Financial regulatory authorities have paid close attention to executive compensation structures during the past few years. Now, the SEC is adopting rules related to pay versus performance. Recently, the SEC announced that these proposed amendments would require registrants to disclose specific information regarding the relationship between executive compensation and the performance of that specific executive. These rules are mandated under the Dodd-Frank Act, and the commission first proposed disclosure rules in 2015. Recently, the SEC reopened the comment period on those proposals, and rules related to pay vs. performance disclosure are going to go into effect.
SEC Chair Says This Information Is Valuable To Investors
The SEC wants to make sure that investors have access to all the information they need to make adequate financial decisions with their money. According to SEC Chair Gary Gensler, the public has made it clear that it cares about executive compensation structure. He stated, “Today’s rule makes it easier for shareholders to assess a public company’s decision-making with respect to its executive compensation policies.”
Under this rule, investors should have access to flexible disclosures that allow companies to easily describe the performance measures it cares about most when deciding how much executives should be paid. That way, investors have comparable, consistent, and clear information they can use to decide whether they feel the compensation structure of executives is appropriate. A few examples of key investor rights include voting power, the right to transfer ownership, dividends or distributions, access to certain corporate documents, and the right to sue for illegal activity.
If investors believe that the company is compensating executives fairly, they may decide to continue investing with that company. On the other hand, if investors feel that executives are being paid too much in light of their performance, they might decide to take their money elsewhere.
How Must Executive Compensation Be Reported Under the New Rules?
Under the rule, issuers must provide a table that discloses how executives are being compensated and how their financial performance has been measured for the five prior fiscal years. There are a few ways that companies can report financial performance, but companies will be required to report:
The total shareholder return
The company’s net income
A specific measure of financial performance chosen by the company itself
Companies will also be required to describe the relationship between how much the executive has actually been paid and his or her performance.
Issuers will be asked to disclose at least three (and up to seven) financial performance measures that the company feels are most important when deciding executive compensation. That way, investors can see how companies have decided to compensate their executives, why they feel that compensation is appropriate, and how the compensation structure of that company compares to other companies in the same industry. Examples of performance measures include changes in profit margin, changes in revenue growth, total market share, and overall share price.
Of note, smaller companies will also be required to disclose specific information, but they might not be required to disclose the same amount of information.
Executive Compensation Could Play a Major Role in Investor Decision-Making
Right now, this release has been published on the SEC’s website, and the rules will become effective 30 days after they have been published in the Federal Register. Companies will need to think carefully about how they document executive compensation and what they need to do to comply with the new rules. Investors could take a close look at how much money companies pay their executives and whether they feel this compensation is worth it.