On April 29, 2015, the U.S. Securities and Exchange Commission (SEC) voted 3-2 to propose new rules (Release No. 34-74835) that would require certain publicly held companies to disclose the relationship between the compensation “actually paid” to Named Executive Officers (NEOs) and the company’s financial performance.
These proposed “Pay versus Performance” rules are based on the requirements of Section 953(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. It is estimated the rules would affect about 6,000 corporations across the country.
According to the SEC statement announcing the proposal, the rules “would provide greater transparency and allow shareholders to be better informed when they vote to elect directors and in connection with advisory votes on executive compensation.” SEC Chair Mary Jo White stated, “These proposed rules would better inform shareholders and give them a new metric for assessing a company’s executive compensation relative to its financial performance. The proposal would require enhanced disclosure that can be compared across companies.
Major Elements of the Pay Versus Performance Proposal
Based on this proposal, companies would be required to provide the following information in their annual proxy statements:
- Total executive compensation of the CEO, and the average of the total compensation of the other NEOs, as reported in the already required Summary Compensation Table;
- Executive compensation “actually paid” to the CEO, and the average of the executive compensation “actually paid” to the other NEOs, calculated according to the proposed rules,
- The company’s cumulative total shareholder return (TSR*); and
- The company’s peer group cumulative total shareholder return (TSR*).
Large companies (those with more than $75 million in public float, or shares in the hands of public investors) would be required to disclose this information for their five most recently completed fiscal years, while smaller companies would be required to disclose this information for their three most recent fiscal years. Emerging growth companies, foreign private issuers and registered investment companies would be exempt from the new disclosure requirement. Smaller companies would also not be required to present a peer group TSR*.
Disclosing executive compensation “actually paid” will involve the following changes to existing regulations:
First, the grant date fair value of equity awards would be removed, and the fair value of equity awards that vested during the relevant year would be added. Fair value for this purpose would be determined under the applicable accounting standards. If any previously vested equity awards have been materially modified, any incremental fair value resulting from the modification would need to be added as well.
Second, the change in pension value would be removed, and only the “service cost” of defined benefit and actuarial pension plans for the year would be added back. This is intended to exclude the effects of changes in interest rates, the executive’s age, and other actuarial inputs and assumptions regarding benefits accrued in previous years.
For a company’s chief executive officer (CEO), information must be presented separately, whereas for the remaining NEOs, the amount disclosed need only be the average compensation paid to those executives.
Using the values of actual pay, as determined and disclosed in a newly required a table, companies would need to describe:
- The relationship between the executive compensation “actually paid” and the company’s TSR, and
- The relationship between the company’s TSR and the TSR of its peer group. .
If companies believe supplemental disclosures would provide useful information about the relationship between the compensation paid and the company’s financial performance they would be allowed to supplement the proposed new disclosure by providing pay-versus-performance disclosure based on other compensation measures, such as “realized pay” or “realizable pay.
In selecting its peer group for purposes of this disclosure, a company could either use its peer group as defined for its stock performance graph, or the peer group used in its Compensation Discussion and Analysis (CD&A) for benchmarking compensation practices.
The new disclosure would have to be tagged in interactive data format using eXtensible Business Reporting Language (XBRL). This would be the first time the SEC requires XBRL tagging outside of financial statements.
What’s Next for the Pay Versus Performance Proposal?
The proposed rule was published in the Federal Register on May 7, 2015. Comments are being accepted until July 6, 2015 at the SEC website and at regulations.gov. The initial time it took for the SEC to propose Pay Versus Performance disclosure rules, the divided SEC vote, and public comments received so far, indicate the degree of difficulty in implementing such rules.
Extensive feedback is anticipated until July 6. Additionally, while enhanced transparency is anticipated from this proposed rule, it is not clear what effect it may have on the levels of executive compensation. Some experts are already debating whether disclosing executives’ actual pay on a consistent basis will result in executives’ demands for even higher pay.
* Total Shareholder Return (TSR) is measured by dividing the sum of the cumulative amount of dividends for the measurement period, assuming dividend reinvestment, and the difference between the company’s share price at the end and the beginning of the measurement period, by the share price at the beginning of the measurement period.