SEC Proposes Dodd-Frank Pay vs Performance Disclosure Rules

SEC Proposes Dodd-Frank Pay Versus Performance Disclosure Rules

May 6 2015

PDFExecutive Summary
On April 29, 2015, the Commissioners of the SEC voted three-to-two along party lines to propose a rule implementing the pay versus performance ratio disclosure mandated under Section 953(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Proposed Rule”).  The Proposed Rule will require U.S. reporting companies (excluding emerging growth companies and foreign private issuers) to disclose the relationship between executive compensation actually paid and financial performance.

For the first time, U.S. reporting companies will need to calculate compensation “actually paid” to the Principal Executive Officer (“PEO”, i.e. the Chief Executive Officer) and average compensation “actually paid” to the other named executive officers and provide a clear description of the relationship between compensation “actually paid” to the company’s cumulative total shareholder return (TSR) over the last five fiscal years.  The proposal also requires a description of the relationship between the company’s TSR and that of a peer group selected by the company.

Similar to the proposed CEO Pay Ratio requirements, the utility of the pay versus performance disclosure required under the Proposed Rule was hotly debated amongst the five SEC Commissioners.  There are disparate perspectives on whether this pay versus performance disclosure will provide meaningful insight into a company’s pay programs or performance levels.

The SEC is proposing to require the pay versus performance disclosure in annual proxy statements because it believes that the proposed disclosure would be “most useful” to shareholders when they are deciding whether to approve the compensation of named executive officers through the Say on Pay vote, as well as in making voting decisions on an executive compensation plan and election of directors.

The Proposed Rule requests extensive and detailed comments, including responses to the 64 questions specifically asked by the Staff.  Comments will be due 60 days after publication of the proposal in the Federal Register.

We will be submitting a comment letter in response to the Proposed Rule and we welcome any thoughts, comments or concerns that you would like to share with us as we prepare our response.  Please contact Joseph Sorrentino at 212-488-5400.

Proposed Rule
Under this Proposed Rule, new Item 402(v) of Regulation S-K would be added to require the Pay versus Performance disclosure as prescribed in the following tabular format:

Year Summary Compensation Table Total for PEO Compensation Actually Paid to PEO Average Summary Compensation Table Total for non-PEO named executive officers Average Compensation Actually Paid to non-PEO named executive officers Total Shareholder Return Peer Group Total Shareholder Return


The disclosure regarding the relationship between pay and performance would follow this table and could be described as a narrative, graphically, or a combination of the two.  This description should also include a comparison of the cumulative TSRs for both the company and the peer group.

While the Staff did not require a specific disclosure of the relationship between pay and performance following the mandatory table, examples included a “graph providing executive compensation actually paid and change in TSR on parallel axes and plotting compensation and TSR over the required time period” and “showing the percentage change over each year of the required time period in both executive compensation actually paid and TSR together with a brief discussion of that relationship.”

Additionally, the Proposed Rule would allow companies to provide supplemental measures of financial performance, as long as any additional disclosure is clearly identified, not misleading and not presented with greater prominence than the required disclosure.

For the first time in a proxy statement, the Proposed Rule would require XBRL data tagging of information provided in the table of pay versus performance data and the description of the relationship between executive compensation actually paid and company performance.  The SEC believes that requiring XBRL will lower the cost to investors of collecting the information, permit investors to analyze data more quickly and facilitates analysis of how data related to a specific company changes over time as well as comparisons among companies.

How is compensation “actually paid” calculated?
Compensation “actually paid” equals the compensation number disclosed under the Total column of the Summary Compensation Table with adjustments for equity awards and defined benefit/pension values.  Any adjustments made to calculate compensation “actually paid” are required to be disclosed in a footnote to the table.

For equity grants, instead of grant date present value, awards are calculated at the fair value on vesting date.  Pension values are calculated based on the actuarial present value of the benefit attributable to services rendered (service cost) in that year, excluding any value derived from modifications to actuarial assumptions.  Modifications to actuarial assumptions comprise changes in interest rates, executive’s age and other actuarial inputs that are included in determining the Change in Pension Value column in the Summary Compensation Table.  Smaller reporting companies would not be required to include pension values in the calculation of compensation “actually paid”.

How is the fair value of equity awards calculated?
For awards of stock and options that vested in the applicable year, the fair value at vesting date must be calculated in accordance with ASC Topic 718.  This means that stock options will be valued using an option pricing model (such as Black-Scholes), rather than the intrinsic value, on the date the award vested even if the executive did not exercise the option in the applicable year.  A company would be required to disclose vesting date valuation assumptions in a footnote to the table if they are materially different from those disclosed in its financial statements on grant date.

How is TSR calculated?
The Proposed Rule specifies that TSR is calculated in the same manner as provided for in the stock performance graph included in the annual report as required by Item 201(e) of Regulation S-K.  TSR is calculated on a cumulative basis by dividing the (i) sum of (A) the cumulative amount of dividends for the measurement period, assuming dividend reinvestment, and (B) the difference between the share price at the end and the beginning of the measurement period; by (ii) the share price at the beginning of the measurement period.

Where To Disclose The Pay Versus Performance Analysis
The SEC is not proposing a specific location within the proxy statement for the new disclosure. The proposed regulations note that pay versus performance disclosure may provide a useful point of comparison for the analysis provided in the CD&A.  However, the Staff also notes that including the disclosure within the CD&A might suggest that the company considered the pay versus performance relationship in its compensation decisions, which may not be the case. 

Peer Groups
TSR will be calculated based on either the peer group utilized in the stock performance graph (per Item 201(e)) or the peer group used for executive compensation benchmarking purposes as disclosed in the CD&A.  If the peer group is not a published industry or line-of-business index, the identity of the issuers comprising the group must be disclosed.  Peer group TSR disclosure is not required for smaller reporting companies.

What if there are two CEOs in the same fiscal year?
If more than one person served as the CEO in the same year, then the compensation “actually paid” for the CEO position in the required table would represent the aggregate pay of both CEOs in that year. 

Effective Date
While the proposed release did not specify an effective date, we believe it is unlikely that companies will be required to provide this disclosure earlier than the 2017 proxy statements, covering 2016 fiscal year compensation.  

Transition Periods
In the first applicable filing after the rules become effective, most companies will be required to provide disclosure for the prior three fiscal years, with an additional year added in each of the two subsequent proxy filings.  Smaller reporting companies would be required to provide disclosure for only the last two fiscal years in the first applicable filing.  In subsequent years, smaller reporting companies are only required to provide disclosure for the prior three fiscal years.

Our View
In our view, a principles-based approach that allows companies more flexibility to communicate their pay versus performance story will serve as a superior construct to the prescriptive methodology offered in the Proposed Rule.  We strongly believe a holistic approach that takes into account key financial metrics relevant to the company and industry as well as long-term stock price performance is the appropriate way to measure the relationship between pay and performance.  By defining performance solely in the form of TSR, we believe that the SEC is highlighting a performance metric for both companies and investors that is limited in scope and may not directly correlate with underlying operating performance.

Another concern we have is the potential for a significant disconnect between the pay and performance time frames.  This is due to the proposed methodology of valuing equity awards on vesting date instead of fiscal year end.  For equity awards that vest on a date other than the fiscal year end, the connection between compensation “actually paid” and TSR performance has been broken.

We also have concerns related to the calculation of compensation “actually paid.”  Valuing stock options at vesting date on a fair value basis using an option pricing model, instead of at intrinsic value or upon exercise, does not represent compensation “actually paid” to the executive.  Therefore, we do not think that the proposed definition appropriately captures the concept of compensation “actually paid” to executives.   

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About Steven Hall & Partners
Steven Hall & Partners is an independent executive compensation consulting firm, specializing exclusively in the areas of executive compensation, board remuneration, non-profit compensation and related governance issues.  By focusing solely on this critical and complex segment of the human resources arena, we are able to provide our clients with the highest quality expertise and best counsel available on a practical basis.  For more information, please visit and follow us on Twitter @SHallPartners.

Contacting Steven Hall & Partners
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Joseph Sorrentino