SEC Adopts Pay Versus Performance Disclosure Rules

On August 25, 2022, the Securities and Exchange Commission (SEC) adopted final “pay versus performance” (PvP) disclosure rules, which were initially required by the Dodd-Frank Act of 2010. The SEC’s adopting release cites the purpose of the rule from the Dodd-Frank legislative history as addressing a “significant concern of shareholders” by requiring disclosure of the relationship between executive pay and performance. The new rule expands Item 402 of Regulation S-K and requires reporting of pay of the principal executive officer (usually the CEO) versus company performance separately from average pay of the other named executive officers (NEOs) as a group versus company performance.

At a high level, the rule requires disclosure of the following:

• Inclusion of a new PvP table showing, for the last five fiscal years (or, for smaller reporting companies, for the last three fiscal years):
  • Total compensation as reported in the summary compensation table and the total compensation “actually paid” to the CEO.
  • An average, for all other NEOs, of total compensation as reported in the summary compensation table and the total compensation “actually paid.”
  • Total shareholder return (TSR) for the reporting company.
  • TSR for the company’s peer group.
  • Net income for the company.
  • A “company-selected measure” of performance.
• An additional narrative or graphical description of the relationship between the executive compensation actually paid and the three performance measures (TSR, net income and a company-selected measure) over the period of time covered by the table.
• A tabular list of the three to seven most important performance measures the company uses to link executive compensation actually paid to company performance.

Companies Required to Comply

The rule applies to all public reporting companies, except for emerging growth companies, registered investment companies, foreign private issuers and companies that only report under Section 15(d) of the Exchange Act and thus are not subject to proxy filing requirements. Smaller reporting companies (SRCs) are eligible for scaled disclosures, as described below.

Compliance Dates

The PvP disclosure must be included in any proxy statements that are required to include executive compensation disclosures pursuant to Item 402 of Regulation S-K for fiscal years ending on or after December 16, 2022. However, the initial disclosure is only required to include three years of information, adding one additional year each year until five years of information is presented. For SRCs, only two years of information are required to be disclosed in the initial disclosures.

Location of Disclosure

The PvP disclosure can go anywhere in the proxy statement and does not need to be included in the Compensation Discussion & Analysis section.  The disclosure will be considered “filed” (as opposed to “furnished”) and companies must tag certain of the data and disclosure in XBRL, as described below.

Substance of the Required Disclosures

PvP Table

The first step is to prepare the table as set forth in the exhibit to this summary. The information for each column and row is described below:

COLUMNS

Summary Compensation Table Total for CEO – Disclose the total compensation calculated in accordance with and reported in the Summary Compensation Table for the CEO; the number should be identical to the total number in the Summary Compensation Table.

Note: If more than one person served as CEO during the fiscal year, provide the total compensation for each person by adding an additional column. A footnote to the table should list the name of each CEO.

Average Summary Compensation Table Total for Other NEOs – Calculate the average of the total compensation amounts reported in the Summary Compensation Table for the NEOs other than the CEO.

Note: A footnote to the table should list the name of each NEO for each year presented.

Compensation Actually Paid to CEO – Starting with the CEO’s total compensation from the summary compensation table, adjust for the pension plan value and equity awards as described below:

Note: Except for the pension value and equity awards adjustments described below, no other adjustments can be made to the Total Compensation amount disclosed in the Summary Compensation Table. Accordingly, companies cannot adjust the total compensation amount for sign-on bonuses, severance payments or other amounts even though such amounts may otherwise skew the total compensation amount reported.

Pension Value: Deduct the aggregate change in actuarial present value of the accumulated benefit under all defined benefit and pension plans in that fiscal year and then add (i) the service cost, calculated as the actuarial present value of the officer’s benefit under such plans attributable to services provided during the fiscal year, and (ii) if a new plan has been adopted, or a plan has been amended, during the applicable fiscal year, the prior service cost, calculated as the entire cost of benefits granted (or credit for benefits reduced) that are attributed to services rendered in periods prior to the amendment/adoption.

• With regard to the service cost attributable to services provided during the applicable year, no amount is deducted if the change in pension value was negative.
• The “service cost” and “prior service cost” must be calculated using the methodology as used for the company’s financial statements under GAAP.
• The vested or unvested status of pension benefits is disregarded.
• Changes in amounts due based on differences in actuarial assumptions are excluded.
  

  This adjustment to total compensation serves to approximate the additional funding that the company must set aside to pay for defined benefit and pension benefits.

  SRC Note: The pension-related adjustments do not apply to SRCs because they are not required to disclose the change in pension value in the summary compensation table.

  Equity Awards: Replace the equity award values in the Summary Compensation table by deducting the amounts reported in the Stock Awards and Option Awards columns (i.e., the grant date fair values of such awards) and adding:

  1. For equity awards granted in the applicable fiscal year that are outstanding and unvested at year-end, the year-end fair value of any equity awards; plus
  2. For equity awards granted in prior years that are outstanding and unvested at year-end, the change in the fair value of the awards as of the end of the applicable fiscal year (as compared to the end of the prior fiscal year); plus
  3. For equity awards that are granted and vest in the applicable fiscal year, the fair value as of the vesting date; plus
  4. For equity awards granted in any prior fiscal year that vest in the applicable fiscal year, the change in fair value as of the vesting date (as compared to the end of the prior fiscal year); minus
  5. For awards granted in prior fiscal years that are determined to fail to meet the vesting conditions during the applicable fiscal year, the fair value of the awards as of the end of the prior fiscal year; plus
  6. The dollar value of any dividends or earnings paid on stock or option awards in the applicable fiscal year prior to the vesting date that are not otherwise reflected in the grant date fair value or any other component of the total compensation for the applicable fiscal year.
  • Include footnotes describing any valuation assumptions that materially differ from those disclosed at the time of grant.
  • The fair value calculations required to determine the add-back amounts are calculated consistent with fair value calculations required for GAAP financial statements, which will require coordinating with the financial accounting team to prepare the calculations.
  • If at any time in the last completed fiscal year, the company adjusted or amended the exercise price of a stock option or SAR held by an NEO (whether by amendment, cancellation, replacement or other means) or otherwise materially modified such awards, the change in fair value must take into account the excess value, if any, of the modified award over the fair value of the original award as of the date of modification.

Disclose in a footnote to the table each amount added or deducted from the total compensation amounts.

Average Compensation Actually Paid to Other NEOs – Using the same methodology above, adjust the total compensation for each other NEO and calculate the average of the adjusted total compensation amounts for all NEOs other than the CEO.

• Disclose in a footnote to the table the names of each executive officer included in each fiscal year.
• Disclose in a footnote to the table each amount added or deducted from the total compensation amounts by name of each officer.

Total Shareholder Return – The company’s annual cumulative TSR calculated and presented as a dollar value based on an investment of $100, using the same methodology as in the existing stock price performance graph included in the annual report.

Peer Group Total Shareholder Return – The cumulative annual TSR of the companies in the company’s peer group, weighted by market capitalization, calculated and presented as a dollar value based on an investment of $100. Use either the same index or peer group used in the stock price performance graph or, if applicable, the peer group used for purposes of determining executive compensation as disclosed in the CD&A.

• If the peer group is not an industry or line-of-business index, disclose the identities of the peer group members in a footnote to the table.
• If the company changes its peer group from one year to another:
  • Disclose the peer group TSR for the new peer group for all years presented in the PvP table.
  • Explain in a footnote the reasons for the peer group change.
  • Compare the company’s TSR to both the new peer group and the prior peer group.

  SRC Note:  The peer group TSR is not required for SRCs.

Net Income – The company’s GAAP net income for the year.

Company-Selected Performance Measure – A financial performance measure that the company has determines represents the most important financial performance measure for the most recently completed fiscal year.

• The measure must be one of the following:
  • A GAAP measure or measure derived wholly or in part from a GAAP measure.
  • Stock price.
  • Total shareholder return.
• If the measure is a non-GAAP measure, must disclose how the measure is calculated from the comparable GAAP financial measure, consistent with disclosure of non-GAAP measures used for incentive plan purposes generally.
• This measure may change from year-to-year, and, in many cases, may be the financial performance measure that contributes the greatest percentage in determining the annual incentive award payouts for the year.

SRC Note: The company-selected performance measure is not required for SRCs.

Voluntary Disclosure of Other Performance Measures

• Companies may, but are not required to, report additional financial or non-financial performance measures in the table.
  • Any such voluntary measures must not be misleading or obscure.
  • Any such voluntary measures cannot be more prominent than the required measures.

ROWS

Ultimately, information must be provided for the five most recently completed fiscal years, subject to the transition and scaled disclosure rules below.

• For the initial filing, only three years of information are required. One additional year should be added in the second and third years until the table includes five years of information.
• Newly public companies only need to include the most recently completed fiscal year if they were not a reporting company in prior years.

SRC Note: Smaller reporting companies only need to include the two most recently completed years in the initial filing, and then three years in all subsequent filings.

Narrative or Graphical Description of Relationship Between Pay and Performance

The next step is to prepare a description of the relationship between executive pay and performance. 

• The description must describe the relationship between:
  • Executive compensation actually paid to the CEO and other NEOs and the company’s TSR across the last five years (or shorter period, if applicable).
  • Executive compensation actually paid to the CEO and other NEOs and the company’s net income across the last five years.
  • Executive compensation actually paid to the CEO and other NEOs and the Company-Selected Measure.
  • The company’s TSR and the peer group TSR.
• The disclosure can be a narrative, a graph or a combination of the two. Examples of graphic disclosures are:
  • A scatterplot providing data on executive compensation actually paid and a change in a financial performance measure on parallel axes over the required number of fiscal years.
  • A table showing the percentage change over each year of the required fiscal years in both executive compensation actually paid and a financial performance measure together with a brief discussion of how those changes are related.
  • A line graph, showing TSR coupled with a corresponding line showing the executive compensation paid.

Tabular List of Most Important Performance Measures

In addition, companies are required to prepare and disclose a list of the most important measures used to link compensation actually paid for the most recent fiscal year to company performance.

• The list of measures should include no fewer than three nor more than seven measures.
  • If fewer than three financial performance measures were used by the company to link compensation and performance, the list must include all the measures, if any, that were used.
  • As long as at least three financial performance measures are listed, the company may also include non-financial performance measures in the list.
  • The list does not need to be “ranked” in order of importance.
  • The tabular list can be broken down into multiple lists if desired, including one for the CEO, one for other NEOs as a group or one for each individual NEO.

SRC Note: Smaller reporting companies are not required to comply with this tabular list requirement.

XBRL Data Tagging

Using Inline XBRL:

• Separately tag each value in the PvP table.
• Block-text tag the footnote, PvP description of relationship of PvP and tabular list of measures.
• Tag specific data points within the footnotes, description of relation of PvP and tabular list of measures.

SRC Note: SRCs are not required to disclose using XBRL formatting until the third year of disclosure.

Include Required Disclosures in Proxy Statement

• Include the table and related disclosures in any proxy statement including executive compensation disclosure required by Item 402 of Regulation S-K for a fiscal year ending on or after December 16, 2022.
  • The table and related disclosures need not be included in the CD&A but could appear elsewhere in the proxy statement. Companies that have been providing additional voluntary pay versus performance disclosures, similar to the manner presented in the required disclosures, are likely to include the disclosures in the CD&A, and those that do not will include the disclosures elsewhere.

Preparing for Your First Disclosure

• Consider doing a “dry run” by preparing the new PvP table and related disclosures based on the last fiscal year. This will give the company a sense for what the disclosures might look like and how the information is compiled.
• Leave sufficient time to draft the extensive required footnotes to the disclosures.
• Prepare the list of the most important performance measures and have early discussions with the compensation committee to ensure alignment on the measures to be listed.
• The modifications required to calculate compensation actually paid to executives will require complex adjustments to equity award and pension benefit values and will require coordination with the financial reporting team.
• Consider whether any aspect of the new disclosures in fact reflects the compensation committee’s thinking and process for setting executive compensation, such that the new disclosure should be included in the CD&A or whether it should be included elsewhere in the proxy statement.
• If the new required PvP disclosures do not accurately reflect how the compensation committee thinks about aligning pay and performance (which we believe will often be the case), consider whether other existing disclosures adequately address this or whether other disclosures in the CD&A should be enhanced.

* These items are not required for SRCs.