SEC proposal on more extensive ‘pay for performance’ disclosures

The Securities and Exchange Commission (SEC) recently reopened the comment period for its previously issued proposal that would expand what companies include in their “pay versus performance” disclosures under the Dodd-Frank Wall Street Reform Act of 2010. This action expanded on its 2015 proposal and would require an extensive tabular disclosure of the performance measures that are most important to companies. This may prompt companies to reassess how they present the details of their pay programs in their compensation discussion and analysis (CD&A) for the 2023 proxy, as a more uniform, required table common to all companies may make CD&As less relevant to shareholders.

Under the recent proposal, public companies would need to provide a tabular disclosure of “compensation actually paid” to their CEOs/named executive officers (NEOs) compared with absolute and relative total shareholder return (TSR) as well as the generally accepted accounting principles (GAAP) metrics of “pre-tax net income” and “net income,” plus a “company-selected measure” that represents the “most important performance measure used by the registrant to link compensation actually paid during the fiscal year to company performance.”

Further, the SEC is considering requiring a tabular disclosure listing the five most important performance measures that drove “compensation actually paid.”

Comments on the proposal are due on or before March 4, 2022; therefore, it is possible that calendar-year companies will need to include this disclosure on their 2023 proxy.

Background

In 2006, the SEC revised how executive pay would be presented on company proxies by requiring a single depiction of CEO/CFO/NEO pay as Total Compensation on the Summary Compensation Table (SCT). Rather than create a new regime for determining pay, the SEC instructed companies to value cash compensation as amounts earned during the year (roughly akin to FICA wages); for equity and pensions, it would look to existing GAAP measures of compensation. Equity grants would be shown on the SCT at the full grant date ASC 718 (FAS 123R, at the time) value, not spreading the value over the vesting/performance period as per the required presentation on company financial statements.

One downside was that showing the full grant date value of equity almost always would be a different value than the executives ultimately received, and many companies were left to explain that fact to shareholders and then demonstrate they paid for performance. Within a few years, many companies added a CD&A pay for performance presentation of “realizable pay” or “pay realized” compared with absolute and/or relative TSR to better reflect the true value of the compensation granted to executives. Over time, these presentations became an expected part of CD&As.

Dodd-Frank was enacted in 2010, mandating that the SEC require proxy disclosure of “information that shows the relationship between executive compensation actually paid and the financial performance of the issuer, taking into account any change in the value of the shares of stock and dividends of the issuer and any distributions.” However, the SEC did not propose regulations for this disclosure until 2015 when it sought a tabular disclosure that compared CEO and average NEO SCT compensation (with some adjustments) and compensation “actually paid” to both absolute and relative TSR, over a five-year period.

How to complete the table

Below are details on how to complete the proposed table. The 2015 proposal includes extensive descriptions of how the mechanics of each of these calculations will work. The final regulations are expected to provide even more guidance.

Proposed table (a) – (e)

Proposed table (f) – (j)

• Compensation actually paid would continue to be defined as SCT compensation, excluding changes in pension value, with a different manner of valuing pensions and with the value of equity awards at vesting rather than when granted.
• CEO and the average of other NEO compensation would appear with both SCT values (columns [b] and [d]) and compensation actually paid values (columns [c] and [e]).
• Performance measures to be disclosed, in what we will call the “Pay vs. Performance Table,” would be the company TSR (column [f]); the TSR of the company’s peer group, as chosen by the company (column [g]); pre-tax net income (loss) (column [h]); net income (loss) (column [i]); and a company-selected measure.
• Five years of history would be required to be disclosed on the table. Small reporting companies must show only three years. Exempt from the disclosures would be foreign private issuers, registered investment companies and emerging growth companies.
• The five most important performance measures that drove compensation actually paid, in a separate tabular disclosure titled “Five Most Important Company Performance Measures for Determining NEO Compensation.” We call this the “Top 5 Table.”

Proposed Top 5 Table

Proposed adjustment to executive compensation disclosure

The new Pay vs. Performance Table, if mandated, will present both tactical and strategic considerations for companies:

• Selecting a measure for the Pay vs. Performance Table in year one. The proposal would require a disclosure of any measure the company selects, although the SEC has not yet finalized whether this measure needs to be one that is used to determine executive pay. This selection must be made carefully, as whatever is selected as “most important” is going to drive shareholder perceptions of company success, at least as it pertains to executive pay.
• Pay program and disclosure changes in year two and beyond. The SEC has not yet determined how frequently companies will be allowed to change the disclosure of their “most important” measure. Because executive pay programs can change from one year to the next, the SEC will need to clarify the rules for how companies that switch measures would present their five-year history. In the longer term, these new disclosure rules will provide shareholders, proxy advisors and other stakeholders more data to analyze how different pay plans overperform and underperform compared with those of peers.
• A new Top 5 Table. This would present a company’s chosen measures in an easy-to-follow, single disclosure with cross-references to those other sections of the proxy where more description is provided. The SEC will need to clarify whether this single disclosure mixes CEO pay measures with those for other NEOs. Companies will need to carefully consider which metrics to include in their Top 5. Commissioners have indicated wanting to see a focus on environmental, social and governance (ESG) measures, and shareholders may view the absence of ESG measures in this table negatively if they are included in those of peer companies.
• Existing proxy depictions of pay for performance. Companies will need to revisit existing proxy depictions as well as how the proxy’s executive summary is written. They will need to decide if the Pay vs. Performance Table will become the de facto standard by which they can demonstrate pay for performance, or if it would make sense to have several depictions, including their current realized or realizable pay disclosures.

Immediate action steps

Companies can begin taking steps now to start planning for the disclosure requirements:

• Model the Pay vs. Performance Table for 2021 based on the proposal. This will prove a useful exercise, both in understanding how the rules will work and in anticipating how to determine the “most important” measure. This model should include the five-year history as well.
• Create a Top 5 Table. List the five most important company performance measures for determining NEO compensation. The proposed rules would require cross-references to where those measures are discussed elsewhere, so charting those in advance could be helpful.
• Start thinking about existing pay for performance depictions. Identify and discuss with advisors the challenges in assimilating existing pay for performance disclosures with this new pay versus performance tabular disclosure.

Authors

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Gary Chase

Director, Retirement and Executive Compensation

email Email phone +1 212 309 3802

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Steve Seelig

Senior Director, Executive Compensation

email Email phone +1 703 258 7623

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