As public companies navigate the 2015 proxy season, a potential change to executive compensation disclosure is on the horizon. The US Securities and Exchange Commission (SEC) has proposed new rules to implement the "pay-versus-performance" disclosure requirement under Section 953(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new rules would mandate and standardize companies' "realizable" and "realized" pay disclosures and compare them to total shareholder return (TSR).

Under the proposed rules, a US public company will be required to add a new "Pay Versus Performance Table" to its proxy statements that shows the pay of its named executive officers (NEOs) as shown on the Summary Compensation Table (SCT), and an adjusted pay number representing compensation "actually paid," as defined in the proposed rules. The Pay Versus Performance Table will also report the company's total shareholder return and the aggregate weighted of its peer group. Companies will still be permitted to show "realized" or "realizable" pay in their proxies, but the new Pay Versus Performance Table will provide a uniform presentation of compensation data for shareholders to compare across companies.

Click here to read proposed rule.

Required format for new table

The following format is required for the Pay Versus Performance Table under the proposed rules:

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New table to show average pay for NEOs other than the PEO

As proposed, the Pay Versus Performance Table would show the total compensation figure taken directly from the SCT for the principal executive officer (PEO), and it would show the average total compensation for the year for the other NEOs. The average is used because the SEC believes that the identity of the NEOs other than the PEO changes frequently, and it might not be as helpful to shareholders if the other NEOs were shown individually. PEOs also change with some frequency, and the proposed rules provide that, in such instance, the table should reflect the sum of the compensation paid to all PEOs during the year.

Five years of compensation reported

As proposed, the Pay Versus Performance Table would show compensation for the current year (i.e., the year for which the proxy statement is filed) and each of the four prior years. This four-year look-back requirement phases in over three years, with only the current and two prior years' compensation required to be shown the first year the new rules are in effect. In the second year the rules are in effect, four years' actual compensation must be shown. The full four-year look-back will apply in the third year the rules are in effect.

Adjustments to "pay" shown on the Summary Compensation Table

The Pay Versus Performance Table would repeat the total compensation figure from the SCT, so that shareholders can compare data without having to look up the current or historic figures. "Actual" pay information in the new table is to be derived from the company's SCT with two specified adjustments designed to convert the "compensation awarded to, earned by or paid" to a named executive officer shown in the SCT to compensation "actually paid."

To derive the compensation "actually paid" to the NEOs, the SCT total compensation figure must be adjusted (and shown with appropriate footnotes describing and quantifying the adjustments) as follows:

  • Defined benefit pension adjustment. Subtract the portion of the increase in the actuarial present value of the NEO's accumulated defined benefit pension reported in the SCT that is not attributable to services rendered during the applicable fiscal year (i.e., include only the portion of the increase that the plan's actuary would refer to as the "normal cost").
  • Equity award adjustment. Replace the grant date fair value of equity awards reflected in the SCT with the vesting date fair value for equity awards that vested during the applicable year, plus, if the awards have been modified during the year, add the incremental fair value of vested equity awards that were materially modified. For equity awards other than options (or stock appreciation rights), the vesting date fair value will generally have already been reported in the Options Exercised and Stock Vested Table. For options, a new calculation of the vesting date fair value would be required. Following are some rules of thumb to illustrate the possible differences in the two values:
    • The grant date fair value of a time-vested option is often reported in the SCT as the Black-Scholes value of the option, which is typically 25 percent to 33 percent of the value of the underlying shares.
    • The vesting date fair value of a time-vested option, calculated under the Black-Scholes method, may be higher or lower than the grant date fair value. The key determining factors are the change in stock price (the higher the price, the higher the Black-Scholes value), the remaining term of the option (the longer the remaining term, the higher the Black-Scholes value) and the volatility of the stock (the higher the volatility, the higher the Black-Scholes value). Applying these rules of thumb, if the stock price and volatility remain the same as at the grant date, the vesting date fair value will be lower than the grant date fair value because of the shorter remaining term.

The proposed rules do not require any particular valuation method, and they do not require the company to use the same valuation methodology in reporting the grant date fair value and the vesting date fair value, but the differences would need to be explained in a footnote.

Reporting "performance"

The Pay Versus Performance Table must report the company's TSR determined in the same manner as for the company's "stock performance graph" required to be shown in the annual report. The new table must also show the aggregate weighted TSR for the peer group. The peer TSR may be based on the peer group used for that stock performance graph. Alternatively, a company may opt to use the peer group used to benchmark executive compensation, as disclosed in its compensation discussion and analysis (CD&A). The aggregate weighted peer group TSR is based on each peer group member's stock market capitalization at the beginning of the applicable fiscal year.

In addition, the company would be required to describe the relationship between the reported compensation actually paid to its NEOs and the company's TSR compared to the TSR of its peers.

The SEC proposes using TSR as the relevant performance measure because it takes into account the change in value of shares as well as dividends and distributions. Under the proposed rules, companies that do not find TSR to be an appropriate indicator of company performance may supplement the Pay Versus Performance Table by providing supplemental performance measures, as long as TSR is included in the new table, and the other measures are clearly identified.

Subject to "say on pay" vote 

The disclosure in the new Pay Versus Performance Table would be subject to a company's regular "say on pay" vote. The proposed rules do not require the new table to be included in any particular section of the applicable proxy statements, but the SEC generally suggests including it with the other tables showing executive compensation instead of the CD&A, unless the company's compensation committee considered the disclosure in making compensation decisions.

Other considerations 

Emerging growth companies, registered investment companies and foreign private issuers are not subject to the proposed rules. In addition, special rules apply under the proposed rules for smaller reporting companies.

While many companies will wait until the proposed rules become final to undertake a full-blown analysis of the requirements, there are some preliminary steps companies should consider taking now to prepare:

  • XBRL format. The disclosure required under the proposed rules must be made in Extensible Business Reporting Language (XBRL) format, with the intention of providing shareholders with easier searching capabilities and greater ease in comparing data across different companies. Given that these rules could represent the first time that the SEC would require this format in connection with a proxy statement, companies unfamiliar with the format should become acquainted with it.
  • Valuing options. Companies should consider the methodology and assumptions to be used in valuing any stock options grants based on the vesting date (as opposed to grant date) approach to valuation. Once those methodologies and assumptions are set, companies can begin to customize reports through their stock plan administrator to pull the relevant stock option information, starting with 2014 and 2013 data, required to be disclosed. For stock awards, the vesting date value of the awards is already included in a proxy's Option Exercises and Stock Vested Table.
  • Contact pension plan actuary. To isolate the "normal cost" under a defined benefit pension plan that is required to be disclosed under the proposed rules, companies should contact the plan's actuary to provide the relevant figures, which should exclude the portion of the total increase in pension value reported in the SCT that results solely from changes in interest rates and actuarial assumptions.

The comment period for the proposed rules remains open through July 6, 2015, and the rules are not expected to become effective prior to the 2016 proxy season.