On August 25, 2022, the Securities and Exchange Commission (SEC) adopted final pay-versus-performance disclosure rules for publicly traded companies. These rules will require three new disclosures in upcoming proxy and information statements:
- A table disclosing the compensation of the principal executive officer, the average compensation of the other named executive officers, and certain performance measures over the preceding five years.
- A description of the relationship between the amounts actually paid to the company’s named executive officers and the performance measures in the table over the last five years.
- A list of three to seven financial performance measures that, in the company’s assessment, represent the most important financial performance measures used to link compensation actually paid to the named executive officers for the most recent year to the company’s performance.
Companies subject to the new rules must comply in proxy and information statements that are required to include executive compensation disclosure for fiscal years ending on or after December 16, 2022. This means that, for calendar year companies, the new disclosures will be required in their proxy statements filed for their 2023 annual shareholder meetings.
Although these disclosures apply only to publicly traded companies, over time they may impact the pay practices of privately held companies as well if the rules influence which performance measures are seen as best exemplifying a pay-for-performance philosophy.
How Will the New Table Look?
The new table must show, for each of the last five completed fiscal years, (a) the compensation for the principal executive officer and the average compensation for the other named executive officers, calculated as required for purposes of the summary compensation table and calculated as an amount “actually paid,” (b) the company’s total shareholder return (TSR) compared to the TSR of the company’s peer group, (c) the company’s net income, and (d) a company-selected financial performance measure.
The format of the new table is shown below:
How Will Compensation “Actually Paid” Be Calculated?
Compensation “actually paid” must be calculated by starting with “total compensation” in the summary compensation table and adjusting it as follows:
If any awards granted in a prior year were forfeited during the covered year, the fair value as of the end of the prior year would be subtracted. If the exercise price of options or stock appreciation rights was adjusted or amended, the changes in fair value must take into account any excess fair value over the original fair value resulting from the adjustment or amendment.
- Rather than including the change in actuarial present value of the named executive officer’s benefit under the company’s defined benefit and actuarial pension plans (as in the summary compensation table), the calculation of “actually paid” compensation will substitute the service cost of the named executive officer’s benefit under the company’s pension plans for the applicable fiscal year plus the prior service cost attributable to any amendment during the applicable fiscal year.
- Rather than including the grant date fair value of all stock and option awards granted during the year, the calculation of “actually paid” compensation will substitute all of the following:
- The fair value as of the end of the covered year for all stock and option awards that were granted during the year and that remain unvested as of the end of the covered year.
- The change in fair value (whether positive or negative) as of the end of the covered year for any awards granted in any prior fiscal year that remain outstanding and unvested as of the end of the covered year.
- The fair value as of the vesting date for any awards that were granted and vested in the covered fiscal year.
- The change in fair value (whether positive or negative) as of the vesting date of any awards granted in any prior year for which all applicable vesting conditions were satisfied during the covered year.
- The dollar value of any dividends or other earnings paid on awards during the covered year that are not otherwise included in total compensation.
The amounts of the adjustments to calculate “actually paid” compensation, as compared to total compensation for summary compensation table purposes, must be disclosed in footnotes to the table, along with the names of the named executive officers whose compensation is included in the table.
How Will TSR Be Calculated?
The TSR disclosures of the company and its peer group must be calculated in the same manner as TSR is calculated for the existing stock graph requirement under Item 201(e) of Regulation S-K, converting the beginning share price to a fixed investment of $100 and showing the value of the investment as of the end of the applicable fiscal year.
The peer group used for the peer group TSR disclosure in the table must be either (a) the same index or group of issuers used by the company for purposes of its Item 201(e) disclosure in its Form 10-K, or (b) the peer group that the company uses for purposes of its disclosures in its Compensation Discussion and Analysis. If the peer group is not a published industry or line-of-business index, then the component issuers must be disclosed in a footnote. If the company uses a different peer group one year from the preceding year, it will need to explain in a footnote the reasons for the change and compare its cumulative total return with both the new and the previous peer group.
What Is The “Company-Selected Financial Measure” Required In The Table?
The table will require disclosure of an amount for each fiscal year attributable to an additional financial performance measure that, in the company’s assessment, represents the most important financial performance measure (other than TSR or net income) used to link compensation actually paid to performance in the most recent fiscal year. The measure must be one that is included in the list of three to seven performance measures described below.
What Are the Requirements for the Description of the Relationship Between Pay and Performance?
The table discussed above must be accompanied by a clear description of the following relationships:
- Between (a) the executive compensation actually paid to the principal executive officer and the average paid to the other named executive officers, and (b) the company’s TSR over the last five years, including a comparison of the TSR of the company and the TSR of the peer group over the same period.
- Between (a) the compensation actually paid to the principal executive officer and the average paid to the other named executive officers, and (b) the company’s net income over the last five years.
- Between (a) the compensation actually paid to the named executive officers, and (b) the company-selected performance measure over the last five years.
If the company elects to include on a voluntary basis any additional performance measures in the table, each additional measure must be accompanied by a clear description of the relationship between (a) the compensation actually paid to the principal executive officer and the average paid to the other named executive officers, and (b) the company’s performance under the additional measure over the last five years.
The description may take the form of graphics, narrative or a combination.
What Is the “Tabular List” of Three to Seven Financial Performance Measures?
In addition to the table and accompanying description, the company must provide a “tabular list” of at least three, and up to seven, financial performance measures that, in the company’s assessment, represent the most important financial performance measures used to link compensation actually paid to the named executive officers for the most recent year to the company’s performance.
If a company used fewer than three performance measures to link compensation actually paid to company performance, the tabular list must include all such performance measures that were used. Non-financial performance measures may be disclosed if the company considers them among its most important performance measures and has disclosed its most important three (or fewer, if the company only uses fewer) financial performance measures.
Is There a Required Location and Format for the New Disclosures?
The new pay versus performance disclosure must appear with the rest of the executive compensation disclosure under Item 402 of Regulation S-K and must be provided in an Interactive Data File. All values disclosed in the table must be separately tagged in Inline XBRL, along with specific data points within the footnote disclosures, and the footnote and relationship disclosures must be block-text tagged.
Do the Rules Apply to Smaller Reporting Companies
Smaller reporting companies may provide the disclosure required by the new rules for three years (two years in the first filing subject to the new rules), rather than five years. In addition, smaller reporting companies are not required to provide the TSR of a peer group or the company-selected financial performance measure otherwise required in the table, a description of the relationship between pay and performance or a tabular list of most important financial performance measures.
Are There Transition Period Rules Available?
Companies may provide only three years of disclosure in their first filing under the new rules and only four years in their second filing. New registrants will not be required to disclose information for years prior to the last completed year if the registrant was not required to report under Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended, during that year.
Are Emerging Growth Companies Required to Comply?
Emerging growth companies, registered investment companies and foreign private issuers are exempt from the new requirements.
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