On Thursday, August 25th, 2022, the Securities and Exchange Commission (the “SEC”) adopted amendments that will require registrants to disclose information reflecting the relationship between executive compensation actually paid by a registrant and the registrant’s financial performance. These rules implement the so-called “pay-versus-performance” disclosure requirements prescribed by Section 953(a) of the Dodd Frank Act. This rule was first proposed in 2015 and the comment period was reopened in January 2022, nearly twelve years after Congress directed the SEC to create such a rule. This rule is intended to provide shareholders with a more clear and digestible understanding of the relationship between “executive compensation actually paid” (described below) by a company and the company’s overall financial performance.
The pay-versus-performance amendment will require affected registrants to provide:
- a table disclosing specified executive compensation and financial performance measured for the five most recently completed fiscal years;
- a “clear” description of the relationships between each of the financial performance measures included in the table and the “executive compensation actually paid,”, to its PEO and, on average, to its other NEOs over the registrant’s five most recently completed fiscal years, as well as the relationship between the company’s TSR and the TSR of its peer group; and
- disclosure of between three and seven financial performance measures the registrant believes to be the most important performance measures for linking executive compensation actually paid, to company performance. Registrants are permitted, but not required, to include non-financial measures in the list if they considered such measures to be among their three to seven “most important” measures.
Perhaps the most onerous aspect of the new rule is the required table. Specifically, this new table will require companies to specify two types of information – executive compensation and financial performance measures for the five most recently completed fiscal years. The required company financial performance measures include:
- The registrant’s TSR;
- The TSR of companies in the registrant’s peer group;
- Net income calculated in accordance with U.S. GAAP; and
- A financial performance measure of the registrant’s choice (which should be specific to the company).
With respect to the executive compensation component, the table must show, for the PEO and, on average, its other NEOs, a measure of total compensation (taken from the Summary Compensation Table), as well as a measure reflecting “executive compensation actually paid,” calculated as prescribed by the rule, for the five most recently completed fiscal years. Inline XBRL must be used to tag the pay-versus-performance disclosure.
The new pay-versus-performance rules will apply to all regular reporting companies, excluding foreign private issuers, registered investment companies and emerging growth companies. Smaller reporting companies will be subject to scaled disclosure obligations. Moving forward, most reporting companies will have to comply with the new requirement in their proxy and other statements that are otherwise required to provide compensation disclosure for fiscal years ending on or after December 16, 2022. This means most reporting companies will need to adhere to the new requirements for the 2023 Proxy season.
Registrants subject to the rule for the 2023 proxy season (other than smaller reporting companies) will be required to provide information for the past three fiscal years, with another year added to each of the two subsequent proxy statements until a full five years has been disclosed. Smaller companies will initially be required to provide the information for two years, adding an additional one year in the subsequent proxy or information statement that requires disclosure until a full three years has been disclosed.
In order to prepare for the undertaking required to comply with the new rule for the 2023 proxy season, companies should start:
- Understanding and collecting the information necessary for the historical executive compensation disclosures, particularly those pertaining to the “actually paid” component of the executive compensation disclosure, since this may involve calculations that have not typically been run for proxy disclosures in the past.
- Begin to assess which company-selected financial measure to include in the new disclosure, keeping in mind that a “clear” description of the relationship between such metric and executive compensation will be required.
- Discussing how the company wants to approach “clearly” describing the relationship between executive compensation and the financial performance metrics it must disclose.
- Begin to draft additional narrative disclosure to explain pay decisions if the company has concerns about whether the required disclosure will be perceived by shareholders as exhibiting a misalignment between executive pay and company performance.