From the SEC: Please Link Executive Pay to Performance

untitledSleep well sweet Prince, or perhaps Emperor. We now send executive compensation to its inevitable peaceful and infinite slumber. Shown brightly for a few decades, your glory days are over.  April 29, 2015 was officially the beginning of the end of soaring executive pay. The SEC proposed a new rule on executive pay for performance, pursuant to the requirements laid out in Section 953(a) of Dodd Frank, that will change everything we know. Essentially, the rule can be summarized thusly: “You must disclose how your executives are paid relative to company and peer performance.” With this rule, it is obvious that companies will no longer be able to justify executive pay at the levels of the past decade or more.

Who am I kidding? The new rule will just make it easier for all of your shareholders to know what your more engaged and advanced shareholders already know. Do you pay your executives in a way that aligns with total shareholder return for a three to five year period? It is an important thing to know, but it is not earth shaking new information, or even the most important metric for some companies or their shareholders.

Ok. Now that the fireworks have concluded, let’s get back to reality. The proposed new rule has several parts. I will summarize them and discuss their potential impact below.

1)     There will be a new table in the proxy. The table will show the following:

  • Compensation reported in the Summary Compensation Table (SCT) and the amounts “actually paid”(I) to the principal executive officer. Basically, this will be the information from the SCT that already exists, with some added information for the change in value to pensions and equity. Equity and pension adjustments will be shown in another new table.
  • Same values, averaged for the remaining NEOs (Named Executive Officers)
  • Companies’ TSR (total shareholder return) on an annual basis for the past five fiscal years (or three years for smaller companies).
  • The TSR for companies’ peer group for the same periods (smaller companies will avoid this for now).

2)     Companies will be required to, “describe the relationship between the executive compensation actually paid and the company’s TSR and the relationship between the company’s TSR and the TSR of its selected peer group. This disclosure could be described as a narrative, graphically, or a combination of the two.

(I) Amounts actually paid will be the amounts from the SCT with adjustments for changes to pension and equity value. Pension amounts would be adjusted by deducting the change in pension value reflected in that table and adding back the actuarially determined service cost for services rendered by the executive during the applicable year. Equity amounts will be considered “actually paid” on the date of vesting, using the Fair Value (usually Black-Scholes Value for options or Intrinsic Value for full value awards) calculated on that date.

What’s this mean to you?

1)     Private companies.  It means very little. Maybe several years from now some of this will trickle down, but for now this may be another advantage of staying private.

2)     Smaller public companies. First, look here to see if you qualify. If so, you will have at least a couple of years to transition. Even then some of the most onerous stuff won’t apply to you.

3)     The rest of public companies. You will still have some time to transition, but you also have 60 days to submit a comment letter.  Will creating, managing and communicating a peer group for this be difficult? Let the SEC know. Do you think the amount “actually paid” is a reasonable method for valuing compensation? If not, send the SEC a comment letter.

4)     Do you calculate TSR differently than the SEC? If so, how will you communicate the different methods to your executives, or will you change your plan(s) definition(s) for future periods?

  • (The SEC 201(e) calculation for TSR is “measured by dividing the sum of the cumulative amount of dividends for the measurement period, assuming dividend reinvestment, and the difference between the registrant’s share price at the end and the beginning of the measurement period; by the share price at the beginning of the measurement period.)

5)     Are their peer groups your peer groups? It is pretty unlikely these groups will be the same. We don’t yet know if this rule will impact the peer groups that companies use for their actual plan design and pay comparisons. We do know that many companies are unlikely to agree with the peer groups that may be provided.

 

So, this is an important update. How will this change the way your company looks at executive compensation (if at all)?

P.S. The full text (all 129 pages) of the SCE proposal can be found here: http://www.sec.gov/rules/proposed/2015/34-74835.pdf

Dan Walter is the President and CEO of Performensation a firm committed to aligning pay with company strategy and culture. Do you want to be a better business leader? “Everything You Do in COMPENSATION IS COMMUNICATION” was written by 3/8th’s of the Comp Café, Dan Walter, Ann Bares and Margaret O’Hanlon. It’s a practical guide to improving the communication process (with how-to worksheets). Dan has also co-authored of several other books you may find useful including “The Decision Makers Guide to Equity Compensation”and “Equity Alternatives.” Dan welcomes connections on LinkedIn. Follow him on Twitter at @Performensation and @SayOnPay.