Find out why the SEC’s new “pay vs. performance” disclosure rule requires companies to implement new processes to track changes in the fair value of equity compensation awards.

It is important to investors that executive compensation is directly linked to a company’s financial performance. To help ensure investors have adequate information to monitor this relationship, the SEC adopted new “pay vs. performance” (“PvP”) disclosure rules on August 25, 2022. The disclosures must be included in proxy statements for fiscal years ending on or after December 16, 2022, for all reporting companies, except foreign private issuers, registered investment companies, and emerging growth companies.

The new PvP rules require registrant companies to provide a table disclosing multiple historical years (three years for small reporting companies and five for larger registrants) of company-level and executive compensation figures. These figures include total shareholder return (TSR), TSR for a peer group of companies, net income, three to seven company-selected performance metrics linked to compensation, and executive compensation actually paid. Registrants must report compensation for principal executive officers (PEOs) individually and may report an average for the compensation actually paid to named executive officers (NEOs). In addition to the tabular disclosures, clear descriptions of the relationships between compensation and financial performance and between the company’s TSR and the selected peer group’s TSR must also be provided.

READ MORE: Volatility: The Effects On Total Shareholder Return Awards

These rigorous disclosure rules will require companies to implement a new process to track changes in the fair value of their equity classified awards to the PEO and NEOs for each fiscal year required to be included in the disclosure. To comply with the new PvP rules, a registrant company must perform the following tasks:

• Gather Data & Assess Valuation Needs
  • Summarize all awards issued to named executive officers:
    • Award type (restricted stock unit, or RSU, performance units with market conditions, options, stock appreciation right, or SAR, etc.).
    • The number of units issued on the grant date.
    • The number of units vested by the vesting date.
  • Determine required valuation dates by the award.
• Perform Necessary Valuations
  • RSUs can generally use the stock price on the valuation date.
  • Performance units with market conditions generally require Monte Carlo simulations.
  • Options may be able to use the Black-Scholes model; however, special consideration of the expected term is required. In certain circumstances, Lattice models may be required
• Prepare Supporting Workbook For Disclosure
  • Detail the settled values by award at each vesting date for awards that vest in a given year.
  • Detail the fair value by award at each fiscal year-end for all unvested awards.
  • Preparation of a summary table showing compensation actually paid related to the equity awards for each fiscal year.

To ease the burden of implementing these new rules, the SEC allows small reporting companies to disclose two years of the requisite PvP metrics initially and three years of data the following year and thereafter. Larger registrants will need to disclose three years of data initially, four years of data the following year, and five years of PvP measures thereafter. While the transition period will reduce the amount of work required to comply with the new rules initially, it will still be a large undertaking for many companies to prepare the initial PvP disclosures.

READ MORE: Accounting Considerations For Bridge Loans

Companies should start developing these tabular disclosures as soon as possible to avoid unnecessary surprises and to allow additional time to complete the accompanying qualitative disclosures describing the relationship between compensation actually paid and the financial performance and between the company’s TSR and the selected peer group’s TSR.