SEC Is Set to Propose New Rules on Executive Compensation
Proposal makes it easier for investors to determine whether pay aligns with a firm’s financial results
By: Andrew Ackerman and Joann S. Lublin
WASHINGTON—Securities regulators want publicly traded companies to make it easier for shareholders to determine whether top executives’ compensation is aligned with the firm’s financial performance.
On Wednesday, the Securities and Exchange Commission is set to propose long-awaited rules that would force thousands of companies to tell investors how the pay of top management tracked the firm’s financial results.
The proposal, a requirement of the 2010 Dodd-Frank financial law, marks the latest attempt to strengthen investors’ ability to understand—and challenge—companies over their executive-pay practices. The SEC has previously greenlighted so-called “say-on-pay” votes that require companies to put executive-compensation packages up to a nonbinding shareholder vote at least once every three years.
Wednesday’s proposal aims to give investors greater clarity about the link between what corporate executives are paid each year compared to total shareholder return—the annual change in stock price plus reinvested dividends, according to people familiar with the measure. Weak links between executive pay and financial performance may increase popular outcry about overpaid bosses, compensation consultants said.
If finalized, companies would have to include a new table in their annual proxy filings disclosing top executives’ “actual pay.” That is a new figure based on total compensation companies already calculate for their five highest-paid executives, though it would exclude certain components of compensation that officers don’t actually take home, such as share grants that have yet to vest, people familiar with the matter said.
The new disclosures are expected to also include descriptive language explaining how actual pay is tied to “total shareholder return,” which companies are already required to disclose in proxies. The SEC would require pay-for-performance disclosures for a period of up to five years, people familiar with the proposal said. Companies would have to provide actual pay for their chief executives but could provide an average figure for other top executives, these people said.
Michael Kesner, who heads the executive compensation practice at Deloitte Consulting LLP, said the rules are a “game-changer” that would provide uniformity in an area that is “pretty much a free-for-all in terms of what gets disclosed and when it gets disclosed.”
“It will actually bring a true discipline to this disclosure,” he said.
Establishing consistent pay-for-performance metrics could also pressure companies to change their practices if they lag behind peers. The disclosure gives the public “much more opportunity to be critical of the disconnect between pay and performance,’’ said Steven Seelig, a senior regulatory adviser for Towers Watson & Co., a human-resources consultancy. “There will be negative implications for [some] companies.’’
SEC Chairman Mary Jo White has made tackling executive-compensation rules a priority, though progress has been slow. The agency proposed related rules in 2013 that would require companies to disclose the pay gap between CEOs and their employees, though the U.S. agency isn’t expected to finalize that controversial measure until at least the second half of the year.
The SEC and other regulators are also designing rules to curb compensation packages at Wall Street firms that encourage excessive risk taking, The Wall Street Journal reported earlier this year. The rules may include requirements that certain employees at financial firms hand back bonuses for egregious blunders or fraud as part of incentive compensation rules also required by Dodd-Frank.
Wednesday’s proposal is seen as less contentious than the 2013 pay-ratio idea, in part because the requirement is related to company performance. In contrast, Republican SEC commissioners and business groups say the pay ratio is designed to shame chief executives and is unrelated to a company’s bottom line.
“We are going to have to see what the details of the proposal are, but conceptually this is a disclosure that could be useful for investors and businesses alike,” said Tom Quaadman, vice president of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, of the pay-for-performance plan.
The expected required inclusion of total compensation along with “actual pay” in a new table won praise from Brandon Rees, deputy director of the AFL-CIO’s Office of Investment. “The total compensation figure is important to investors,’’ he said. But Mr. Rees worries the “actual pay” figure may cause confusion if it omits equity grants that haven’t vested.
SEC commissioners would have to vote on the proposed rule a second time before it takes effect. But the pay-for-performance disclosure “could be effective as early as the 2016 proxy season,” said Timothy J. Bartl, president of the Center on Executive Compensation, an advocacy group of human-resources chiefs of major companies.
Though the rules will provide greater uniformity in the kinds of pay-for-performance disclosures companies make, some pay consultants said it’s unlikely they will alter how sophisticated institutional investors vote during advisory votes on executive pay.
That’s partly because a number of big businesses already voluntarily tell investors about connections between their financial performance and “realized pay.” Realized pay counts annual and long-term incentives earned plus the value of vested awards and stock option exercises, according to Towers Watson.
In a proxy analysis of Fortune 500 companies last year, Towers Watson found 27% had pay-for-performance disclosures—and 10% of that group used realized pay as their measure.
“These rules will provide a little conformity and bring all the laggards in” that currently don’t divulge pay-for-performance links, predicted Mark Borges, a principal at Compensia Inc., an executive-pay consulting boutique.