Will revealing more be enough? A new SEC executive compensation proposal has sparked debate about just how to go about disclosing more. Financial Executives Research Foundation looks into the potential impact of the new rules.Call it a tale of two executives who "gave at the office." In 2004, Brad Anderson, the CEO (1) (Chief Executive Officer) The highest individual in command of an organization. Typically the president of the company, the CEO reports to the Chairman of the Board. of Best Buy Inc., voluntarily gave 200,000 of his stock options--worth up to $7.5 million--to non-executive employees of the consumer electronics company.
Conversely, in January, Richard Scrushy, former CEO of HealthSouth Corp. was forced to repay the company $47.8 million in bonuses. Though Scrushy was acquitted of criminal charges in connection with a $2.7 billion accounting fraud, the Alabama Circuit Court ruled that the bonuses should not be retained since they were tied to the company's financial performance (which was later found to be misstated).
This latter case, among other examples related to executive compensation at The Walt Disney Noun 1. Walt Disney - United States film maker who pioneered animated cartoons and created such characters as Mickey Mouse and Donald Duck; founded Disneyland (1901-1966)
Disney, Walter Elias Disney Co., Tyco International For the unrelated division of Mattel, see .
Tyco International Ltd. NYSE: TYC is a diversified manufacturing conglomerate incorporated in Bermuda, with United States operational headquarters in New Jersey. and the New York Stock Exchange New York Stock Exchange (NYSE)
World's largest marketplace for securities. The exchange began as an informal meeting of 24 men in 1792 on what is now Wall Street in New York City. , has led to increased focus on executive compensation. Virtually all of the recent corporate scandals in the U.S. were related to executive compensation in one form or another, notes James T. Brady, compensation committee member of the board of directors of T. Rowe Price T. Rowe Price (NASDAQ: TROW) is an independent global investment management firm and mutual fund manager based in Baltimore, Maryland. It was founded in 1937 by Thomas Rowe Price, Jr..
T. Group Inc. (He also serves as audit committee chair of T. Rowe Price, Constellation Energy Constellation Energy (NYSE: CEG), headquartered in Baltimore, Maryland, generates, trades, supplies, and distributes energy. The company operates over 35 power plants in 11 states (mainly Maryland, Pennsylvania, New York, West Virginia, and California) under its operating Group, McCormick & Co. Inc. and Aether aether: see ether, in physics and astronomy.
god of whole atmosphere. [Gk. Myth.: Jobes, 42]
See : Air Systems Inc.)
"Incentive arrangements led people to do things that were counter to the company's goals and not in the best interest of shareholders. I'd be hard-pressed to find a case where executive compensation was not an element," he says.
Since the task of creating these senior executive incentives falls largely to compensation committees of boards of directors, it would seem that boards of directors may be due for some rethinking on managing the process and then better communicating with shareholders what exactly top executives are getting paid.
In the Sarbanes-Oxley era, direction for boards and other decision-makers may be coming from the U.S. Securities and Exchange Commission (SEC) in the form of more disclosure. On January 17, the SEC announced that it unanimously voted to publish proposed rules to amend disclosure on executive and director compensation. In his opening remarks during at the meeting, Chairman Christopher Cox noted that the commission had not undertaken significant revisions to its executive compensation rules in 14 years, and that current rules don't reflect changes that have occurred in the marketplace. "Simply put," he said, "our rules are out of date."
Components of the SEC Proposal
Current proxy disclosures would be refined to include improved narrative disclosure on the compensation of the CEO, CFO See Chief Financial Officer. and the three other highest paid executive officers, a change from current rules that don't specifically name the CFO. Disclosure is also required for three additional non-executive employees if their pay exceeds that of the top five named executives. The existing compensation committee report and performance graph would be replaced with a Compensation Discussion and Analysis section that focuses on the key factors underlying compensation policies and decisions. Disclosure would be organized into three broad categories:
1) Compensation over the last three years. The current Summary Compensation Table would now include a new total compensation column and a dollar value for stock-based awards measured at grant date, with fair value calculated per FAS 123(R). The All Other Compensation column would now include the accrued increase in the actuarial ac·tu·ar·y
n. pl. ac·tu·ar·ies
A statistician who computes insurance risks and premiums.
[Latin value of pension plans and non-tax-qualified deferred compensation. The threshold for disclosing perquisites Fringe benefits or other incidental profits or benefits accompanying an office or position.
The abbreviation perks is used in reference to extraordinary benefits afforded to business executives, such as country club memberships or the free use of automobiles. would be reduced to $10,000. And, two supplemental tables would report grants of performance-based and other equity awards.
2) Holdings of outstanding equity-related interest (future gains). The Outstanding Equity Awards at Fiscal Year-End Fiscal Year-End
The completion of a one-year, or 12-month, accounting period.
The reason that a company's fiscal year often differs from the calendar year and does not close on Dec 31, is due to the nature of company's needs. Table would show potential amounts that may be received in the future. The Option Exercises and Stock Vested Table would show amounts realized during the last year.
3) Retirement plans and other post-employment payments and benefits. This section would include two tables: Retirement Plan Potential Annual Payments and Benefits, as well as those payments payable to each named executive officer. The Nonqualified Defined Contribution and Other Deferred Compensation Plans table would disclose year-end balance, the executive and company contributions and earnings and withdrawals that apply to that year. This category would also include disclosure and quantification of payments and benefits (including perquisites) payable on termination or change-in-control.
The proposal also calls for a new table on Director Compensation. This would include, but not be limited to, cash fees, equity or other long-term compensation, perquisites, tax reimbursements, contributions to defined contribution plans Defined contribution plan
A pension plan whose sponsor is responsible only for making specified contributions into the plan on behalf of qualifying participants. Related: Defined benefit plan , increases in the actuarial value of all defined benefit plans Defined benefit plan
A pension plan obliging the sponsor to make specified dollar payments to qualifying employees at retirement. The pension obligations are effectively the debt obligation of the plan sponsor. Related: Defined contribution plan , charitable program awards and insurance premiums. A narrative description of compensation committee procedures for determining executive and director pay, security ownership of officers and directors, as well as director independence, would also be detailed.
Disclosure of related-party transactions Related-Party Transaction
A business deal or arrangement between two parties who are joined by a special relationship prior to the deal. For example, a business transaction between a major shareholder and the corporation, such as a contract for the shareholder's company to perform would be impacted, as the threshold would change from $60,000 to $120,000. Form 8-K Form 8-K
The form required by the SEC when a publicly held company incurs any event that might affect its financial situation or the share value of its stock.
See 8-K. disclosures on employment arrangements would be consolidated and modified. Finally, companies must prepare this information in plain English Plain English (sometimes known, more broadly, as plain language) is a communication style that focuses on considering the audience's needs when writing. It recommends avoiding unnecessary words and avoiding jargon, technical terms, and long and ambiguous sentences. .
Potential Challenges to the SEC Proposal
While all could agree with the proposal's intent to foster transparency in executive compensation, there are some concerns that are expected to surface during the comment process. First is the potential overstatement o·ver·state
tr.v. o·ver·stat·ed, o·ver·stat·ing, o·ver·states
To state in exaggerated terms. See Synonyms at exaggerate.
o of specific pay elements. A stock option, for example, would first be disclosed at fair value at date of grant in the Summary Compensation Table. During the vesting Vesting
The process by which employees accrue non-forfeitable rights over employer contributions that are made to the employee's qualified retirement plan account.
Notes: period, the option would be reflected in the Outstanding Equity Awards Table. Once an option is exercised, it would be shown in the Option Exercises Table.
In some situations, both amounts earned and subsequently paid out would be disclosed. Though this raises the risk of double-counting, the proposal states that "the risk inherent in such double disclosure is outweighed by the clearer and more-complete picture it would provide to investors."
Regardless, many say that proxies should address the fact that options granted and disclosed in the summary table may never vest or become exercisable. Further, investors should be able to understand that in some earlier year, an exercised option would have been previously disclosed at date of grant. Accordingly, the proposal encourages companies to use the narrative following the tables (and where appropriate, the Compensation Discussion and Analysis) to explain how disclosures relate to each other.
Additionally, changes in stock option plans could further complicate disclosures. For example, Derrick P. Neuhauser, senior manager, Executive Compensation and Employee Benefits at BDO Seidman BDO Seidman, LLP is the United States arm of BDO International, one of the largest accounting firms outside of the Big Four. History
BDO Seidman, LLP was founded as Seidman and Seidman in New York City in 1910 by Maximillian L. Seidman. , says that some companies are now looking at stock options awards linked to a specific measure, such as comparison of stock price against companies within the same industry. Disclosure would have to clearly address that this type of instrument may never be realized.
A potentially more problematic area relates to change-in-control payments. To quantify amounts payable upon change-in-control would be very speculative, says James F. Reda, corporate governance Corporate Governance
The relationship between all the stakeholders in a company. This includes the shareholders, directors, and management of a company, as defined by the corporate charter, bylaws, formal policy, and rule of law. specialist and co-author of Compensation Committee Handbook. Change-in-control payments are typically 1 percent to 3 percent of a transaction amount, which is normally based on stock price. One would have to make certain assumptions about stock price at the disclosure date, he says, but, when the triggering event Triggering Event
A certain milestone or event that a participant in a qualified plan must experience in order to be eligible to receive a distribution from a qualified plan. occurs, the actual stock price would probably increase--resulting in a different value.
Neuhauser comments that contracts with change-in-control provisions often provide for pension plan credits for additional years in service. From a preparer perspective, this puts the CFO in the position of quantifying payments based on multiple scenarios that, again, may never occur. Calculations may have to consider tax gross-up payments and, Reda adds, there may be several different documents that have change-in-control provisions.
As noted previously, disclosure may be required for three additional non-executive employees. Jill Kanin-Lovers, who chairs the compensation committees of Heidrick & Struggles and Alpharma Inc., is ambivalent about the change. "Back in the days when I was in human resources The fancy word for "people." The human resources department within an organization, years ago known as the "personnel department," manages the administrative aspects of the employees. [as an HR executive at Avon Products Avon Products, Inc. NYSE: AVP is a US cosmetics, perfume and toy seller with markets in over 135 countries across the world and sales of $8.1 billion worldwide as of 2005. Inc., IBM (International Business Machines Corporation, Armonk, NY, www.ibm.com) The world's largest computer company. IBM's product lines include the S/390 mainframes (zSeries), AS/400 midrange business systems (iSeries), RS/6000 workstations and servers (pSeries), Intel-based servers (xSeries) Corp. and American Express American Express (NYSE: AXP), sometimes known as "AmEx" or "Amex", is a diversified global financial services company, headquartered in New York City. The company is best known for its credit card, charge card and traveler's cheque businesses. Co.], there were people in the sales-force who could make a fortune. Compensation could go out the door in different ways, not to the proxy five." She says compensation committees never looked at non-executive pay then. "We never reviewed sales plans." Now, she ponders, "Would the charter of the compensation committee have to be expanded to do this?"
Additional Responsibilities for Compensation Committees
In his opening statement, Cox said the proposal is "about wage clarity, not wage controls," and there appears to be general agreement that the proposal will allow better visibility into and control over whether or not executives are truly being paid for performance.
"I'm delighted that Chairman Cox has taken this as an initial focus," says Roger W. Raber, president and CEO of the National Association of Corporate Directors (NACD NACD National Association of Corporate Directors
NACD National Association of Conservation Districts
NACD National Association of Chemical Distributors
NACD National Academy for Child Development
NACD National Advisory Committee on Drugs ), who supports the disclosure in lieu of regulation or legislation over compensation. "I'm not in favor of putting caps on compensation. If an executive gets $50 million, for example, [boards should] look at the shareholder value and make sure they are connected."
Kanin-Lovers believes that the proposal will force compensation committees to look at pay elements in their entirety. She says that retirement benefits, in particular, were sometimes viewed separately. Those serving on compensation committees, try as hard as they can to have the proxy be transparent. With new rules, she says, "We will have to get educated as a committee to understand what the SEC wants [rather than] just plugging in numbers in numbered parts; as, a book published in numbers.
See also: Number year after year," which will likely encourage companies to start from scratch to start (again) from the very beginning; also, to start without resources.
See also: Scratch .
However, Kanin-Lovers dismisses the notion that full disclosure would create a "me-too syndrome" that would further raise pay levels. People already know what others are getting, she notes, but at least now they would be "comparing something that is accurate." That said, she stresses the importance of data that is clear and understandable.
For some compensation committees, the proposal would only strengthen the practices that do work. Terry Allison Rappuhn, corporate director and compensation committee member of Genesis Health-Care, agrees that the transparency promoted by the SEC proposal is a real advantage. She says that Genesis' ethical obligation to effectively use its resources to care for people is reflected in its compensation policies. Since the company was formed only in December 2003, it was able to foster transparency by following NACD best practices such as using independent consultants, rather than ones used by management, to assist with developing and reviewing its compensation plans.
Timing, Applicability and Implementation
The complete 370-page proposal is open to a 60-day public comment period following publication in the Federal Register (which did not occur by press time). Depending on the specific form filed (10-K, 8-K, etc.), the new rules, if adopted, would become effective anywhere between 60 days to 120 days after publication. Most estimate that the rules would not be in full force until Spring 2007.
Generally speaking, however, some changes are likely to be voluntarily adopted this year. Indeed, as cited in The Wall Street Journal, some larger companies have already included voluntary proxy disclosures that may align with the new rules. Pfizer Inc. provided disclosure on executive perks perk 1
v. perked, perk·ing, perks
1. To stick up or jut out: dogs' ears that perk.
2. To carry oneself in a lively and jaunty manner. , including the methodology used to value benefits such as use of corporate aircraft. Meanwhile, Wachovia Corp.'s Summary Compensation Table gave a dollar value for 2004 option grants, along with a total compensation figure for each top official. The company told the Journal that any changes as a result of new rules would not be substantial.
Though it may not be as easy as it sounds, the bottom line, say experts, is to keep it simple. A compensation committee should not be approving something it does not understand. "Too many times, boards have relied almost solely on compensation consultants and compensation surveys," argues Brady. "While they are capable of providing good information, they should not be viewed as the last word."
Board members, he says, should ask compensation committees the following: "At the end of day, regardless of what other companies give, when you look at compensation arrangements for a certain executive at a specific company--given the performance of that company--are you satisfied that this is fair?" If they can say "yes," Brady says, "I'm OK; I don't need any other info than that."
Cheryl de Mesa Graziano, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. (email@example.com), is Vice President of Research and Operations for Financial Executives Research Foundation (FERF FERF Financial Executives Research Foundation
FERF Far End Reporting Failure
FERF Far End Receive Failure ). A more detailed analysis of the proposal is available on FEI's website.
RELATED ARTICLE: takeaways
* The SEC proposed new rules for disclosing executive and director compensation, the first revision in 14 years.
* The rules would mandate improved narrative on the CEO, CFO and the three other highest paid executive officers. Also, disclosure is required for three additional non-executives if their pay exceeds that of the top five.
* Disclosure would be organized into three broad categories: Compensation over the last three years; holdings of outstanding equity-related interest (future gains); and retirement plans and other post-employment payments and benefits.
* If approved, the rules become effective in Spring 2007.