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Article | Insider

SEC adopts final pay versus performance disclosure rules

By Heather Marshall , Maria Sarli , Steve Seelig and Stephen Zwicker | September 27, 2022

Companies must compile new information and start taking steps now to comply with the pay versus performance disclosure.
Executive Compensation|Ukupne nagrade

On August 25, 2022, the U.S. Securities and Exchange Commission (SEC) adopted final rules implementing the pay versus performance (PVP) requirement in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The final regulations are thematically consistent with the rules first proposed in April 2015 (with a comment period reopened in 20221), but with several modifications and clarifications.

Notably, the adopted rule incorporates the concept of “realizable pay” in measuring equity values as part of the “compensation actually paid” calculation. In addition, the required tabular list of the most important financial performance measures used by a company to link annual compensation actually paid to company performance will comprise at least three and up to seven unranked measures, changed from the proposed ranked “top five” list.

Below is a discussion of the rules, along with some immediate action steps for companies to consider.2

The PVP table

The SEC’s final rules attempt to close a gap in the existing compensation disclosure framework, which it sees as being overly prospective in nature, with different companies taking different approaches to viewing compensation paid to executives through a backward-looking lens. To fill this gap, the SEC is requiring companies to fulfill the Dodd-Frank mandate of disclosing “compensation actually paid” compared with company performance to provide investors with a more informed view of executive compensation.

The required form of the PVP table is shown below:

Pay versus performance table
Year (a) Summary compen-sation table total for PEO (b) Compensation actually paid to PEO (c) Average summary compensation table total for non-PEO NEOs (d) Average compensation actually paid to non-PEO NEOs (e) Value of initial fixed $100 investment based on
Total shareholder return (f) Peer group total shareholder return (g)
Net income (h) [Company-selected measure] (i)
  • Compensation actually paid is defined as “adjusted” summary compensation table (SCT) compensation. The adjustments involve: 1) calculating pension values as service cost and prior service cost (if any) from the company’s financial statements, and 2) determining equity award values based on the change in fair value for the year for both outstanding and vested equity (rather than at the date granted per the SCT).
  • Principal executive officer (PEO) and the average of other named executive officer (NEO) compensation appear with both SCT values (columns [b] and [d]) and compensation actually paid values (columns [c] and [e]).
  • Performance measures to be disclosed in the PVP table would be company total shareholder return (TSR) (column [f]), TSR for the company’s chosen peer group (column [g]), net income (loss) (column [h]) and a company-selected measure (column [i]). Smaller reporting companies (SRCs) need not include peer group TSR nor a company-selected measure.
  • Five years of history are required to be disclosed. SRCs must show only three years. For the first fiscal year ending after December 16, 2022, only three years of disclosure will be required (two for SRCs), then increasing by one year each year until five years are shown (three  years for SRCs).

Exempt from the disclosures would be foreign private issuers, registered investment companies and emerging growth companies.

Footnotes will be required detailing differences between SCT values and actual compensation values, in effect reflecting the key assumptions and values used in respect of the equity figures.

Companies will be required to separately tag each value disclosed in the table, block-text tag the footnote and relationship disclosure, and tag specific data points (such as quantitative amounts) within the footnote disclosures, all in Inline XBRL. The SEC believes providing real-time access to these data will create far greater transparency than requiring those users to pay data firms for executive compensation proxy data. This may indicate the SEC is considering requiring additional proxy data to be in Inline XBRL at some point in the future.

Calculating equity values

To adjust SCT compensation to PVP table actual compensation, companies will need to deduct the grant date fair value figures included in the SCT and add back (or subtract) the value of the categories of equity shown in the table below. The SEC determined that it prefers an approach that considers the values of all equity outstanding during a fiscal year, not just the equity awards that vested during the year. This is more of a running total akin to the concept of “realizable pay” that may be earned at the ultimate vesting date. This differs markedly from the proposal to report the value of equity vested for any given year, which would have been more akin to the W-2 values recognized by an executive for the year.

Following are the categories and calculation methodologies:

Calculation methodology
When granted When vested (or not) Calculation methodology
1. Granted during the covered fiscal year Remains outstanding and unvested at the end of the covered fiscal year Add the fair value calculated as of the end of the covered fiscal year
2. Granted during the covered fiscal year Vested during the fiscal year Add the fair value as of the vesting date
3. Granted during any prior fiscal year Remains outstanding and unvested as of the end of the covered fiscal year Add the change in fair value as of the end of the covered fiscal year relative to the prior fiscal year (whether positive or negative)
4. Granted during any prior fiscal year Vested during the fiscal year Add the change in fair value as of the vesting date relative to the prior fiscal year value (whether positive or negative
5. Granted during any prior fiscal year Fail to meet the applicable vesting conditions during the covered fiscal year Subtract the amount equal to the fair value at the end of the prior fiscal year

The notion of a vesting date or year-end fair value in the PVP table will be new to many companies. The SEC believes this calculation can generally be accomplished by revaluing the appropriate inputs and entering these into the existing valuation models. The assumptions used in those calculations would be disclosed via footnotes that must disclose an assumption made in the valuation of an award that differs materially from those disclosed as of the grant date of such equity awards.

For stock options, revaluations with a pricing model through the dates of vesting will be required to ensure the value of stock options appropriately recognizes their potential time value beyond the vesting date. The remeasurements will consider how the value has changed over time due to changes in the company’s stock price, as well as changes in assumptions (e.g., expected exercises, volatility rates, dividend yields and interest rates).

For performance shares without a market condition, a revaluation must take place each year of the probability the award would vest based on a year-end reassessment. The regulations make clear that footnote disclosure is required about how the assumptions used to calculate the value of equity awards at year-end may differ materially from those disclosed as of the grant date of such equity awards (on an award-by-award basis, rather than in aggregate). Companies will need to assess what disclosures they make regarding these probability expectations.

For those subject to market-based measures, similar to stock options, updated valuation models that align with those used to calculate grant date fair values must be used to determine updated fair values. For companies that are used to valuing a relative total shareholder return (RTSR) award just once at its grant date, the new disclosures will require each outstanding RTSR award to be revalued at the end of each fiscal year. The year-end measurements will consider how the value has changed over time due to actual TSR experience for the company and the peer companies, as well as changes in economic assumptions (e.g., volatility rates, dividend yields and interest rates).

Calculating pension values 

To adjust SCT compensation to PVP table actual compensation, companies will need to remove the defined benefit (DB) pension compensation included in the SCT (which is the difference between the end-of-year and beginning-of-year values from the pension benefits table, adjusted for benefit payments) and substitute a new calculation for the DB pension benefits, as follows:

  • Add the ASC 715 service cost for all DB plans for the executive for the year.
  • Add the increase or reduction in the projected benefit obligation for all DB plans for the participant for the year caused by a plan amendment made during the fiscal year (i.e., the prior service cost/credit).

For pensions, because many of the assumptions used for determining service cost and prior service cost are already included in the Form 10-K, it is not required that the assumptions be included in a footnote for the pension figures.

Company and peer TSR comparisons

The PVP table will require companies to include values for their own as well as peer TSR. While the requirements for calculating TSR are consistent with those underpinning the total return chart required in 10-Ks, companies can either use the peers from that disclosure or choose a peer comparison that is included in the compensation discussion and analysis (CD&A) for the purposes of “compensation benchmarking practices.”

As with the 10-K disclosure, this will be a spot cumulative calculation weighted by market capitalization over the five-year period rather than a smoothed average calculation on an unweighted basis as is used in most RTSR performance conditions. Also, in contrast to most TSR performance conditions, the calculation does not track percentage change, which will provide another point of departure when companies seek to provide a perspective on how this table differs from the operation of their incentive plans.

Other financial measures — a company-selected measure or measures and net income

When identifying the company-selected measure for this table, it must be the “most important financial performance measure” that is not otherwise required in the disclosed table used to link actual compensation to company performance for the most recently completed fiscal year. If TSR (absolute or relative) happens to be the most important measure, then the company must select the next most important measure (similarly for net income).

Companies can decide to add an additional measure to the table, but this will then require the additional explanatory narrative/graphical disclosure (discussed below) explaining the link between compensation actually paid and any additional measures voluntarily included. Further, if the company-selected measure changes from year to year, the narrative disclosure should describe the reasons for this change.

The PVP table will also require companies to include values for net income calculated in accordance with generally accepted accounting principles.

Narrative/graphical disclosure requirements

Companies must provide a narrative or graphical — or combination of the two — description of the relationships between executive compensation actually paid and TSR. The SEC also requires a similar comparison of compensation paid to the company TSR and peer group TSR. Finally, companies must provide a clear description of the relationship between executive compensation actually paid and both net income and the company-selected measure (or supplementary measures, if included). This must be done both for the PEO(s) and the average for all other NEOs.

These comparisons must be made over a five-year period, although they should be covered by the transitional relief, meaning that in year one only a three-year lookback is required.

“Most important” measure tabular list

In addition to deciding on the “most important” measure included in the PVP column (i), companies will have to include a tabular disclosure that details the company’s three to seven most important performance measures used to link compensation actually paid during the fiscal year to company performance, over the most recently completed fiscal year. The “most important” measure from the PVP table also is listed here.

The list can include non-financial measures only if the company has disclosed at least the three most important financial measures, defined as those in or derived from the company’s financial statements, stock price or TSR. Performance measures do not need to be ranked by relative importance and can change from year to year. This list can appear as one tabular list, as two separate tabular lists (one for the PEO and one for all other NEOs), or as separate tabular lists for the PEO and each other NEO.

While there is no requirement to do so, a company may elect to include a narrative if it would be helpful for investors. A company may also cross-reference to existing disclosures that describe how NEO compensation is calculated using these performance measures.

Location in the proxy statement

The SEC permits companies to determine where the PVP disclosure will appear, just as with other stand-alone disclosures, such as the CEO pay ratio.

Going forward

Companies should consider the following steps to prepare for the extensive changes required by the new regulations:

  • Ensure key decision makers — senior management, the compensation committee, legal, finance and investor relations — understand the details of the final rules.
  • Determine a process for identifying the most important performance measures in respect of compensation actually paid for the year.
  • Calculate compensation actually paid for the 2021 and 2020 NEOs to test the equity valuation process and calculation methodology.
  • Use the same process to perform TSR peer group back-testing using each of the permissible peer groups using 2020 and 2021 data. This can help determine an appropriate peer group to be used for the 2023 proxy and beyond.
  • Determine where you intend to locate the PVP disclosures in the proxy statement. Start early in updating the CD&A, looking for potential areas of overlap or complication (such as more prominent disclosures related to realizable or realized pay that could be confusing to investors).

The above are just the first steps. Companies should also work now to establish their timeline and required tasks to perform all the work necessary post year-end. Our key piece of advice on that front is to make sure the people tasked with doing the work have the capacity to do so. There is a lot of work to do for many of them in addition to the already heavy workload they have in preparing 10-K disclosures and then working on the proxy.


1 See “SEC proposal on more extensive ‘pay for performance’ disclosures,” Insider, March 2022.
2 For a more extensive discussion and WTW observations, see “SEC approves pay versus performance disclosure rules,” Executive Pay Memo North America, September 2022.

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