The Securities and Exchange Commission has proposed rules to implement the Dodd-Frank Act’s requirement that companies disclose how the pay of their top executives compares with the company’s performance, setting off another compliance effort for public companies.
The SEC’s proposal would require companies to add a table in their proxy statements that includes the total compensation for the CEO, as reported in the proxy’s Summary Compensation Table, as well as another measure showing the CEO’s “actual pay,” which is the total compensation with adjustments made to reflect pensions and equity awards.
The proposed table would also include an average of the total compensation of the company’s other named executive officers, an average of those executives’ actual pay, the company’s cumulative total shareholder return (TSR), and the cumulative TSR of a peer group of companies. After a transition period, companies would be required to report all those statistics for each of the latest five years, with smaller companies required to provide just three years of data.
Below the table, the company would be required to describe the relationship between its executives’ pay and its total shareholder return, and between its total shareholder return and the TSR of its peer group. The SEC’s proposal suggests the explanation could take the form of a graphic or a narrative.
Steve Seelig, senior regulatory advisor for executive compensation at consulting company Towers Watson, said that while the proposed rules don’t require companies to gather additional information, “each company is going to have a number of difficult decisions to make about what the best way will be to present that information.”
One key decision involves the peer group of companies whose TSR the company includes in the table, Seelig said. When companies decide on a peer group, they need to consider not only what would work in the current year, but what would work in coming years, he said.
Deborah Lifshey, a managing director at Pearl Meyer & Partners, a compensation consulting company, said the new disclosures will involve “a good deal of cost” for companies.
For large accelerated filers, the proposed table involves “two years more of data—five years instead of three years,” she said.
In addition, companies will have to revalue their options, “and that’s not a small task,” said Lifshey, pictured at left. “There are many layers of review and a lot of assumptions that go into it.”
The SEC’s proposed rules have arrived five years after Dodd-Frank was enacted. Lifshey said that while few companies were making disclosures about the relationship between pay and performance back in 2010, since then say-on-pay votes and proxy advisors’ assessments of companies’ compensation packages have focused attention on the issue.
As a result, many companies have started to provide a discussion of the relationship between executive pay and company performance in the proxy, she said. “It’s not in any one specific format, but over the years this discussion has blossomed and it’s really quite good for most companies.”
The SEC’s proposal would “rein in” that discussion, Lifshey said. She described the proposed disclosure rules as “one-size-fits-all” and argued that they will make it hard for companies to show “their true pay for performance theme.”
TSR vs. Other Pay Metrics
For starters, while the SEC has staked its pay for performance comparison to total shareholder return, that’s not the key measure used in most companies’ compensation programs.
Seelig said companies are more likely to link executives’ pay to the company’s revenue or some other measure. “Congress certainly thought TSR was a really great way of measuring performance, but it’s absolutely not the way most executive pay programs are structured, at least for the bulk of the pay the executives receive.”
Lifshey suggested that the SEC’s use of total shareholder return in the pay for performance disclosure might lead some companies to switch to using TSR more heavily, or even exclusively, in their compensation programs, in place of other metrics they’re currently using to link pay to long-term strategy and success.
“We think TSR is an important measure and aligns short-term with returns to shareholders, but it shouldn’t be the only measure,” she said.
Meanwhile, the proposed table in corporate proxies would likely display “a lot of noise,” reflecting the turnover among named executive officers and CEOs, Lifshey said.
For example, in a year when the company gets a new CEO, its CEO pay could include a retirement package granted to the departing executive and a signing bonus for the new CEO. “You’re going to get big outliers in the data,” she said.
Pearl Meyer & Partners recommends that companies use “realizable pay”—which values equity grants at the end of the pay period, rather than the grant date—instead of the SEC’s “actual pay,” and show a three-year aggregate of all compensation along with a three-year cumulative total shareholder return, she said.
Companies are free to provide more explanation below the proposed table, but Lifshey noted that the focus is likely to be on the numbers in the table, which will be tagged in XBRL. Analysts will pull the tagged data and analyze it, she said. “Whether they look at the supplemental data, you don’t really know.”
Pearl Meyer & Partners has also suggested that companies be allowed to incorporate into the proposed table other metrics that they regard as important to their performance, and tag those numbers just as they’re tagging total shareholder return, Lifshey said. “While you can still have the information in the supplemental disclosure, we think it can get lost there.”
One of the big questions regarding pay for performance is the possible effect on companies’ say-on-pay votes.
Seelig, at right, argued that the new disclosures wouldn’t make much difference for institutional investors, who have developed sophisticated analyses of executive compensation.
“Where it is going to become a big issue isn’t with shareholder votes but with popular opinion and how the press interprets these numbers,” Seelig said. “It is going to be readily apparent to the press that this company has good alignment and this company does not, simply by looking at the tables and comparing those disclosures to what others provide.”
And companies may soon have even more on their plate. Seelig noted “rumblings” that the SEC will soon finalize regulations regarding CEO pay ratios and Dodd-Frank-compliant clawbacks. The additional rules would “create a lot more work for our clients in their proxy presentations,” he said. “It’s exciting times in the executive comp world.”