practice of offering benefits they deem necessary to attract top talent. One vehicle used by 30% of the responding companies is splitting the plans into two parts to take advantage of grandfathering provisions in the final rules. "Benefits vested as of Dec. 31, 2004 are grandfathered into the old deferred compensation rules," says David Wax, principal in Buck Consultants' talent management and rewards strategy practice.
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