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The financial reform bill would require companies to adopt "say on pay" and put a host of other executive-comp disclosures into effect.
Alix Stuart, CFO.com | US
June 29, 2010
While the Dodd-Frank Wall Street Reform and Consumer Protection Act is mostly about reforming banks and other companies in the financial-services industry, there are some dramatic new mandates for public companies across all industries buried deep in the 2,000-plus page document.
Offering shareholders a so-called say on pay, or vote on executive compensation, is perhaps the most prominent of those mandates. According to the bill, which is a compromise between the House of Representatives and the Senate but must still pass both houses, companies must offer their shareholders both the vote on pay, which is nonbinding, and a chance next proxy season to vote on how often they want to take the vote — every year, every two years, or every three years.
Assuming the bill passes as is, all public companies will also be required to have a clawback policy regarding how they revoke previously awarded performance-based compensation when a financial restatement is necessary. They will also have to better disclose the relationship between executive pay and performance, as well as the ratio between the CEO's pay and the pay of the average worldwide employee. In addition, all public companies will have to adopt policies banning executive officers from hedging or otherwise betting against their company stock holdings, something most companies already prohibit.
Many of the details of the potential rules remain fuzzy and are subject to further rule-making by the Securities and Exchange Commission. Already, though, it appears that many of the measures, contained in Sections 951-956 of the bill, will create a fair amount of work for companies. "There are a litany of questions companies will have to struggle with in the next six months," says Steve Seelig, senior executive compensation consultant at Towers Watson.
Say on pay is likely one of those, according to a survey Towers Watson ran this month. The survey found that only about 12% of companies consider themselves very well prepared for say on pay, with another 6% either offering it currently or already planning to roll it out. The bulk of respondents, 46%, are only "somewhat prepared," and 22% say they don't know where their company stands.
While the notion of say on pay has been in the works for years, so far only about 80 companies offer it. Some critics point out that many shareholders don't want it, with majorities rejecting the opportunity this year at AT&T, Johnson & Johnson, Dow Chemical, and UnitedHealth, among others. Investors who oppose it generally believe the measure is too binary, and that more-qualitative discussions with company management and board members are more appropriate. There's also some concern that investors will rely too heavily on proxy advisory services rather than their own analysis.
However, this past proxy season showed that shareholders who do vote are no longer simply rubber-stamping proposals. Several companies, including Motorola, Occidental Petroleum, and KeyCorp, saw their shareholders reject their executive-pay packages. Such votes are nonbinding, but generally spark intense discussions and possible changes at companies when shareholders voice disapproval.
As for the steps companies are taking to prepare, the Towers Watson survey indicated that most are reassessing whether or not they truly are paying for performance, and how well that is communicated to shareholders. "Companies over the next six months will likely be asking themselves: How do we best tell our story? What analysis should we be doing? Should it just be what the SEC asks for, or something more?" says Seelig.
That work should also serve companies in trying to comply with the mandate to show how pay and performance are related. In their proxies, public companies must offer "information that shows the relationship between executive compensation actually paid and the financial performance of the issuer," potentially including graphics, the bill says. The SEC must still define exactly which pay metrics it is looking for, and possibly add some detail on what might constitute acceptable measures of financial performance. It could also be a chance for the SEC to advance its long-standing agenda to get companies to disclose more-specific performance targets and the thresholds executives must meet to receive bonuses and long-term incentives in the compensation discussion and analysis (CD&A) section.
Critics of the measure say the language is vague and may lead to inaccurate comparisons, particularly if companies compare the "summary compensation" tally currently in the CD&A — which includes both current pay and future, unrealized pay — with the previous year's financial performance. More important, they charge that the measure could prompt compensation committees to take a "formulaic approach and look only at financial metrics," to the exclusion of more-qualitative, strategic goals such as talent development and product innovation, says Tim Bartl, general counsel for the Center On Executive Compensation, a lobbying group funded by the HR Policy Association, a group of 300 large-company HR executives.
Some uncertainty remains around what the clawback provisions would look like, too. Bartl and others are hoping the SEC will give boards of directors some discretion in whether or not to pursue a clawback, particularly when it pertains to a small amount of money or a former officer who may sue the company. How a clawback would be accomplished is also up for definition. For example, asks Seelig, "What if the person doesn't have the money anymore? Do you sue to recover or just take best efforts? And if they've already paid taxes on it, do you recover it net of taxes?"
The calculation of the ratio of CEO salary to the average salary of all employees, including those around the world, is also likely to create extra work for companies, says Seelig, since most don't have such data easily accessible. Some critics take a darker view. "If you're worried about CEO pay being too high, showing it as a ratio doesn't tell you whether the problem is in the numerator or the denominator," says Charles Tharp, executive vice president for policy at the Center On Executive Compensation. It could even "discourage some job creation" by prompting companies to outsource lower-paying job functions, he says, thus lowering the ratio.