When the U.S. Securities and Exchange Commission (SEC) adopted final rules implementing the pay versus performance (PVP) requirement in the Dodd-Frank Act last August, considerable uncertainty was generated around how the new calculations and disclosures would unfold. The rules apply to fiscal years ending on or after December 16, 2022, meaning companies that use a calendar year as their fiscal year were required to include the new PVP disclosure in their 2023 proxy statements.
While the SEC’s Compliance & Disclosure Interpretations (CD&Is) released in February clarified certain aspects of the rule, a number of questions remain, leading to differences in how companies approached the disclosure in its inaugural year.
With a critical mass of proxy statements from year one now available for analysis, a broad consensus on disclosure practices has emerged. WTW reviewed the disclosures of nearly 600 S&P 1500 companies that filed on or before March 31, 2023. In general, practices among this year’s sample aligned closely with those from a smaller sample of early filers reviewed in March 2022 (see “Early trends in pay versus performance disclosures”). We highlight the preliminary trends revealed in the analysis below.
Most companies are using the same industry index that’s used in the 10-K total return chart. For full filers (i.e., those not subject to the lesser Smaller Reporting Company rules), the PVP table must include cumulative TSR comparisons for a company-selected peer group. This peer group must either be one used for the 10-K performance graph (other than broad market indices) or one disclosed in the Compensation Discussion and Analysis (CD&A) that is used to help determine executive pay. Initial interpretations had widely understood the rule to limit the CD&A peer group options to those used for “benchmarking” pay levels, but the CD&Is clarified that a broader interpretation was possible. Given that a footnote must be included with additional cumulative TSR calculations for peer group changes, many companies were inclined to select an index managed by a third party, which relieves the company of the burden of footnoting additional TSR calculations for peer group changes. It is not uncommon for compensation peer groups to change subtly from one year to the next. This appears to be playing out, with over 75% of companies selecting an industry or line-of-business index for peer comparisons (Figure 1).
Source: 598 S&P 1500 companies that filed a proxy or PRE-14A on or before March 31, 2023.
Some form of profit or income is the most common company-selected measure. Full filers are required to include a company-selected measure in the PVP table, which is defined as the most important financial measure in linking compensation actually paid (CAP) to company performance in the most recently completed fiscal year. It can’t be a measure that already appears on the table (i.e., TSR and net income, calculated on a generally accepted accounting principles [GAAP] basis), and a company is permitted to omit this column if no such measure exists.
Source: 598 S&P 1500 companies that filed a proxy or PRE-14A on or before March 31, 2023.
A wide range of financial measures have been selected, with profit- and income-based measures representing over 60% (Figure 2). Among those, measures based on earnings per share (EPS) are most common, followed by other earnings measures such as earnings before interest, taxes, depreciation and amortization (EBITDA) and earnings before interest and taxes (EBIT). These findings track with studies of incentive measures disclosed in CD&As as well as WTW surveys on annual and long-term incentive (LTI) design. One exception is that the prevalence of TSR measures in LTI plans is relatively high in the market, but given that TSR is already required, including it again as the company-selected measure would have been duplicative (even if the incentive plan measure was somewhat different from absolute TSR as the rule required).
Some companies included growth measures (which inherently compare current year to prior year performance), with rare examples of three-year measures (likely prepared prior to the CD&Is being issued). Most companies are reporting absolute numbers or ratios, probably because the CD&Is confirmed that company-selected measures must be selected annually. Additionally, very few companies are including supplemental columns with other measures.
Compensation actually paid (CAP) tends to track with TSR and is more volatile than summary compensation table (SCT) pay. CAP values tracked slightly higher than SCT pay in 2020, well above SCT in 2021 and materially lower than SCT in 2022.
Unsurprisingly, a wide range of CAP figures were reported, with values from minus $300 million to over $800 million for principal executive officers (PEOs) in this sample. Almost 25% of companies reported at least one negative CAP figure in their PVP table. Figure 3 shows median S&P 1500 CEO pay tracked versus S&P 1500 index TSR over the three-year period.
CAP values are heavily influenced by stock price movements and, in the case of performance-based awards, the assumed or actual level of performance achievement. Accordingly, years where stock prices and/or performance expectations fall relative to the prior year can result in the reporting of some of these large negative figures. While negative values may not require much explanation for this first year of filing, companies may wish to explain exceptionally high figures as representing compensation that has not yet been “earned” or “realized” by an executive where that is in fact the case. Numbers may simply reflect that an outstanding and unvested value has increased during the year, and for awards that continue to remain unvested and outstanding, those values will change again.
Most companies disclosed a single tabular list featuring three to five measures; the inclusion of non-financial measures is uncommon. In addition to the company-selected measure, full filers are required to include a tabular list of the three to seven most important measures in linking CAP to company performance during the year. The first three most important measures must be financial in nature; if a company has fewer than three, then it must list all of them. Companies may include multiple lists — separate lists for the PEO(s) and non-PEO named executive officers (NEOs) — or separate lists for each NEO, if deemed appropriate.
Source: 598 S&P 1500 companies that filed a proxy or PRE-14A on or before March 31, 2023.
We find most companies are including three to five measures in their tabular list (Figure 4). Most companies in the sample would have been required to disclose at least three measures, as they have at least three financial measures between their annual and LTI plans. While the SEC might have hoped the tabular list would encourage companies to disclose more non-financial measures — environmental, social and governance (ESG) measures in particular — we find disclosures of non-financial measures to be limited, both in terms of the number of companies disclosing any such measures and the number disclosing more than one. In fact, almost 80% of companies are only including financial measures. When non-financial measures are included, they often do relate to ESG — most typically safety as well as diversity, equity and inclusion — perhaps in line with the SEC’s push. Many companies direct the reader to the CD&A for additional details on the measures included in their tabular lists rather than including any supplementary disclosure in the PVP section of the proxy statement.
Almost all companies (97%) have included only a single tabular list. This is perhaps not surprising given that, for most companies, the “most important” measures as defined in the rule will be those used in equity-based incentive plans, which are generally consistent across all NEOs. Even in annual incentive plans where more metric differentiation is observed, you often find that measures that vary by NEO will roll up into consistent measures across the NEO population (e.g., segment NEOs being measured against segment revenue, corporate NEOs being measured against corporate revenue), so the tabular list simply includes “revenue” as the listed measure that applies to all.
Almost all companies are including the PVP section alongside the CEO pay ratio following the compensation tables and utilize graphs to describe relationships. The rules permit companies to determine where in the proxy statement to include the disclosure and provide flexibility in how companies explain the relationship between the CAP and performance columns of the PVP table. Most companies have included the PVP disclosure as a stand-alone part of the proxy statement, most typically located alongside the CEO pay ratio. There is very limited evidence of companies including any disclosure in their CD&A, beyond pointing to the PVP section elsewhere in the proxy statement.
Slightly more variance can be found in how companies are explaining the pay and performance relationships. A fundamental aspect of the rule is that companies must clearly describe the relationship between CAP and performance measures in the table (TSR, GAAP net income and the company-selected measure). The guidance in the rules suggests that companies may approach this graphically or narratively.
Source: 598 S&P 1500 companies that filed a proxy or PRE-14A on or before March 31, 2023.
As Figure 5 shows, most companies have elected to use graphical descriptions of the relationship between CAP performance. A small minority (less than 5%) have chosen also to include SCT pay on the charts, presumably to demonstrate how CAP differs. The movement between these two columns is often correlated with the performance measure trajectory, as that can affect how fair values change during the PVP measurement period versus those computed on a grant date basis. Very few companies are relying solely on narrative, with some using graphs alongside varying degrees of narrative explanation.
Most companies are providing a detailed reconciliation from SCT to CAP, but detailed equity valuation assumptions are notably absent. Perhaps the area of most variance has been the supporting footnotes. While several footnote requirements are featured in the rules, the most burdensome relates to discussing adjustments from SCT to CAP, including the various equity component adjustments, and equity valuation assumptions that differ materially from those at the date of grant.
Since the SEC issued its CD&Is, we have seen an increase in companies providing a full reconciliation of the SCT to CAP adjustments, inclusive of the component equity adjustments. Over 90% of the filings analyzed included these reconciliations, either in tabular or narrative footnotes. For clarity, this means providing details on each of the required equity calculations as set out in paragraph (v)(2)(iii)(C)(1)(i)-(iv). We expect this will continue and become the norm given the CD&Is plainly clarified what is expected.
In contrast, very few companies have provided any details on the equity valuation assumptions, an area that the CD&Is were notably silent on. The rule states that “for the value of equity awards added pursuant to paragraph (v)(2)(iii)(C) of this section, disclose in a footnote to the table required by paragraph (v)(1) of this section any assumption made in the valuation that differs materially from those disclosed as of the grant date of such equity awards.”
Most companies are simply stating that measurement date fair values required for PVP purposes have been calculated in a manner consistent with those for grant date purposes (a requirement under paragraph (v)(C)(3)), with some cross-referencing to the form 10-K grant date valuation assumptions. Only around 11% of companies are including details on specific fair values, assumed payout factors or underlying assumptions specific to their CAP calculations. In the absence of any further CD&Is from the SEC, this precedent will likely hold, provided companies are comfortable they are complying with the requirements of the rule.
While some companies will reshape or expand their PVP disclosures in year two, we expect most companies to follow the emerging market standard practices through the rest of 2023 and into 2024. Companies should stay abreast of any additional guidance or comment letters from the SEC as well as the potential for PVP-related changes in proxy advisor policies for 2024.
