Checking another item off its Dodd-Frank to-do list, the Securities and Exchange Commission on Wednesday proposed new executive compensation disclosure requirements. The pay-versus-performance proposal, gestating for more than five years, calls upon all public companies to disclose the relationship between the compensation paid to named executive officers and its relationship to both the total shareholder return of the company and that of its peer group.

Notably, the proposal would require companies to provide information in XBRL (eXtensible Business Reporting Language), an interactive data format. “Requiring the disclosure in interactive data format could increase the comparability and usefulness of the disclosures,” SEC Chair Mary Jo White said prior to the 3-2 vote by the Commission (Commissioners Daniel Gallagher and Michael Piwowar voted in the negative). It is the first time that the SEC will require data tagging of information in the XBRL format outside of financial statements.

The disclosures, covering a five-year period, are intended to provide shareholders a new metric for assessing a company’s executive compensation relative to its financial performance. The new rules will require disclosure of “actual pay” for named executive officers versus total shareholder return over a 5-year period. The starting point for the calculations is a company’s Summary Compensation Table and Total Shareholder Return metrics. The proposal does allow companies some flexibility (narrative or graphics) in how they present their pay-versus-performance relationship and supplement their disclosure to reflect their specific situation.

Companies will be required to disclose in a proxy or information statement a table that includes, for each of the company’s last five years:

 • The executive compensation actually paid to the company’s principal executive officer and separately, as an average, the compensation paid to the other named executive officers;

• The financial performance of the company and, in addition, either a recognizable industry or line-of-business index and/or an identified peer group, calculated by using cumulative total shareholder return;

• For comparison purposes, the summary compensation data that is already disclosed under current rules for the principal executive officer and the other named executive officers.[15]

The proposal requires pay-versus-performance disclosure for all companies other than foreign private issuers, registered investment companies, and emerging growth companies, which are statutorily exempted from the requirement. Smaller reporting companies would be subject to the requirements, but the proposal includes scaled disclosure demands, some of which will be phased-in over time.

Commissioner Dan Gallagher had a philosophical concern with the proposal in that it pulls SEC resources away from work that would otherwise be a priority. “The Division of Corporation Finance has much important work to do on top of its day-to-day duties, including its review of corporate disclosure requirements and hopefully someday a much-needed review of the shareholder proposal system,” he said. “The last thing we need is to spend precious time thrusting ourselves into corporate governance matters best left to state law.”

Gallagher also thinks the proposal should have “pursued a more rational,” less prescriptive approach.

 “’Pay’ is defined in detail, with specified adjustments to existing, prescriptive compensation disclosures we mandate, to reach a calculation of ‘compensation actually paid.’ It is dubious whether that’s the most meaningful definition for every company across the board,” he said.

Also, the rule would require disclosures to be provided regarding all named executive officers. “But disclosures for named executive officers other than the principal executive officer may be unnecessary, given that the compensation ‘tone’ for top executives is typically set by the principal executive officer’s compensation,” Gallagher said.

The use of Total Shareholder Return also raised concern. “As a stock price-based measure, TSR may be gamed by any of the usual corporate strategies for boosting stock prices in the short term—for example, cutting spending on R&D projects to inflate net profit, or focusing resources on a corporate strategy that pays off in year three, at the expense of year one with a much larger payoff in year,” Gallagher said. “The Commission’s chosen metric risks exacerbating the current overemphasis on short-term performance at the expense of long-term shareholder value creation.”

“Today’s pay-versus-performance proposed rules go to the heart of good corporate governance,” Commissioner Luis Aguilar countered. “A company’s executive compensation practices can demonstrate whether senior management will be held accountable for their performance. When it comes to executive pay, shareholders benefit when good performance is rewarded, and when poor performance is not.”

 

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