Pay for performance is not just a good idea, it’s the law. At least, disclosing how well you do it is. On August 25th, 2022, the US Securities and Exchange Commission (SEC) amended its rules to require companies to disclose information reflecting the relationship between executive compensation and the company’s financial performance.
According to law firm White & Case, the new rules “represent the most fundamental change to the executive compensation rules since 2006.”
Companies must begin to comply with the new disclosure requirements in filings for fiscal years ending on or after December 16th, 2022.
What will it take to cope with the new rules in the most efficient way?
Old idea, new requirements
Reporting on executive compensation is nothing new. Existing regulations (Item 402 of SEC Regulation S-K) require companies to disclose the compensation of their named executive officers (NEOs) and directors. In 2006 the SEC updated its disclosure rules, requiring companies to include a compensation discussion and analysis (CD&A) section in their filings, along with data tables and discussions regarding the compensation of executives, directors, and employees.
The new rules on pay versus performance disclosure have been a long time coming. They represent the implementation of a requirement first mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), and were first proposed in 2015, with a final review period that commenced in January 2022.
Transparency and traceability
Like many SEC rules, the goal is to provide stakeholders with transparency and its companion, traceability. Transparency is a key element of any compliance reporting, to aid both investors and auditors. Investors want to understand whether a company is well-managed. Auditors need to be able to see exactly where the numbers come from and how they are calculated.
Compensation teams are already familiar with SEC disclosure mandates, such as the requirement to report the median annual total compensation of all employees other than the chief executive officer (CEO), the CEO's total annual compensation, and the ratio between the two (pay ratio disclosure).
Those disclosures provide visibility that can help evaluate pay fairness or flag exorbitant CEO compensation. The new rules attempt to shine a light on pay effectiveness. While most companies already look at pay for performance in some fashion, the new rules require using a prescribed approach to that measurement which involves gathering and manipulating lots of data and presenting the information in a standardized tabular format.
The new disclosures will give investors an objective measure of the relationship between executive pay and company results, providing a metric that can be used to compare companies and to help evaluate the effectiveness of executive pay packages.
More requirements mean more data, time, and cost
What’s the upshot for compensation teams who are tasked with compliance? It means collecting and analyzing mounds of compensation and performance data, performing calculations, and being able to present the information in a clear and traceable way.
To fulfill the requirements means being able to report five years of executive compensation actually paid along with company performance details (only three years of data during the initial transition period). “Compensation actually paid” is calculated through a complex formula that looks at not just total compensation as reported on the Summary Compensation Table, but also must include a host of adjustments for pension benefits, equity awards, options, and other earnings.
You also need to calculate the average compensation paid to all NEOs, regardless of whether their pay is linked to performance.
Compliance can be costly and time-consuming, as it requires assembling, tagging, and manipulating a lot of data and then producing reports that not only must be accurate and precisely formatted but traceable back to the source data.
Failure to comply adds another dimension of risk, as it can have legal consequences and impact shareholder confidence in company transparency and reporting.
How to take the pain and cost out of compliance
To ensure accuracy, efficiency, transparency, and overall reduced risk requires a centralized, rules-based compensation management platform.
A compensation platform provides a central location to store all the related data, yielding one consistent version of the truth that is transparent and traceable, and readily available for reporting and analysis. A system should further be able to import and store whatever compensation or performance data is not already housed in the system but may be needed for calculations or reporting.
A compensation system like beqom not only provides the needed transparency and reporting, but provides a full audit trail of compensation decisions and approvals.
To find out how a dedicated compensation platform can facilitate compliance while improving your compensation administration efficiency and reducing costs, contact the compensation experts at beqom.