Disclosure of Pay versus Performance: SEC's Finalized Rules

April 19, 2023
Daily digest

The business world just got a bit more transparent, thanks to the SEC's adoption of the final Pay versus Performance Disclosure rules! Companies now have to openly report the relationship between their executives' compensation and company performance. This new rule, a critical component of the Dodd-Frank Wall Street Reform and Consumer Protection Act, has everyone talking. Let's dive into the vibrant details of these regulations.

The Securities and Exchange Commission (SEC) has announced the adoption of final rules for the disclosure of pay versus performance. The rules require public companies to disclose the relationship between executive compensation and company performance in the annual proxy statement. This information will help shareholders better understand how executive pay aligns with company performance over time.

The final rules provide flexibility for companies to choose from several methods of reporting, but all methods must include a clear description of how the pay versus performance information was calculated. The rules apply to all US public companies, except for emerging growth companies, foreign private issuers, and registered investment companies.

The new rules aim to enhance transparency and accountability in executive compensation practices and provide investors with valuable information for making informed investment decisions. Companies should begin preparing for compliance with the new rules in advance of the next proxy season.

The Pay versus Performance rules mandate that companies paint a clear picture of their executive compensation policies. This includes revealing a five-year historical analysis of both the CEO's pay and the company's overall performance. Companies can no longer hide their pay practices behind a curtain of ambiguity. The aim? To empower shareholders and promote better alignment between executive pay and company success.

The keypointers from SEC's Finalized Rules

  • On August 25, 2022, SEC adopted new rules for disclosing executive compensation and financial performance.

  • The rules require a table with specified compensation and performance measures for the five most recent fiscal years (three years for smaller reporting companies).

  • The disclosures are for proxy and information statements that are required to include executive compensation disclosures pursuant to Item 402 of Regulation S-K.

  • The new disclosures apply to fiscal years ending on or after December 16, 2022.

  • Only three years of information are required in the initial year, with an additional year added in each of the two subsequent proxy filings.

  • Smaller reporting companies may provide two years in the initial year, with a third year added in the subsequent year.

  • The rules will apply to all reporting companies, except foreign private issuers, registered investment companies, emerging growth companies, and Business Development Companies (“BDCs”).

Disclosure Guidelines - The Palette of Requirements

These rules are not without their complexities, but we've broken them down into a colorful array of requirements:

  1. The Canvas - Eligible Companies: The rules apply to SEC-registered companies, with some exceptions such as Registered Investment Companies, emerging growth companies, Business Development Companies (“BDCs”) and foreign private issuers. Smaller Reporting Companies (“SRCs”) are subject to the amendments but are permitted to provide scaled disclosures.
  1. Compensation Colors - Which Executives to Disclose: The CEO's pay is in the spotlight, along with the compensation of the other named executive officers (NEOs).

  2. Performance Pigments - TSR & Peer Group Comparison: Total Shareholder Return (TSR) serves as the performance metric. Companies must also provide a peer group comparison, illustrating how their performance stacks up against others.

  3. Brush Strokes - Formatting & Presentation: A combination of narrative and tabular presentations is required to make the disclosure clear and comprehensible.

Compliance Countdown - Timelines & Deadlines

The clock is ticking, and companies need to be ready to comply with these rules. The Companies need to incorporate these pay vs performance reports into their 2023 proxy season reports. Transitional provisions allow for a three-year phase-in period, giving companies ample time to adapt to the changes.

The Art of Strategy - Preparing for the New Rules

Companies must not only adhere to these regulations but also find ways to leverage them strategically. Here's how they can turn these new rules into a masterpiece:

Assess the Current Compensation Structure

When assessing the current compensation structure, the focus is on evaluating an organization's existing salary and benefits framework. This process involves analyzing how both the CEO and NEOs are compensated, including their base pay, bonuses, commissions, and other benefits, to ensure that their compensation is fair, competitive, and aligned with the organization's objectives and values.

Assessing the current compensation structure typically involves the following steps:

  1. Gather data: Collect information on their salaries, bonuses, commissions, and other benefits, including data on their job titles, roles, responsibilities, experience, education, and performance metrics.

  2. Analyze pay disparities: Identify any pay disparities between the CEO and NEOs, such as differences in compensation based on gender, race, or other personal characteristics. This can help determine if there are any systemic issues that need to be addressed to promote pay equity.

  3. Benchmark against industry standards: Compare the compensation structure of the CEO and NEOs to industry standards, considering factors such as company size, location, and market competitiveness. This can help determine if their pay practices are competitive and if adjustments are needed to attract and retain top talent.

  4. Review job descriptions and evaluations: Assess the accuracy and relevance of their job descriptions and evaluations to ensure they accurately reflect the skills, qualifications, and responsibilities required for each role. This can help establish appropriate salary ranges and assess the value of different roles objectively.

  5. Evaluate the effectiveness of compensation policies: Assess the organization's compensation policies and practices for the CEO and NEOs to determine if they are effective in motivating and retaining employees, promoting fairness, and supporting the organization's strategic objectives.

  6. Identify areas for improvement: Based on the assessment, identify areas where adjustments may be needed to address pay disparities, ensure competitiveness, or better align the compensation structure with the organization's goals and values.

  7. Develop and implement a plan: Create a plan to address any identified issues and make necessary adjustments to the compensation structure for the CEO and NEOs. This may include updating compensation policies, adjusting salary ranges, or implementing new benefits or incentive programs specific to these top-level positions.

Review Peer Group Selection

Reviewing peer group selection refers to the process of evaluating and selecting a group of comparable organizations, often within the same industry or sector, to benchmark various aspects of business performance, including compensation practices. This comparison helps organizations understand their relative position in the market, identify industry trends and best practices, and make informed decisions to stay competitive.

In the context of compensation, peer group selection is crucial for ensuring that an organization's pay structure is competitive and in line with industry standards. The process typically involves the following steps:

  1. Define criteria for selecting peers: Establish the criteria to identify suitable peer organizations for comparison. Common criteria include company size (revenue, number of employees), industry or sector, geographic location, and business model.

  2. Identify potential peers: Based on the defined criteria, create a list of potential peer organizations. This list can be compiled using industry databases, business directories, or other relevant sources.

  3. Analyze peer compensation practices: Gather information on the compensation structures and practices of the selected peer organizations. This may include data on salary ranges, bonus structures, benefits, and incentive programs.

  4. Compare and evaluate: Analyze the compensation data from the selected peers and compare it with your organization's compensation practices. This comparison helps identify any significant differences, potential areas for improvement, or emerging trends in the industry.

  5. Adjust your compensation strategy: Based on the insights gained from the peer group comparison, make any necessary adjustments to your organization's compensation structure to ensure competitiveness and alignment with industry standards.

  6. Monitor and update: Regularly review and update the peer group selection to ensure that the comparison remains relevant and reflects any changes in the industry or market.

Reviewing peer group selection is essential for organizations to maintain a competitive edge in attracting and retaining talent, promoting fairness in compensation, and staying informed about industry trends and best practices. By carefully selecting and analyzing peer organizations, companies can make informed decisions to enhance their compensation practices and create a more inclusive and equitable workplace.

Enhance Communication with Shareholders

Enhancing communication with shareholders is crucial for maintaining trust, transparency, and a strong relationship between a company and its investors. Effective communication ensures that shareholders are well-informed about the company's performance, strategic direction, and any significant developments. Here are some strategies to enhance communication with shareholders:

  1. Develop a clear communication strategy: Create a comprehensive plan outlining the channels, frequency, and content of communication about executive pay and other company's performance related matters with shareholders. Make sure it aligns with the company's overall business objectives and is regularly reviewed and updated..

  2. Utilize multiple communication channels: Share information about executive pay and company's performance through various channels, such as annual reports, shareholder letters, press releases, investor presentations, and company websites. This ensures that shareholders have access to relevant information through their preferred medium.

  3. Host regular shareholder meetings: Organize annual general meetings (AGMs) and other investor events to provide shareholders with an opportunity to interact with the company's management, ask questions, and voice their concerns about executive pay.

  4. Engage in proactive investor relations: Establish an investor relations function within the company to manage communication with shareholders and address their inquiries and concerns promptly. This function can also help in identifying potential issues or concerns among shareholders and addressing them proactively.

  5. Be transparent and timely: Share information about the company's performance, executive pay, strategic direction, and any significant developments in a transparent and timely manner. This helps build trust and credibility with shareholders.

  6. Use digital platforms and social media: Leverage digital platforms and social media channels to share information and engage with shareholders. This can include posting updates on LinkedIn, Twitter, or other relevant platforms, as well as hosting webinars or online investor events.

  7. Encourage two-way communication: Solicit feedback from shareholders and create opportunities for dialogue. This can be done through surveys, investor forums, or direct communication channels such as email or phone.

  8. Provide clear and concise information: Ensure that all communication with shareholders is clear, concise, and easy to understand. Avoid using excessive jargon or technical language that may be difficult for some shareholders to comprehend..

  9. Educate shareholders: Provide educational resources to help shareholders better understand executive pay and its importance to the company's business, industry, and investment proposition. This can include investor presentations, fact sheets, or explanatory videos.

  10. Monitor shareholder sentiment: Regularly track shareholder sentiment and opinions about the company through surveys, market research, or social media analysis. This can help identify potential issues or concerns and inform the company's communication strategy.

By implementing these strategies, companies can enhance communication with shareholders, fostering trust, transparency, and a strong relationship between the company and its investors. This, in turn, can contribute to increased shareholder confidence and long-term shareholder value.

Conclusion: A Gallery of Corporate Transparency

The Pay versus Performance Disclosure rules have opened a new chapter in the world of executive compensation. By embracing these regulations and aligning pay with performance, companies will hopefully be able to create a more equitable and transparent corporate environment.

  1. SEC: Pay Versus Performance Rules (2022) [Sec.gov]

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