Many companies will shortly be making their first attempt at showing why their senior executives are worth their salt. 

The newly required disclosures stem from the pay-versus-performance disclosure requirements adopted by the Securities and Exchange Commission in August. Under the new rule, large U.S. public companies are now required to include a table within their filings that discloses the relationship between executive compensation and their organization’s financial performance. 

The new disclosures are meant to make it easier for shareholders to directly compare executive compensation with their company’s financial performance but the process will pose new and significant burdens for some companies, according to a report from the Harvard Law School Forum on Corporate Governance. At this juncture, it’s too soon to tell whether companies will get it right. 

“The SEC hasn’t issued any FAQs for the rule, so we really won’t see best practices emerging until next year,” said Laura Hay, lead consultant at Meridian, and for all the nuanced things within the rule, companies are having to make a judgment call on how to handle them right now.”

A host of new calculations

While companies have previously disclosed executive comp information, the new SEC requirements — formally known as Item 402(v) of Regulation S-K — involve some tricky calculations for finance teams preparing them. These include: 

• a table with the compensation of principal executive officers that are “actually paid” and an average compensation for other named executive officers, typically the CFO, CEO and COO. 
• a clear description of the relationship between the executive compensation actually paid and total shareholder return as well as the TSR of their peer group. 
• an unranked list of between three and seven of the most important financial performance measures used to link executive compensation and company performance. They also may include non-financial performance measures in the unranked list, as long as at least three financial metrics are included. 

Hundreds of valuations

As a whole, determining the value of compensation actually paid is a new concept, and estimating the fair value of awards vested during the year presents a challenge.

Pam Greene, partner at Aon, works on the company’s equity and corporate governance team and said the new requirements have opened up an unexpected can of worms. 

“They’re talking about having to perform hundreds of valuations and calculations just to comply with this rule,” Greene said, adding that that volume of information is a recipe for mistakes. Furthermore, the expense, the short timeframe companies have to prepare, and the lack of clarity from the SEC has made it even more challenging, she adds.

Meanwhile, the available pool of external experts to do the work is shrinking. As Dan Kapinos, partner and the global practice leader for Aon’s equity services team explains, it’s a lot of work to pull together years of information in a relatively short time frame, and many of the vendors that typically do fair value calculations aren’t doing the type of calculations required by the new rule. “It’s shrunk the number of vendors, making it even harder for companies to get the work done,” he says.

Furthermore, many companies use their stock plan administration system for fair value calculations, he adds, but for the most part, these programs will have to be customized. Not only are there a limited the number of parties that companies can go to for support with all the calculations that exist with this new rule, there are also areas open to interpretation, he said.

The most difficult aspect of the disclosure is going to be finding the internal capacity to perform the calculations and having sufficient knowledge of how to properly model deeply in- or out-of-the-money awards, according to Oksana Westerbeke, partner in valuation and modeling practice at accounting and advisory firm Grant Thornton. 

For companies that granted a lot of options, vesting dates could be staggered and spread over a long term. In addition, standard grant date valuation methodologies may not be appropriate measure of certain awards.

Where should you be?

The onerous and time-consuming work could be delaying how quickly companies can complete the process of meeting the new requirements.

There are a number of companies that would like to show a draft of their reports to their board in February, but because the volume is so high they’re not going to hit that milestone, said Greene. “If a company hasn’t started on this yet, they’re in for a very painful February and March,” she said.

What should companies be doing now to be ready for proxy season? For those companies that have yet to embark on this journey, the first thing to do is to fully understand the rules, said Meridian’s Hay. 

“It’s so important to understand what’s required and understand who needs to be involved in the process, both internally and externally. For example, if you have executive retirement plans, she added, you might have to go to your plan administrator and get information from them,“ Hay said.

The second step is to seek external advice on the calculation of compensation actually paid, and collect the data your advisers need now, she said. Companies should also keep their first disclosures simple.

As to whether the pay-versus-performance disclosure requirements will help investors better understand how top executives are supporting the business, this might not be evident for a couple years, according to Kapinos.

“It’s tough to call anything best practice at this point, and in a lot of ways we don’t understand how investors are going to react to it, or the weight proxy advisors are going to put on it,” he said.