First off, I must say that I was thrilled to see so many of you last week in sunny San Diego (and boy, was it sunny in a perfect kind of way) at our 23rd Annual Conference. The Conference was a wild success and our members helped make it so. Shortly before the Conference, several news outlets carried the story of Twitter’s CEO returning a significant number of his own shares of stock to the Company for use in employee equity programs. There wasn’t time to cover it then, but I wanted to take a moment to share the story now.
In the latter part of October, Twitter CEO Jack Dorsey tweeted (of course!) that he was giving one-third (wow!) of his own shares of Twitter stock, 1% of the Company, to the organization for use in the Company’s equity pool. The value of those shares is estimated to be $200 million. While the return of stock to a company from a CEO or founder is not unprecedented, the size of Dorsey’s stock contribution marks new territory. I am hard pressed to find a CEO that has surpassed that figure.
A Way to Avoid Dilution?
Mr. Dorsey’s gift seems to be a win on multiple fronts. It’s bound to boost employee morale, since the shares are going straight to the Company’s equity pool and will be used to incentivize employees. Shareholders are likely to be happy, since the shares will reward employees without affecting the Company’s dilution figures. And, CEO Dorsey seems excited about it, tweeting “I’d rather have a smaller part of something big than a bigger part of something small.” It can’t hurt that his other company, Square, recently filed for their IPO. Forbes highlights that in an earlier, similar move, Dorsey also returned 20% of his stake in Square to employees as well.
A New Trend?
The question now becomes, will other CEOs follow suit? According to the Washington Post, Dorsey isn’t the first CEO to give shares back to employees. In their coverage of this story, they shared that “The chief executive of a Turkish food delivery company paid out $27 million to 114 employees this summer after selling the firm. In July, Bobby Frist, the nephew of former U.S. Senate Majority Leader Bill Frist, gave $1.5 million of his own shares to 600 employees of the Nashville-based health care company he runs. Dan Price, the founder of Seattle-based Gravity Payments, made headlines for using his $1 million salary (as well as company profits) to fund raises for every employee in his company to at least $70,000. In 2013, Lenovo CEO Yang Yuanqing gave $3.25 million of his $4.23 million bonus to hourly employees.” The noticeable difference in Twitter’s case is the size of the gift – shares valued at $200 million – a huge step above the other recorded cases. I’m guessing that a gift of Dorsey’s magnitude is probably not going to start a wave of similar actions (though it certainly would be nice if it did). For one thing, not all CEOs have such a wealth of stock from which to pull such a sizable donation. Founder CEOs (or simply founders) may have the advantage here, as they are often likely to have a larger stake in the company than subsequent CEOs – which makes them more able to give away a large number of shares without making much of a dent in their own personal fortune. CEO Dorsey is a billionaire, so this is a smaller drop in the bucket for him. However, the gift is not likely to be small potatoes to the employees who will benefit from receiving stock awards.
Time will tell if Mr. Dorsey’s generosity and smart thinking (giving employees more equity without increasing dilution) inspires other founders or CEOs to take similar action.
Our Executive Director, Barbara Baksa, has dedicated a couple of blogs (“CEO Pay Ratio Disclosure Rules” and “More on the CEO Pay Ratio Disclosure Rules“) to helping all of us understand the new CEO Pay Ratio disclosure rules that were adopted by the SEC last month. Although the new disclosures aren’t imminent, companies still need to prepare. The mechanics of that has already been covered here in the NASPP Blog, so today I’m going to cover some of the more philosophical aspects of the new CEO pay ratio disclosure rules.
Another in a Long Line of Changes?
We’ve seen a lot of changes to executive compensation requirements and related disclosures over the past several years. Dodd-Frank’s Say-on-Pay gave shareholders a stronger voice when it comes to executive compensation matters. Last month the SEC adopted final CEO Pay Ratio disclosure rules that essentially require public companies to disclose the ratio of CEO pay relative to the pay of a median employee. Some are wondering – is this yet another attempt to reign in executive compensation?
The Real Impact?
One question that arises from all these changes – what has the true impact been on executive compensation? Have oversized, outsized, CEO packages become a distant memory? Many experts don’t seem to think so as of yet. The question then becomes, will the new CEO pay ratio disclosure rules really do anything to right-size executive pay? One of my favorite assessments of the situation came from a New York Times article (“Why Putting a Number to C.E.O. Pay Might Bring Change“) on the subject, which quoted Charles Elson, professor of finance and director of the John L. Weinberg Center for Corporate Governance at the University of Delaware as saying,“The pay ratio was designed to inflame the employees. When they read that number, employees are going to say, ‘Why is this person getting paid so much more than me?’ I think the serious discontent will force boards to reconsider their organizations’ pay schemes.”
Shareholders have had more of a say for a while now. The latest approach seems to be to give shareholders (but really employees) a very simple number to explain how the CEO’s pay relates to that of the “median” employee – which in the employee’s case would undoubtedly cause them to compare their own pay to not only the CEO, but that of their median peer. I can see where this may lead – it’s quite possible many organizations will have incensed employees, especially those who realize their pay is below that of the median employee. In addition to preparing for the mechanics of the disclosures, companies should be thinking about how to handle the optics of the disclosure with their employees. It may be time to consider some changes to compensation programs now, in advance of the disclosure. If companies do anticipate some delicate situations as a result of the disclosure, they should craft a communication strategy well in advance. The earlier you get ahead of the curve on this one, the better. The last thing needed is a hit to employee morale.
There are no pay ratio disclosures yet, so it’s hard to tell just how large the pay ratios will be. According to the same New York Times article cited above, a 2014 study by Alyssa Davis and Lawrence Mishel at the Economic Policy Institute, a left-leaning advocacy group in Washington, showed that chief executive pay as a multiple of the typical worker’s earnings zoomed from an average of 20 times in 1965 to almost 300 in 2013.
For Some CEOs, Pay is Not the Most Important Thing
Not all CEOs need the optics of a pay ratio disclosure to evaluate the appropriateness of their compensation. Earlier this week, the CompensationStandards.com blog shared the story of a CEO who actually returned his RSU to the company, saying that “he does not believe that he should receive such an award unless Plum Creek’s stockholders see an increase in their investment return.” The estimated value of the RSU shares that were handed back to the company was about $1.85 million. From the appearance of it, the company’s board awarded the CEO a retention RSU grant. Several months later, facing tough economic times and lower than hoped company performance, the CEO approached the board and basically said he’s giving back the award because he didn’t deserve it. So clearly there are great examples of CEOs who are really focused on making sure their pay truly aligns with performance. I’d be interested to see the CEO pay ratio disclosure for that company, but we’ve still got quite a while for that – until the 2018 proxy season.
It’s not too early to start planning for the disclosure and evaluate current compensation practices and communication opportunities.
There’s a lot being said about the new CEO pay ratio disclosure rules, most of it far better than anything I could write myself, so today, as a fill in for Jenn Namazi who is on vacation, I continue my new tradition of “borrowing” other blog entries on this topic.
Today’s entry is a nifty “to do” list for preparing for the CEO pay ratio disclosure that Mike Melbinger of Winston & Strawn posted in his August 6 blog on CompensationStandards.com. Given that the disclosure isn’t required until 2018 proxy statements, you might have been lulled into thinking that this isn’t something you have to worry about yet. While it’s true that there’s no need to panic, there is a lot to do between now and 2018 and it is a good idea to start putting together a project plan now to get it all done. Don’t let this turn into another fire that you to put out. Here are Mike’s thoughts on how to get started:
1. Brief the Board and/or the Compensation Committee as to the final rules and the action steps. Press coverage of the rules has been extensive. They are likely to ask.
2. Each company may select a methodology to identify its median employee based on the company’s facts and circumstances, including total employee population, a statistical sampling of that population, or other reasonable methods. We expect that the executive compensation professionals in the accounting and consulting firms very soon will be rolling out available methodologies (they began this process when the rules were proposed, two years ago). The company will be required to describe the methodology it used to identify the median employee, and any material assumptions, adjustments (including cost-of-living adjustments), or estimates used to identify the median employee or to determine annual total compensation.
3. As I noted yesterday, the rules confirm that companies may use reasonable estimates when calculating any elements of the annual total compensation for employees other than the CEO (with disclosure). Assess your ability to calculate precisely all items of compensation or whether reasonable estimates may be appropriate for some elements. The company will be required to identify clearly any estimates it uses.
4. Begin to evaluate possible testing dates. The final rules allow a company to select a date within the last three months of its last completed fiscal year on which to determine the employee population for purposes of identifying the median employee. The company would not need to count individuals not employed on that date.
5. Consider tweaking the structure of your work-force (in connection with the selection of a testing date). The rules allow a company to omit from its calculation any employees (i) individuals employed by unaffiliated third parties, (ii) independent contractors, (iii) employees obtained in a business combination or acquisition for the fiscal year in which the transaction becomes effective. Finally, the rule allows companies to annualize the total compensation for a permanent employee who did not work for the entire year, such as a new hire. The rules prohibit companies from full-time equivalent adjustments for part-time workers or annualizing adjustments for temporary and seasonal workers when calculating the required pay ratio.
As I noted yesterday, the rules permit the company to identify its median employee once every three years, unless there has been a change in its employee population or employee compensation arrangements that would result in a significant change in the pay ratio disclosure.
6. Determine whether any of your non-U.S. employees are employed in a jurisdiction with data privacy laws that make the company unable to comply with the rule without violating those laws. The rules only allow a company to exclude employees in these countries. (The rules require a company to obtain a legal opinion on this issue.)
7. The rules only allow a company to exclude up to 5% of the company’s non-U.S. employees (including any non-U.S. employees excluded using the data privacy exemption). Consider which non-U.S. employees to exclude.
8. The rules allow companies to supplement the required disclosure with a narrative discussion or additional ratios. Any additional discussion and/or ratios would need to be clearly identified, not misleading, and not presented with greater prominence than the required pay ratio.
The rules explicitly allow companies to apply a cost-of-living adjustment to the compensation measure used to identify the median employee. The SEC acknowledged that differences in the underlying economic conditions of the countries in which companies operate will have an effect on the compensation paid to employees in those jurisdictions, and requiring companies to determine their median employee and calculate the pay ratio without permitting them to adjust for these different underlying economic conditions could result in a statistic that does not appropriately reflect the value of the compensation paid to individuals in those countries. The rules, therefore, allow companies the option to make cost-of-living adjustments to the compensation of their employees in jurisdictions other than the jurisdiction in which the CEO resides when identifying the median employee (whether using annual total compensation or any other consistently applied compensation measure), provided that the adjustment is applied to all such employees included in the calculation.
If the company chooses this option, it must describe the cost-of-living adjustments as part of its description of the methodology the company used to identify the median employee, and any material assumptions, adjustments, or estimates used to identify the median employee or to determine annual total compensation.
Companies with a substantial number of non-US employees should seriously consider the ability of apply a cost-of-living adjustment to the compensation measure used to identify the median employee.
Last week, the SEC adopted the final CEO pay ratio disclosure rules. I’ve been on vacation, so I don’t have a lot to say about them, but Broc Romanek’s blog on ten things to know about the rules is better than anything I could have written anyway, so I’m just going to repeat that here:
1. Effective Date is Not Imminent (But You Still Need to Gear Up Now): We can look forward to new “Top 10″ Lists in a couple years. Highest and lowest pay ratios. Although the rules aren’t effective until the 2018 proxy statements for calendar end companies, you still need to start gearing up, considering the optics of your ultimate disclosures. The rules do not require companies to report pay ratio disclosures until fiscal years beginning after January 1, 2017.
2. You Don’t Need to Identify a New Median Employee Every Year! This is the BIG Kahuna in the rules! A big cost-saver as the rules permit companies to identify its median employee only once every three years (unless there’s a change in employee population or employee compensation arrangements). Your still need to disclose a pay ratio every year—but you don’t have to go through the hassle of conducting a median employee cost analysis every year. During those two years when you rely on a prior-calculated median employee, your CEO pay is the variable.
3. Pick Your Employee Base Within Three Months of FYE: The rules allow companies to select a date within the last three months of its last completed fiscal year to determine their employee population for purposes of identifying the median employee (so you don’t count folks not yet employed by that date—but you can annualize the total compensation for a permanent employee who did not work for the entire year, such as a new hire).
4. Independent Contractors Aren’t Employees: Duh.
5. Part-Time Employees Can’t Be Equivalized: The rules prohibit companies from full-time equivalent adjustments for part-time workers—or annualizing adjustments for temporary and seasonal workers—when calculating pay ratios.
6. Non-US Employees & the Whole 5% Thing: For some reason, the mass media is in love with this part of the rules. The rules allow companies to exclude non-U.S. employees from the determination of its median employee in two circumstances:
– Non-U.S. employees that are employed in a jurisdiction with data privacy laws that make the company unable to comply with the rule without violating those laws. The rules require a company to obtain a legal opinion on this issue—can you say “cottage industry”!
– Up to 5% of the company’s non-U.S. employees, including any non-U.S. employees excluded using the data privacy exemption, provided that, if a company excludes any non-U.S. employee in a particular jurisdiction, it must exclude all non-U.S. employees in that jurisdiction.
7. Don’t Count New Employees From Deals (This Year): The rules allow companies to omit employees obtained in a business combination or acquisition for the fiscal year in which the transaction took place (so long as the deal is disclosed with approximate number of employees omitted.)
8. Total Comp Calculation for Employees Same as Summary Comp Table for CEO Pay: The rules state that companies must calculate the annual total compensation for its median employee using the same rules that apply to CEO compensation in the Summary Compensation Table (you may use reasonable estimates when calculating any elements of the annual total compensation for employees other than the CEO (with disclosure)).
9. Alternative Ratios & Supplemental Disclosure Permitted: Companies are permitted to supplement required disclosure with a narrative discussion or additional ratios (so long as they’re clearly identified, not misleading nor presented with greater prominence than the required ratio).
10. Register NOW for the Proxy Disclosure Preconference and August 25 Pay Ratio Workshop:Register now before the discount ends next Friday, August 21. The Proxy Disclosure Preconference will be held on October 27, in advance of the NASPP Conference in San Diego. Registration for the Proxy Disclosure Preconference also includes access to a special online Pay Ratio Workshop that will be offered on August 25. The Course Materials will include model disclosures and more. Act by Friday, August 21 to save!
Last Wednesday, the SEC proposed the last set of compensation-related rules required under Dodd-Frank: clawback policies. This is one of those things where the SEC can’t directly require companies to implement clawback provisions, so instead, they are proposing rules that would require the NYSE and NASDAQ to add the requirement to their listing standards for exchange-traded companies.
Clawback Policies
The requirements for clawback policies under Dodd-Frank are much broader than under SOX (which required misconduct and applied only to the CEO and CFO). Here’s the gist of the SEC’s Dodd-Frank proposal:
Applies to all officers (generally the same group subject to Section 16) and former officers
Clawback is triggered by any material noncompliance with financial reporting standards, regardless of whether intent, fraud, or misconduct is involved
Applies only to incentive compensation contingent on the financial results that are subject to the restatement (interestingly, this includes awards in which vesting is contingent on TSR or stock price targets)
Recoverable Amount
The amount of compensation that would be recovered is the excess of the amount paid over what the officer is entitled to based on the restated financials.
In the case of awards in which vesting is contingent on TSR or stock price targets, the company would have to estimate the impact of the error on the stock price. Which seems a little crazy to me. But I didn’t take a single math, science, economic, or business course in college so my understanding of what drives stock price performance is most charitably described as “rudimentary.” Perhaps this is more straightforward than I think.
In the case of equity awards, if the shares haven’t been sold, the company would simply recover the shares. If the shares have been sold, the company would have to recover the sale proceeds (good luck with that). If you weren’t in favor of ownership guidelines and post-vesting holding periods for executives before, this might change your mind, possession being nine-tenths of the law and all. Check out our recent webcasts on these topics (“Stock Ownership Guidelines” and “Post-Vest Holding Periods“)
Disclosures
In addition to requiring a clawback policy, the SEC has also proposed a number of disclosures related to that policy:
The policy itself would be filed with the SEC as an exhibit to Form 10-K.
Companies would be required to disclose whether a restatement that triggered recovery of compensation has occurred in the past year.
If a restatement has occurred, the company must disclose the amount of compensation recoverable as a result of the restatement and the amount of this compensation that remains unrecovered as of the end of the year. For officers for whom recoverable compensation remains outstanding for more the 180 days, the company must disclose their names and the amounts recoverable from them.
For each person for whom the company decides not to pursue recovery of compensation, the company must disclose the name of the person, the amount recoverable, and a brief description of the reason the company decided not to pursue recovery.
More Info
For more information, check out the NASPP alert on this topic. The memos from Ropes & Gray, Jenner & Block, and Covington, as well as Mike Melbinger’s blogs on CompensationStandards.com, were particularly helpful to me in writing this blog (in case you don’t want to read all 198 pages of the SEC’s proposal).
How many grant dates can one option have? The answer, as it turns out, is more than you might think. I was recently contacted by a reporter who was looking at the proxy disclosures for a public company and was convinced that the company was doing something dodgy with respect to a performance option granted to the CEO. The option was not reported in the SCT for the year in which it was granted, even though the company discussed the award in some detail in the CD&A, had reported the grant on a Form 4, and the option price was equal to the FMV on the date the board approved the grant. The reporter was convinced this was some clever new backdating scheme, or some way of getting around some sort of limit on the number of shares that could be granted (either the per-person limit in the plan for 162(m) purposes or the aggregate shares allocated to the plan).
Bifurcated Grant Dates
When I read through the proxy disclosures, I could see why the reporter was confused. The problem was that the option had several future performance periods and the compensation committee wasn’t planning to set the performance goals until the start of each period. The first performance period didn’t start until the following year.
Under ASC 718 the key terms of an award have to be mutually understood by both parties (company and award recipient) for the grant date to occur. I’m not sure why the standard requires this. I reviewed the “Basis for Conclusions” in FAS 123(R) and the FASB essentially said “because that’s the way we’ve always done it.” I’m paraphrasing—they didn’t actually say that, but that was the gist of it. Read it for yourself: paragraph B49 (in the original standard, the “Basis for Conclusions” wasn’t ported over to the Codification system).
The performance goals are most certainly a key metric. So even though the option was granted for purposes of Section 409A and any other tax purposes (the general standard to establish a grant date under the tax code is merely that the corporate action necessary to effect the grant, i.e., board approval, be completed), the option did not yet have a grant date for accounting purposes.
And the SCT looks to ASC 718 for purposes of determining the value of the option that should be reported therein. Without a grant date yet for ASC 718 purposes, the option also isn’t considered granted for purposes of the SCT. Thus, the company was right to discuss the grant in the CD&A but not report it in the SCT. (The company did explain why the grant wasn’t reported in the SCT and the explanation made perfect sense to me, but I spend an excessive amount of time thinking about accounting for stock compensation. To a layperson, who presumably has other things to do with his/her time, I could see how it was confusing and suspicious).
Trifurcated Grant Dates?
The option vested based on goals other than stock price targets, so it is interesting that the company chose to report the option on a Form 4 at the time the grant was approved by the compensation committee. Where a performance award (option or RSU) is subject to performance conditions other than a stock price target, the grant date for Section 16 purposes doesn’t occur until the performance goals are met. So the company could have waited until the options vested to file the Form 4.
If you are keeping score, that’s three different grant dates for one option:
Purpose
Grant Date
1. Tax
Approval date
2. Accounting / SCT
Date goals are determined
3. Form 4
Date goals are met
If the FASB is looking for other areas to simplify ASC 718, the determination of grant date is just about at the top of my list. While they are at it, it might nice if the SEC would take another look at the Form 4 reporting requirements, because I’m pretty sure just about everyone (other than Peter Romeo and Alan Dye, of course) is confused about them (I had to look them up).
Arguments in a recent divorce proceeding potentially cast doubt on the idea of pay-for-performance, i.e., that outsized executive compensation is justified by performance.
The Jed Clampett Defense
If this sounds familiar, it’s because we highlighted an article (“Are C.E.O.s That Talented, or Just Lucky?,” Robert Frank, Feb. 7, 2015) in the New York Times that discussed case in the Across Our Desk column in the March-April 2015 NASPP Advisor. Lawyers for the founder and CEO of Continental Resources argued that he should only have to pay a small portion of his overall wealth to his ex-wife because most of the growth in his wealth was attributable to factors outside his control. Apparently under the applicable state laws (and in the laws of a number of states), the increase in value of an asset that you owned prior to marrying is not divisible in your divorce if the increased value is not due to your own efforts.
According to the article, the CEO’s lawyers argued that “under 10 percent of his wealth was a result of skill and effort, and that mostly he rode the crest of oil prices and the slide.” The CEO’s holdings included a 68% stake in Continental Resources, which has market capitalization of over $30 billion. Essentially the argument was that, although the CEO’s wealth increased during his marriage and much of that wealth was attributable to his holdings in the company he founded and runs, the holdings increased in value through little effort of his own. He was just lucky enough to be CEO of a successful company (sort of like Jed Clampett of The Beverly Hillbillies striking it rich by finding oil in his backyard).
Pay-for-Performance?
This was interesting to me because there is so much emphasis these days on paying for performance. This emphasis has lead to a surge in the use of performance awards, which often include multipliers when the company performs well, increasing payouts to execs.
I looked up what the Continental Resources proxy said about the CEO’s compensation. The 2014 proxy included statements like: “We rely upon our judgment in making compensation decisions, after…reviewing the performance of the Company, and evaluating an NEO’s contribution to that performance…and long-term potential to enhance shareholder value,” and other statements that seemed to indicate that compensation is based, at least in part, on individual performance. So while the CEO might not have thought he contributed to the company’s success, management and the compensation committee didn’t seem to share this view.
On the other hand, the Times article notes that academic research seems to indicate that individual executives don’t necessarily have a lot of control over the success of a company:
“As we know from the research, the performance of a large firm is due primarily to things outside the control of the top executive,” said J. Scott Armstrong, a professor at the Wharton School at the University of Pennsylvania. “We call that luck. Executives freely admit this — when they encounter bad luck.”
The Ends Justify the Payouts, Even If They Aren’t the Means?
Ultimately, do shareholders care about the reason for a company’s success? I suspect that if the company is doing well and increasing shareholder wealth, they are fine with large payouts to executives even if the company’s success is not due to the efforts of executives.
As expected (and as I blogged last week), the SEC has issued a proposal for the pay-for-performance disclosure required under Dodd-Frank. Proxy disclosures aren’t really my gig, so I don’t have a lot more to say about this topic. Luckily, Mike Melbinger of Winston & Strawn provided a great bullet-point summary of the proposed disclosure in his blog on CompensationStandards.com. I’m sure he won’t mind if I “borrow” it.
The proposed rules rely on Total Shareholder Return (TSR) as the basis for reporting the relationship between executive compensation and the company’s financial performance.
Based on the explicit reference to “actually paid” in Section 14(i), the proposed rules exclude unvested stock grants and options, thus continuing the trend to reporting realized pay. Executive compensation professionals will need to sharpen their pencils to explain the relationship between these figures and those shown in the Summary Compensation Table.
For equity-based compensation, companies would use the fair market value on date of vesting, rather than estimated grant date fair market value, as used in the SCT.
The proposed rules also would require the reporting and comparison of cumulative TSR for last 5 fiscal years (with a description of the calculations).
The proposed rules would require a comparison of the company’s TSR against that of a selected peer group.
The proposed rules would require separate reporting for the CEO and the others NEOs—allowing use of an average figure for the other NEOs.
The proposed rules would require disclosure in an interactive data format—XBRL.
Compensation actually paid would not include the actuarial value of pension benefits not earned during the applicable year.
The proposed rules would phase in of the disclosure requirements. For example, in the first year for which the requirements are applicable [2018?], disclosure would be required for the last 3 years only.
The proposed rules exclude foreign private issuers and emerging growth companies, but not smaller reporting companies. However, the proposed rules would phase in the reporting requirements for smaller companies, require only three years of cumulative reporting, and not require reporting amounts attributable to pensions or a comparison to peer group TSR.
A Few More Thoughts
In the NASPP’s last Domestic Stock Plan Design Survey (co-sponsored by Deloitte Consulting), usage of TSR targets for performance awards increased to 43% of respondents. With this new disclosure requirement, will even more companies jump on the TSR-bandwagon?
At least there’s one bit of good news: the disclosure covers only the NEOs, not a broader group of officers as was originally feared.
More Information
To learn more about the proposed regs, check out our NASPP alert, which includes a number of practitioner memos. The memo from Pay Governance includes a nifty table comparing the SEC’s definition of “actual” pay to the SCT definition of pay, traditional definitions of realized and realizable pay, and the ISS definition of pay.
It’s beginning to look this is going to be the year of Dodd-Frank rulemaking at the SEC. We may have the CEO pay-ratio disclosure rules by the end of the year, the SEC recently proposed rules for hedging policy disclosures, and now the SEC appears poised to propose the pay-for-performance disclosure rules this week.
Readers will recall that Dodd-Frank requires the SEC to promulgate rules requiring public companies to disclose how executive compensation related to company financial performance (see my blog entry, “Beyond Say-on-Pay,” August 5, 2010). In his April 24 blog on TheCorporateCounsel.net, Broc Romanek noted that the SEC has calendared an open Commission meeting for this Wednesday, April 29, to propose the new rules.
Broc’s Eight Cents
Broc offered eight points of analysis on this disclosure:
1. Companies can get the data and crunch the numbers. I don’t think that the actual implementation itself will be difficult.
2. But I think what could be particularly worrisome is having yet another metric to figure out what the CEO got paid and trying to explain all of it.
3. You know how companies have different schemes for granting equity, including type and timing. If the rules tend to try to fit everyone into a narrow bucket in order to try to line everyone up for comparability, and a company’s program doesn’t quite fit neatly into it, then the disclosure can get even more complicated.
4. There are two elements: compensation and financial performance. What is meant by “financial performance” for example? Maybe the SEC will just ask for stock price, maybe they’ll go broader.
5. A tricky part likely will be the explanation of what it all means—and how it works with the Summary Compensation Table.
6. I don’t think it will be difficult to produce the “math” showing the relationship of realized/realizable pay relative to TSR and other financial metrics, so long as:
– There’s a tight definition of realized pay
– We know what period to measure TSR (and if multiple periods can be used)
– We know what other performance measures can be included (if any) and if they can be as prominent in the disclosure as TSR
7. Another area of potential difficulty is explaining why there is not a tight or tighter correlation with TSR (“we use metrics other than TSR to drive our compensation; thus, the correlation is not very strong; on the other hand, our compensation is based on Revenue Growth and EBITDA Margin, and as Exhibit II demonstrates, the correlation is very significant”).
In addition, Dodd-Frank has no requirement for a relative ranking, and companies will need to decide if TSR and Pay should be put in some type of relative context (“relative to our peers, our realizable pay was well below the peers; so even though compensation is not tightly aligned with stock price performance the last 3 years, we did not pay our bums very much).
8. I think what may be the most difficult to address is a requirement to discuss what the Compensation Committee plans to change—and why is it now that it has performed the analysis?
Let’s Make It a Dime; Here’s My Two Cents
I’m not sure that the problem with executive compensation is that companies aren’t disclosing enough information about it. Isn’t this what the CD&A is for? Isn’t this why the stock performance graph is included with the executive compensation disclosures?
Moreover, does anyone think that any company will just come out and say that their executive compensation is not based on or tied to company performance in any way? I’m just not sure that public companies need one more disclosure to try to convince their shareholders that the amount of compensation they are paying to their executives is justified by the company’s performance.