Risk & Compliance

SEC Plan Could Blur Compensation Reports

The commission's proposals on pay disclosure might hurt shareholders' ability to compare executive compensation from year to year and from company ...
Helen ShawMarch 1, 2006

To the confusion of shareholders, strange rises and dips in the reported compensation of companies’ highest-paid executives could be among the results of the new Securities and Exchange Commission pay-disclosure proposals.

In other words, say corporate compensation advisers, an executive could appear in the top five one year and be bumped in the next for purely extraneous reasons. The proposed proxy disclosures, introduced by the SEC on January 17, could also hurt shareholders’ ability to compare executive compensation from year to year and from company to company.

The result could make a hash of the SEC’s avowed goal of transparency in executive-compensation reporting. Particularly worrisome are proposed disclosures of the earnings on all deferred compensation and of the present value of incremental rises in pension accounts, including supplemental executive retirement plans. (SERPs, as they’re called, can be in the form of defined-benefit or defined-contribution plans; typically they’re provided only to C-suite executives.)

The methods for calculating pension benefits could spawn unwarranted bumps in reported compensation and make comparisons more difficult, maintains Janet Den Uyl, a partner at Mercer Human Resource Consulting.

Reporting the incremental increase in the value of a pension could temporarily land a lower-paid executive in the top five, Den Uyl suggests. It’s plausible, for instance, that a newly appointed executive officer with five years of service could enter a defined-benefit SERP. If the executive’s benefits accrue based on years of service and final average pay, the value could be many times annual salary. That accrual could easily bump the officer into the top five in the first year, when the bulk of the total pension value would be reported. But in the next year, notes Den Uyl, the company would only report a single-year increase in the pension value, resulting in a relatively minor accrual — and a fall from the top earners’ list.

Deferred salary or bonus payouts could also spur volatility in the top five. In some instances, executives may choose to defer part of their salary and all of their bonus into a voluntary deferred-compensation plan (in which all employees can participate) or a defined-contribution SERP (also known, in part for its exclusiveness, as a “top hat” plan), among other options. Some voluntary deferred-compensation plans, including 401(k)s, provide participants with tax benefits and company matches.

Currently, such deferred payouts aren’t reported in the proxy’s compensation table, except for income from company contributions and earnings in excess of an index.

The effect of the SEC proposals on a top-five ranking depends on how much an executive has chosen to save and whether the investments fared well or poorly in a given year. For example, if two executives earned the same salary and bonus but one chose to defer her bonus, that executive would have a large account balance plus investment earnings, which could land her in the top five, depending on the markets’ performance. The executive who chose not to defer, notes Den Uyl, could have invested in the same mutual funds as the other executive and yet not made it on the top-five list.

Other extraneous factors could also send reported income skyrocketing or plummeting. The estimated value of a pension could change if a company revises its discount rate or mortality-table assumptions, says Diana Scott, a consultant at Towers Perrin. Companies might also revise their benefit-obligation assumptions in different years, seemingly increasing executive-pension benefits, adds Scott — except that half the growth in the benefits might stem from those changes in assumptions.

The complex brew of actual and earned compensation required under the SEC proposals could also blur reporting, according to Scott. The proposed summary table includes compensation currently earned and paid, compensation currently awarded but possibly earned and paid in the future, and compensation earned for current and prior years but paid in the current year.

Towers Perrin plans a comment letter to the SEC that will propose two tables: one for compensation granted during the year and one for compensation realized during the year. “It is no more disclosure than what the SEC is proposing,” says Scott, “but it could be structured in a more meaningful way by doing an apples-to-apples comparison.”

For shareholders, the implications of the SEC’s current proposals could be dire, Scott maintains. Without understanding all the components behind the numbers in the proxy disclosure, shareholders might see large accruals of executive benefits in a given year and mistakenly conclude that those executives are overpaid, she says.

Another consequence could be the “Lake Wobegon” effect — the tendency to treat all members of a group as above average. Executive pay could ratchet upward, says Scott, when company peers say, “those guys are getting this, so we should be paid that well, too.”