Those who want to see what the large-company mainstream is doing on comp disclosure might be interested in a recent report, Observations from S&P 500 Pay-Versus-Performance Disclosures, from comp consultant FW Cook & Co. Cook provides analysis of how the 403 companies in the S&P 500 that filed 2023 proxy statements as of June 1, 2023, responded to the SEC’s new rule amendments on pay versus performance.
As you probably recall, the new amendments, adopted in September last year, added new Item 402(v) of Reg S-K, which requires companies to describe the relationship between executive comp actually paid and the financial performance of the company for the five most recently completed fiscal years in proxy or information statements in which executive compensation disclosure is required. Under Item 402(v), companies are obliged to provide a table disclosing specified executive comp and financial performance measures for the principal executive officer and, as a “mean” average, for the other named executive officers. The table must include a measure of total comp (taken from the Summary Comp Table), as well as a measure reflecting “executive compensation actually paid,” a complex calculation prescribed by the rule. In addition, the table must include as financial performance measures the company’s net income and “total shareholder return” for both the company and for its peer group, using either the same peer group used for the performance graph (Item 201(e)) or a peer group used in CD&A to disclose benchmarking practices. Also required in the table is a financial performance measure selected by, and specific to, the company that the company believes “represents the most important financial performance measure,” not otherwise in the table, that the company uses to link compensation actually paid to the named executives to company performance for the most recently completed fiscal year (referred to as the “Company-Selected Measure”). A CSM may be a non-GAAP financial measure, consistent with CD&A; however, if a NGFM is used, the company must provide disclosure regarding the calculation of the number from the audited financial statements.
The company is also required to “clearly describe,” using the information presented in the table, the relationships between compensation actually paid to the PEO and the mean average paid to the remaining NEOs and three measures of the company’s financial performance: cumulative TSR; net income; and the CSM, again over the five most recently completed fiscal years. The company must also describe the relationship between the company’s TSR and the weighted TSR of its peer group over the same period. The required “clear description” of the relationships between CAP and the financial performance measures included in the pay-versus-performance table may be provided in narrative, graphical, or combined narrative and graphical format.
Finally, the company (other than an SRC) must also provide an unranked tabular list of three to seven of the most important financial performance measures—which must include the CSM—used by the company to link compensation actually paid to the NEOs during the last fiscal year to company performance. Companies may also include non-financial performance measures in this list, but “only if such measures are included in their three to seven most important performance measures, and they have disclosed at least three (or fewer, if the registrant only uses fewer) most important financial performance measures.” Companies may also voluntarily provide supplemental measures of compensation or financial performance or other supplemental disclosures, so long as they are “clearly identified as supplemental, not misleading, and not presented with greater prominence than the required disclosure.” (See this PubCo post.)
Among Cook’s key findings:
- The top three most common financial performance measures that companies chose as their CSMs were profit (56%), revenue (17%) and returns (12%). Cook noted that examples of profit measures included EPS, EBIT, EBITDA and operating/pretax profit; examples of returns measures included return on equity, return on assets and return on capital. Interestingly, Cook reported that only three companies said that they did not use any financial performance measures in their executive comp programs and thus did not provide CSMs. The most common practice, Cook reports, was to use the financial performance measure with the highest weighting in either the company’s annual (71%) and/or long-term incentive program (54%) (some used both) not otherwise required to be disclosed in the PVP table. Because many companies use non-GAAP measures in their incentive plans, most companies (84%), as Cook anticipated, used a non-GAAP CSM. Only eight companies included supplemental measures.
- In the required tabular list of three to seven financial performance measures, the majority of companies included profit (88%), TSR (55%), and revenue (51%); only 21% of companies included non-financial performance measures, primarily ESG and safety. Cook noted that “many companies included multiple measures from the same category (e.g., relative TSR and absolute TSR). Although more than one list is permitted for different executives, almost all companies included only one list for all. Most companies provided three (34%), four (25%) or five (20%) financial performance measures, even though only three financial performance measures were required.
- Most companies (76%) used their 10-K published industry or line-of-business index as their TSR peer group. Cook observed that one of the main reasons for selecting an index used in the Form 10-K is that “it avoids the need for additional calculations when changes are made year-over-year to a custom peer group.”
- Most companies (91%) used graphs/charts for the clear description requirement, including many that used graphs/charts together with narrative, while the remaining 9% used a narrative-only description.
- Most companies (80%) included the PVP disclosure near the end of the proxy statement, following the CEO Pay Ratio disclosure and termination tables.
Cook also observed that, in comparing the SCT and PVP tables, the “key take-away is that the CAP values will differ from SCT-disclosed amounts based on short-term stock price performance. The degree of difference, however, depends on many factors including leverage in the overall program (e.g., use of stock options versus other equity awards), correlation between metrics used in the incentive structure and changes in shareholder value, and overall pay mix (e.g., cash versus equity).”