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Article | Executive Pay Memo North America

SEC approves pay versus performance disclosure rules

Effective for fiscal years ending on/after December 16, 2022 

By Heather Marshall , Steve Seelig , Stephen Zwicker and Maria Sarli | September 7, 2022

Companies must compile new information to comply with the pay versus performance disclosure.
Executive Compensation

On August 25, 2022, the Securities and Exchange Commission (SEC) adopted final rules implementing the pay versus performance (PVP) requirement in the Dodd-Frank Act. First proposed in April 2015, with the comment period reopened in 2022, the final rules remain thematically consistent while adopting several modifications and helpful clarifications. The biggest surprise is the SEC’s embrace of the concept of “realizable pay” for measuring equity values as part of the “compensation actually paid” calculation. The SEC also amended its proposal so the new Tabular List would comprise, on an unranked basis, at least three and up to seven most important financial performance measures used by the company to link compensation actually paid for the year to company performance, rather than a “top five” ranked list as previously proposed.

Companies have a lot of work ahead of them to prepare for this initial disclosure, from marshalling the internal resources needed to perform the actual calculations to making key strategic decisions as to the content and location of the disclosure. With the concept of pay for performance now redefined by a common set of rules to be followed by all companies, it is likely the compensation discussion and analysis (CD&A) and its executive summary will warrant at least a revamp, if not a rethinking of existing pay for performance disclosures. An overarching question will be the best location in the proxy statement for including this new disclosure, which need not appear with the other executive compensation disclosures, while considering how the company already makes its case in the CD&A that it pays for performance.

Below we provide an extensive discussion of the rules, along with our observations of issues to confront and resolve. To start, we list some immediate action steps that will help set your focus on the extensive work that needs to be done:

Suggested immediate action steps
  1. Acquaint the key decision makers with the details of the rules. Senior management, the compensation committee, legal, finance and investor relations will all have a role to play in making strategic and tactical decisions, and then in populating the tables.
  2. Have each of those groups identify who will be responsible for which aspects of the disclosure, and make sure they have the bandwidth to accomplish each task required within the required timeline.
  3. Determine a process for identifying the most important performance measures in respect of compensation actually paid for the year based on the weighted relevance of performance measures for 2022 actual compensation.
  4. Calculate compensation actually paid for anticipated named executive officers (NEOs) in respect of 2021 and 2020 as best you can. Given that calculation of equity fair values under the current rules was not required for those years, now may be a good time to perform those calculations rather than waiting until later in the process. This will serve as a good test of the equity valuation process and calculation methodology.
  5. The same process can be used to perform total shareholder return (TSR) peer group back-testing using each of the permissible peer groups using 2020 and 2021 data. This can help influence the decision as to an appropriate peer group to be used for the 2023 proxy and beyond. If you have an RTSR performance condition, for example applicable to the vesting of performance share units, it is also advisable to compare the outcome under the plan calculation methodology with the outcome under the SEC PVP methodology in case this yields significantly different values.
  6. Secure space in the proxy statement and determine where you intend to locate the PVP disclosures. 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).
How to complete the PVP table

It is worthwhile to understand the gap seen by the SEC in the existing compensation disclosure framework. The SEC sees the existing compensation disclosure as overly prospective in nature with different companies taking different approaches, if any, in viewing compensation paid to executives with a backward-looking lens. The SEC wanted to fill this gap by 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. Whether or not the SEC has chosen the best way to depict the notion of PVP will remain an open question; reasonable minds can differ. But our experience has been that once a particular disclosure is created, it tends to become generally accepted as the favored standard.

The required form of the PVP table is shown below:

Please use the scroll bar below to see all columns
Year (a) Summary compensation 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 One Net Income (h) Company-selected Measure (i)
Total Shareholder Return (f) Peer Group Total Shareholder Return (g)

  • 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 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 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.

As noted, SRC have reduced reporting requirements while foreign private issuers, registered investment companies and emerging growth companies are exempt from the disclosure requirements.

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. For companies with multiple overlapping equity grants or multiple pension plans, these footnotes could be quite extensive.

For equity awards, footnotes 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. 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. This will mean that shareholders, competitors and consultants will have direct access to the data provided with relative ease, to the extent they have experience with Inline XBRL SEC filings. Real-time access to these data will create far greater transparency than requiring those users to pay data firms for executive compensation proxy data.

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

As with all disclosures that have been mandated over the years, the question will arise as to whether this extensive disclosure about how pay programs work may lead to similar companies adopting more homogenous pay program designs to avoid increased scrutiny as potential outliers.

Calculating pension values

To determine actual compensation, 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 (i.e., the prior service cost/credit) for all DB plans for the participant for the year caused by a plan amendment made during the fiscal year.

Observations: Rising interest rates during 2022 may mean that many SCT pension values for the year will be $0, because the present value of accumulated DB pension benefits may be lower at the end of 2022 than at the end of 2021. If the plan is not frozen, however, there would still be a benefit accruing during the year, and therefore a service cost, resulting in a pension value being included in the PVP table actual compensation figures. In years where interest rates are more stable, the PVP table actual compensation figures will likely be lower than the SCT values since interest on the beginning-of-year SCT values or changes in pension benefits due to actual compensation during the year will not be included.

Calculating equity values

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.

These 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 at 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 at 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
Calculating a vesting date fair value

While we are all familiar with the notion of grant date fair values as currently contemplated in the SCT, the notion of a vesting date or year-end fair value will be new to many. For stock options, an annual revaluation will be required, as opposed to performing that valuation only once at grant date. One reason cited by the SEC for requiring an annual revaluation is to ensure the value of stock options appropriately recognizes their potential value beyond the vesting date.

The SEC believes this calculation will be reasonably uncomplicated and can generally be accomplished by reevaluating the appropriate inputs and entering these into the existing valuation models. The assumptions used in those calculations would be disclosed via footnotes. While conceptually straightforward, it will increase the number of valuations required and the number of assumptions (e.g., expected lives, dividend yields and volatility rates), particularly for companies with misaligned vesting dates. Importantly, companies will need to carefully assess how the expected life will change over time as the options move in or out of the money.

Another reason for the change cited by the SEC is to enable shareholders to better tabulate the outstanding values of all in-flight full-value grants so that shareholders and compensation committees can monitor all the equity compensation on the table for executives. On this last point, because the PVP disclosure now becomes a part of the say on pay vote (which is based on any compensation disclosures in the proxy), which means compensation committees should be obligated to understand the full value that can be realized, when measured for the prior fiscal year, as it makes decisions on compensation levels to grant for the upcoming year.

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 exercise will be a bit complicated in that 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). The SEC believes this requirement to reassess these probable outcomes should provide insight into the company’s evaluation, which will be something new for investors to ponder. This will be a level of transparency not otherwise required, either in the proxy statement or the 10-K, as we believe updated probability factors will be required for each performance-based equity award that remained outstanding or vested during the year. It is likely companies will have heightened sensitivity to this point.

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. This is a significant increase in the number of valuations that need to be prepared annually. 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).

Observations: It is time to start figuring out who will be able to perform these analyses, whether within the company or with outside help, as soon as possible. There will be a finite amount of time to perform these calculations after year-end, at a time when these valuation resources already are very busy working on other things, including valuations of new grants for the current year. So many nuances are involved in performing these calculations, some of which have never been done before, including determining new assumptions to be applied to prior year grants, that waiting until after year-end to think through how they work will be problematic. We strongly suggest that companies value grants for the prior two fiscal years that will be required in the first year of disclosure now. Starting those early will enable a tested process to be established and give early insight into what the numbers might look like and, as a result, how easy (or otherwise) it might be to develop a compelling narrative.

There is also the question about what footnotes will be required to be attached to the tables to identify material changes in assumptions, with one example being how much detail must be included to inform readers when the probability of goal attainment for equity performance conditions changes. This should be discussed with experts on the accounting side and with SEC counsel, something else we would advise happen sooner than later. Finally, your finance department and SEC counsel will need to think about whether the information created for these tables and footnotes, which does not appear on the Form 10-K, will need to be reviewed by outside auditors. Our amateur view is that because those data will be tagged in Online XBRL language, making it very easy for shareholders and competitors to find, companies will want some form of review before it is published in the proxy given what could be inferred about future financial performance.

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 are consistent with those underpinning the stock price chart required in 10-Ks, companies are permitted the ability to opt for a different peer comparison — namely one that is included in the CD&A for the purposes of “compensation benchmarking practices.” For those not familiar, the 10-K stock price chart simply shows cumulative TSR based on the value of an initial $100 investment, calculated on a spot basis as of the last trading day of each of the fiscal years being reported on. The peer TSR must be weighted according to the respective constituents’ market capitalization at the beginning of each period, which adds a degree of complexity if a custom group is being used.

This will be a spot cumulative calculation over the five-year period rather than a smoothed average calculation 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. One thing not clear from the instructions is whether a peer group that is based on “compensation benchmarking practices” means that companies can select the peer group from their RTSR plan for the cumulative TSR calculation; in our experience, the TSR peer group often differs from the compensation benchmarking peer group, even if only slightly. Further, if a peer group changes from the prior fiscal year, a footnote must explain the reasons for the change and compare the company’s cumulative total return with both the newly selected peer group and the peer group for the prior year.

Observations: Determining the peer group to use will be the first challenge for companies. Using the peer group already included in the 10-K reduces the need for additional work and should be a broadly relevant external reference. Even so, how those peers compare with those used for target pay benchmarking (or RTSR plans if different) purposes will likely inform whether it works in the PVP context. The more difficult decision may be in figuring out whether the compensation peer group is more relevant than the one used to determine payouts based on RTSR performance for performance-based equity awards.

Given the subtle (but potentially material) differences in calculation methodology between what’s required in the PVP table and how RTSR performance measures are typically defined (spot versus smoothed, and weighted by market cap versus unweighted), one may find that even a RTSR peer group shows weaker correlation than expected (e.g., TSR above the peer group median but below the value of an initial $100 investment in the broader index).

Our argument would be that TSR performance peers are potentially a more relevant comparator than target pay benchmarking peers, if different. Under the rules, changes in the peer group from year to year will require companies to make comparisons to both the new and old peer group, increasing the disclosure requirements materially. We understand this may compel companies to think about selecting a broad market index to mitigate against that disclosure complexity, but we are by no means certain that would be the best approach.

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

The PVP table will require companies to include values for net income calculated in accordance with generally accepted accounting principles (the SEC dispensed with the proposed regulation notion that pre-tax net income also must be shown as duplicative), and a company-selected measure. When identifying the company-selected measure, 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 explaining the link between compensation actually paid and any additional measures voluntarily included. Further, if the company-selected measure changes from year to year, comparisons must be made to both the new and former measure (in the narrative).

“Most important” measure tabular list

In addition to deciding on the “most important” measure, which must be 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. This is a change from the proposed regulation that would require the determination to be made over the prior five years.

Tabular list - "Most Important" Measure
"Most Important" Measure Tabular List
Measure (1)
Measure (2)
Measure (3)
Measure 4 - 7 as determined

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. If fewer than three financial performance measures were used by the company, all such measures used must be included in the tabular list. These can change from year to year without the need to offer an explanation, although we expect companies would want to do so in many cases. 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 NEOs.

Unlike the PVP table, there is no descriptive narrative/graphical requirement for this table that requires companies to describe how the measure is calculated; however, a company may elect to include a narrative if it would be helpful for investors to understand the selected measures or if needed to prevent the disclosure from being confusing or misleading. A company may also cross-reference to existing disclosures that describe how NEO compensation is calculated using these performance measures.

The required “company-selected measure” in PVP table, column (i) must be included in this list given it itself is derived from the list in the first place.

Observations: There is an important interplay between the PVP table and the “most important measures” table that will require a good deal of thought and modeling before any decisions are made. There are various schools of thought as to how best to get to an answer that will satisfy all parties, but companies must make sure they are able to make strategic decisions about how to move forward without getting bogged down in the process.

We encourage companies to talk through the rules with key decision makers from management and the compensation committee to get a sense of where the disclosure should be headed. For example, all parties should be able to agree on such items as the most important financial measure early in the process. Some companies also may be able to determine the top three to seven measures by way of a discussion. Others may feel comfortable making this decision only after they see the relative weighting of measures for all awards counted in the table before making this decision. The degree of change over time in performance measures, complexity of plan design, and personalities of key decision makers will be important determinants in what approach makes the most sense for each company. At the end of the day, the most important measure (and broader list) should be defensible and appear logical to an independent reader.

We would also encourage a discussion about where the disclosure should appear in the proxy, although we understand this decision may change as management and the compensation committee get more information. Careful thought should be given to how this backward-looking table will compare with any currently used or planned performance measures and how, in aggregate, these tie back to a company’s evolving strategy, and how this is succinctly addressed in the proxy in a compelling manner.

Companies should consider preparing pro forma tabular disclosures using third-quarter financial data so they can begin to understand what these disclosures might look like. This also could include developing the narrative/graphical disclosures to accompany those tables, as a dry run to understand how these could be depicted in the proxy. Having those sample disclosures available could be very helpful in deciding where the PVP disclosure will appear in the proxy.

The narrative/graphical disclosure requirements

After the determination of how the PVP table will be presented with the required and selected financial measures, companies will need to decide what presentation will follow. Companies must provide a narrative or graphical — or combination of the two — description of the relationships between executive compensation actually paid and its TSR. This is required, according to the SEC, to meet the statutory requirement that companies disclose the “relationship” between executive compensation and company performance. 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.

The SEC even suggested an approach, both for the TSR comparison and for that of the other financial measures on the table: “The required relationship disclosure could include, for example, a graph providing executive compensation actually paid and change in the financial performance measure(s) (TSR, net income, or Company-Selected Measure) on parallel axes and plotting compensation and such measure(s) over the required time period. Alternatively, the required relationship disclosure could include narrative or tabular disclosure showing the percentage change over each year of the required time period in both executive compensation actually paid and the financial performance measure(s) together with a brief discussion of how those changes are related.”

These comparisons are required to 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.

Where to put this in the proxy statement?

Because this is a stand-alone disclosure required in a separate section of the SEC regulations, the SEC permits companies the flexibility to determine where the PVP disclosure will appear, just as with other stand-alone disclosures, such as the CEO pay ratio.

Companies may choose to embed the PVP disclosure within the CD&A as a standalone section, and there is likely value in addressing the highlights in any relevant executive summaries, whether for the proxy as a whole or the CD&A more specifically. Given the potential lengthy footnotes, consideration of relative placement versus other important content will be a challenging decision.

Observations: Placement of the disclosure requires a good deal of consideration. If a company decides to maintain a stand-alone PVP section of the proxy, it will then need to determine how detailed that discussion will be and the extent to which permitted cross-references will be used. Using numerous cross-references could make the disclosure itself unwieldy and repetitive; using more could annoy readers.

This decision also may be influenced by whether the company decides to use graphical versus narrative disclosures. Companies that use graphical disclosures — as many now have in executive summaries or stand-alone pay for performance sections — find them to be a useful resource that visually makes their case when shown in a prominent place. It may be that those companies would want to show the new required disclosures in the same place. That doesn’t necessarily mean that all explanations will be graphical instead of narrative for the PVP disclosure, but a decision to stay the course for these companies would seem to make sense. There are myriad other approaches to consider based on a company’s unique facts.


Senior Director, Executive Compensation and Board Advisory (New York)
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Senior Director, Executive Compensation

Senior Director, Retirement
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U.S. Retirement Resource Actuary

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