Labor Day informally signals the end of summer as students go back to school and businesses gear up for the year-end push. In a similar vein, President Obama recently urged federal regulators to get back to work and issue overdue regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act.
All indicators are pointing to the Securities and Exchange Commission issuing guidance in the near term about how to disclose the ratio of CEO pay to the median for all other employees. (See “Dodd-Frank Pay Ratio Rule — Coming Soon?” Executive Pay Matters, July 18, 2013.) While it’s hard to say what might follow the pay ratio rule on the list of regulators’ priorities with regard to executive compensation, many companies continue to await some SEC ground rules for disclosing pay-for-performance alignment.
COMPANIES AWAITING GUIDANCE
Research conducted by Towers Watson suggests that about one-quarter of large U.S. companies already provide detailed disclosures of pay-for-performance alignment in their proxies and about double that number routinely assess pay-for-performance outcomes, even though many don’t disclose their analyses because they’re not yet required to do so.
Of course, there are two main elements to consider in deciding how to analyze pay-for-performance alignment. With regard to the first element, the following table highlights the most common pay definitions used for these analyses.
As shown in the table below, companies are increasingly focused on alternative pay definitions in their evaluation and disclosure of pay-for-performance alignment. Earned (realized) pay has taken the lead over other forms of pay, which is not surprising for a variety of reasons. Among them, earned pay is intuitive, easy to calculate from current disclosures and may be the most in sync with the Dodd-Frank language that calls for the disclosure of “compensation actually paid.”
Also noteworthy is that the use of realizable pay has pulled even with Summary Compensation Table (SCT) pay and is gaining momentum as companies seem to be concluding that SCT pay doesn’t accurately reflect pay earned for the year (and we tend to agree, despite this being the form of pay that proxy advisors are most closely focusing on).
TIME’S A WASTING
With the summer now behind us, companies should begin to update (or commence) their pay-for-performance analyses. At this juncture, given the lack of regulatory guidance, even companies that don’t plan to disclose the results of their analyses should at least begin to examine how earned pay compares to performance. We also think it’s important for companies to review how Summary Compensation Table pay aligns with performance in order to understand the likely views of proxy advisors. Finally, we would suggest that best practice is also to evaluate the pay-for-performance story using realizable pay, which is increasingly being considered by proxy advisors and other corporate stakeholders.
Clearly, these alternative pay definitions aren’t without their nuances, which we’ll explore in a future blog post.
Steve Kline, CFA, is a director in Towers Watson’s Pittsburgh office who leads the firm’s executive compensation consulting practice in the east central United States. Katherine Edwards is an executive compensation consultant in the firm’s San Francisco office. Email firstname.lastname@example.org, email@example.com, or firstname.lastname@example.org.