Is the corporate governance pendulum swinging back? Well, not quite. While the pace of reform has inevitably slowed, corporate governance reform still has plenty of momentum left. One example: the SEC’s new proposal on executive compensation disclosure. Unveiled in a January speech by SEC chairman Christopher Cox, it’s the most sweeping overhaul of executive compensation disclosure rules in more than a decade.
Critics have been clamoring for more detailed disclosure, and Cox has called the existing rules ‘out of date’. Adding further impetus are the courtroom dramas playing out with overpaid executives center stage. Executive compensation has been at the forefront of many high-profile cases, most notably at the NYSE and Tyco International.
If adopted, the proposed rules would most likely go into effect for the 2007 proxy season. Among the proposals: refine existing tabular disclosure; expand perquisites to cover anything above $10,000; and provide improved narrative disclosure, known as the ‘compensation discussion and analysis’ – a management discussion and analysis (MD&A) for compensation. Disclosures would cover the CEO, the CFO and the three other highest-paid executive officers, as well as directors (see Highlights of the SEC proposal, below).
‘Up until now, the information provided has been on a high level in table format with lots of footnotes,’ explains Michael Sferratore, content specialist at Reuters. ‘Tables are easy to follow, but the footnotes vary and the level of disclosure is different from company to company. Overall, the proposal is another means of offering transparency to investors. We’ve seen such enhanced transparency in stock option expensing, and we may see it with the improved pension cost disclosure that the Financial Accounting Standards Board (FASB) is working on.’
Reuters already tracks executive compensation as part of its product offering, and Sferratore says the firm will adjust its collection process to take advantage of changes in disclosure. ‘Overall, pay should be tied to performance, and this makes that relationship easier to evaluate. Often we read about compensation after a scandal, so being proactive and illustrating to investors what the board has chosen for compensation is important.’
Immediate impact
The SEC issued an interpretive release on perks as part of the new proposal, and US companies are meant to start following it immediately. A few are even going ahead with some enhanced compensation disclosure in anticipation of next year’s new rules. But most are taking a wait-and-see approach while the SEC gathers comments on the proposal. ‘We’re waiting to find out what the final rule, if passed, looks like. We’re also on a March 31 fiscal year, so we put our proxy together after the peak season,’ says Charles Triano, VP of IR at Forest Laboratories.
While much of the focus has been on the content of the proposed new disclosure, there’s a great deal to be said for the way in which the SEC plans to change the form as well. As with other initiatives, this comes back to ‘simplification’ or a move toward plain English.
Addison, a New York-based design company that focuses on corporate literature, has been working to help companies simplify MD&As, particularly through the use of plain English, which the SEC has noted is lacking in many reports. ‘The SEC is not just suggesting a chart of top execs and what they’ve made in the last three years. They’re also saying they want what basically amounts to an MD&A on executive compensation. They want you to look back and say what the rationale was for the compensation and discuss stock options, for example,’ explains Elliott Saltzman, managing director of annual reports at Addison.
To fulfill the requirements of the rules, assuming the proposal is passed, companies will have to address the issue of ‘simplification’. Saltzman notes two parts to this process. ‘There’s the plain English aspect, and there’s the second half: the design and layout of the information,’ he says. ‘So we look at what appear to be the most important aspects of the information. Figures and dates can often be put into a chart – you may have a paragraph that really should just be a chart because it’s all numbers. It’s a good way to make disclosure clearer.’
Then what?
The big question for executives getting ready to bare all is what investors will do with the information. Some investors have never paid it much attention, but some do – a lot.
Christopher Wiles, senior director for large-cap core and growth equity management at Allegiant Funds, says he has always reviewed executive compensation as part of his analysis of companies. ‘It only becomes an issue relative to performance and ownership structure. You have guys who have founded firms who take little compensation given their stake in the company, and you have those who are underperforming making several million a year.’
Wiles says any additional disclosure is welcome, and the proposal would be an improvement. Executives will have to show perks, for example, which usually didn’t get shown before. ‘I’m not sure of how significant that will be, however, given that most abuses are in the dollar numbers. A corporate jet isn’t going to add much to that overall dollar value. An extra $2 mn in options – that’s another story.’
In the UK, executive compensation disclosure is already far ahead of the US. In fact, the SEC’s proposal doesn’t even call for the same level of detail on options grants as in the UK.
‘There has always been a good deal more attention paid to executive compensation by institutions here in the UK compared to the US,’ says Carol Inman, assistant company secretary at BG Group. Her company files a Form 20F (annual report for foreign issuers) with the SEC, and like other foreign issuers she’s keen to see the SEC’s final rule. But she doesn’t expect any major changes in BG Group’s disclosure considering the already strict UK requirements.
‘Our remuneration report is put together by the group company secretariat and human resources,’ Inman explains. ‘We publish it on our web site and try to use the same format each year. The report is about five to six pages on policy and also contains tables detailing remuneration and share interests for all directors. Additionally, this year’s annual report will include disclosure of remuneration of key management personnel as a group, as required by international financial reporting standards.’
Aiming higher
The most significant difference between the SEC’s proposed rule and the current UK requirements is that UK investors get to vote on executive pay – and this is exactly what activists are pushing for in the US. ‘The voting component is the part that’s missing,’ says Richard Ferlauto, director of pension and benefit policy for the American Federation of State, County and Municipal Employees (Afscme), a union for government workers. ‘What the SEC is doing is necessary but not sufficient for shareholders. We want to see a mechanism not only for seeing what’s happening, but also for communicating back to boards.’
Indeed, Ferlauto says Afscme is already filing proxy proposals on this very issue. ‘We’re filing proposals on a company-specific basis that would establish that requirement. It’s the first time we’re doing it this year. As for the current SEC proposal, which we support, I would hope there’s enough shareholder momentum behind it to be passed as is without any watering down.’
Canada is another indicator of how the executive compensation debate could proceed in the US. IROs there have already been feeling the heat from activist investors seeking more executive compensation disclosure. ‘We have very detailed executive compensation disclosure, which we enhanced even further this year,’ says Nabanita Merchant, senior VP of IR at Royal Bank of Canada. ‘We added new charts on the compensation of the CEO and named executive officers to provide greater clarity. And we’ve made it even easier to reconcile between calendar year and fiscal year in terms of performance. Investors have been asking for this, so we’ve had some positive comments about the new disclosure from the buy side.’
At Sun Life Financial, the company’s new disclosure, which is in line with the SEC proposal, includes a total compensation table for the top executives that takes each component into account, including options as well as annual pension costs. The disclosure includes three years of history.
‘It’s what investors have been asking for,’ says Louise McLaren, VP of human resources at Sun Life. ‘Investors are looking at how they can relate compensation to performance. One of the things that is being discussed in Canada is coming up with a common measurement for compensation, a ratio that can be used across companies. We had a proposal from a shareholder to do this, and we worked with them to come up with the measure. We’ve put something in that equates the aggregate compensation of the top nine people with the net income of the company as a percentage, and we show it for the last five years. But investors won’t have a broader context unless other companies offer that measure, too. So we’re working with others to do that.’
Highlights of the SEC proposal
- A new compensation discussion and analysis to replace the compensation committee report.
- Executive compensation in three categories: compensation over the last three years; holdings of outstanding equity-related interests received as compensation that are the source of future gains; and retirement plans and other post-employment payments and benefits.
- A reorganized summary compensation table including a new column for total compensation and a dollar value for all stock-based awards, measured at grant-date fair value (computed according to FAS 123R).
- The threshold for any given perk would be reduced to $10,000. More importantly, guidance is provided to determine just what counts as a perk.
- Two supplemental tables would report grants of performance-based awards and grants of all other equity awards.
- Other developments: tables for outstanding equity interests, retirement plans, post-employment and so on; a director compensation table similar to the summary compensation table; and changes to the 8K disclosure requirements, including consolidation of all 8K disclosure regarding employment arrangements under a single item.
