On August 25, 2022, the SEC adopted final pay versus performance disclosure rules. The breadth and complexity of the new rules require that companies begin to prepare the new disclosures now to provide enough time for data collection, calculations, drafting, review, internal approvals, and appropriate coordination with the compensation committee ahead of the 2023 proxy season.

The new rules will require the following three new disclosures in any proxy or information statements that must include executive compensation disclosure:

1. A table disclosing the compensation of the CEO, the average compensation of the other NEOs, and three performance measures (TSR, net income, and a measure that each company chooses) for each year over the preceding five years.
2. A description of the relationship between the amounts “actually paid” to the company’s NEOs, and the three performance measures for each year over the last five years.
3. A tabular 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 NEOs for the most recent year to the company’s performance.

More detail on each of these new disclosures appears below. 

Emerging growth companies, registered investment companies, and foreign private issuers are exempt from the new requirements. Smaller reporting companies are subject to scaled disclosure, as described below. 

Companies subject to the new rules will be required to comply in proxy and information statements that are required to include executive compensation disclosure for fiscal years ending on or after December 16, 2022. Companies may provide only three years of disclosure in the first filing under the new rules and only four years in the 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.

Companies will need to consider how to involve their compensation committees in the process of responding to the new disclosure requirements as the disclosures may not align exactly with CD&A disclosures or how the committee has approached compensation decisions.

First New Disclosure: Table Disclosing Compensation and Performance Measures

The new table must show, for each of the last five completed fiscal years; (a) the compensation for the CEO, and the average compensation for the other NEOs (those included in the summary compensation table for each fiscal year, including former officers, if any), both as otherwise disclosed for purposes of the summary compensation table and as an amount “actually paid” that is calculated as the rule directs; (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. 

Format of Table. The format of the new table is shown below:

If more than one person served as the CEO during a fiscal year, an additional column should be added for each additional CEO, disclosing the person’s total compensation, and compensation “actually paid” for the fiscal year.

Calculation of Compensation “Actually Paid.” Compensation “actually paid” must be calculated by starting with “total compensation” in the summary compensation table and adjusting it as follows:

• Rather than including the change in the actuarial present value of the NEO’s benefit under the company’s defined benefit and actuarial pension plans (as in the summary compensation table), the calculation of “actually paid” compensation must substitute the service cost of the NEO’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 must 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 remained 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 remained 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. 

  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.

For each of the officers whose compensation is included in the table (whether as CEO or as part of an average), 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.

If a company had multiple CEOs in a year, then a separate line item for each CEO must be included in the table.

Calculation of TSR. The TSR disclosures of the company and its peer group (discussed below) must be calculated in the same manner as TSR is calculated for the existing stock performance graph requirement under Item 201(e) of Regulation S-K that appears in the company’s latest Form 10-K, converting the beginning share price in the earliest year in the table to a fixed investment of $100 and showing the value of the investment as of the end of the applicable fiscal year. For any given proxy statement, the TSR measure presented will be a cumulative measure covering all fiscal years included in the table, using the cumulative TSR measured from the market close of the last trading day before the earliest fiscal year in the table through and including the end of the last fiscal year presented in the table but calculated and presented on an annual basis. Accordingly, for each fiscal year, the amount in the table must be the value of the investment based on the cumulative total shareholder return as of the end of that year.

The peer group used for the peer group TSR disclosure in the table will be the same peer group for all of the years in the table and 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 last Form 10-K or (b) the peer group that the company used 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 in a year the company uses a peer group different from the peer group that it used in the preceding year’s proxy statement, then it will need to include tabular disclosure of peer group TSR for only the new peer group for all years in the table, but it will need to explain in a footnote the reason for the change and compare its TSR to that of both the old and the new group.

Company-Selected Financial Measure. The table requires 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, and will apply to all of the years in the table.

The final rules require that the table include a financial performance measure as defined.  A financial performance measure is a measure determined and presented in accordance with generally accepted accounting principles (GAAP), any measure derived wholly or in part from such GAAP measures, stock price, and TSR. Disclosure of measures that are not financial measures under GAAP will not be subject to the full GAAP reconciliation requirements, but disclosure must be provided as to how the measure is calculated from the company’s audited financial statements. A financial performance measure need not be presented within the financial statements or otherwise included in a filing by a company with the SEC to be the company-selected measure. Therefore, by definition, the company-selected measure may not be subjective or, for example, ESG-based.

The rules do permit companies to provide voluntarily supplemental measures of compensation or financial performance (in the table or in other disclosure), and other supplemental disclosures, so long as any such measure or disclosure is clearly identified as supplemental, not misleading, and not presented with greater prominence than the required disclosure.

Second New Disclosure: Description of 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 CEO and the average paid to the other NEOs, 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 CEO and the average paid to the other NEOs and (b) the company’s net income over the last five years.
• Between (a) the compensation “actually paid” to the NEOs and (b) the company’s performance under 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, then each additional measure must be accompanied by a clear description of the relationship between (a) the compensation “actually paid” to the CEO and the average paid to the other NEOs, 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. Two examples of potential approaches to the required relationship disclosure described in the adopting release were as follows:

• A graph providing executive compensation “actually paid” and change in the financial performance measure on parallel axes; with compensation and the measure plotted over the required time period.
• Narrative or tabular disclosure showing the percentage change over each year of the required time period in both compensation “actually paid” and the company’s performance under the financial performance measures together with a brief discussion of how the changes are related.

Third New Disclosure: Tabular List of Three to Severance Financial Performance Measures

The company must also 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 NEOs for the most recent year to the company’s performance.

The rule permits disclosure of two separate tabular lists – one for the CEO and one for the other NEOs – or of separate tabular lists for each of the NEOs.

If a company used fewer than three performance measures to link compensation “actually paid” to company performance, then the tabular list must include all performance measures that were used. Non-financial performance measures may be disclosed in the list if the company considers them among its most important three to seven financial performance measures and has disclosed its most important three (or fewer, if the company only uses fewer) financial performance measures.

Location and Format

The new pay versus performance disclosure must appear with the rest of the executive compensation disclosure under Item 402 of Regulation S-K, though the disclosure is not required to be located within the CD&A section that is subject to the compensation committee’s report.  The SEC acknowledged mandating companies to include the disclosure in CD&A may cause confusion by suggesting that the company considered the pay-versus-performance relationship in its compensation decisions, which may or may not be the case.

The new disclosure must be provided within the proxy or information statement in an Interactive Data File, with all values disclosed in the table separately tagged in Inline XBRL, along with specific data points within the footnote disclosures, and the footnote and relationship disclosures required to be block-text tagged. Because XBRL tagging has not customarily been part of the proxy statement preparation process, companies should be sure to build this work stream into their timelines.

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.

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