The SEC recently proposed new rules expanding the disclosure of executive pay and corporate governance practices. Like much of what is required to be disclosed in corporate proxies, the proposed rules have some superficial merit. And, who wants to be the first to raise their hand against disclosure?
But take a deeper look and the proposed rules add little value to an investment decision and have a Maginot line-fighting-the-last-war feel about them. In fact, taken together, the ever-expanding proxy disclosure requirements may very well be reducing management accountability rather than enhancing it.
The proposed rules are awaiting public comment and, if finalized, effective for Proxy’s published in 2010 based on fiscal years starting in 2009. The SEC has already put together a great summary of the proposed rules on their website so we will not regurgitate the details here. Below we briefly describe the five changes related to disclosure along with our comments.
1. Expand the the Compensation Discussion and Analysis Section (CD&A) of the Proxy to provide information on the relationship between risk and compensation; this disclosure covers compensation policies throughout the organization and not just for Name Executive Officers.
We have commented on this topic several times. Risk is an integral part of business and its assessment is subjective. It seems somewhat fatuous for the SEC to ask companies to identify those areas of compensation that encourage “excessive or inappropriate” levels of risk.
The bland generalities of four of the five examples provided in the proposed rules show just how problematic it is to disclose how risk may or may not be properly compensated. The SEC summary states that “situations that could potentially trigger discussion and analysis include, among others, compensation policies and practices:
- At a business unit of the company that carries a significant portion of the company’s risk profile;
- At a business unit with compensation structured significantly differently than other units within the company;
- At business units that are significantly more profitable than others within the company;
- At business units where the compensation expense is a significant percentage of the unit’s revenues”
Obviously, these examples could apply to just about any company and provide little or no guidance on when compensation policies might encourage inappropriate risk-taking. The last example the SEC provides is somewhat more useful: a company should consider disclosure and discussion around bonus practices when they “are awarded upon accomplishment of a task, while the income and risk to the company from the task extend over a significantly longer period of time”. It is not uncommon in our experience for companies to grant a sales compensation on the value of a long-term contract without regard to the ultimate revenue received from the contract or to grant a bonus based on closing a transaction without regard to the ultimate success of the transaction.
2. Change the Summary Compensation Table (SCT) to show the market value of an equity grant rather than the accounting value. For example, under current rules, if a company grants options to an executive in 2009 with a black-Scholes value of $6,000, that vest over a three year period, the Summary Compensation Table should show a value of $2,000 in the 2009, 2010 and 2011 fiscal year proxies. These values are consistent with how the option is expensed on the Company’s books. Under the proposed rules, the full $6,000 would be shown as compensation in 2009.
This change comes under the heading of six of one, a half-dozen of the other. Both the current and proposed changes have their pros and cons. The current approach smooths the costs of equity grants from year-to-year and provides more year-to-year stability to the list of “Named Executive Officers”. The proposed approach provides a better measure of the annual compensation decision made by the Board. However, as the full grant value is already disclosed to interested investors in the Grant Award Table, the change would not seem to be worth the effort – particularly as the SCT will need to be restated for prior years to provide consistent values.
3. Expand information provided around the relationship and compensation of any compensation consultants used by the Board. If an executive compensation consultant provides services to the Company beyond executive pay advice, then the Company would be required to disclose the compensation paid to the consultant for compensation-related services as well as any other services provided to the Company.
It is hard to argue against more disclosure – particularly around such a sensitive subject. However, we would prefer shareholders be encouraged to focus less on the underlying motivations of executive pay consultants and more on a) whether board members are rigorous and professional in their review of compensation and b) whether compensation is aligned with results and/or performance and is appropriately competitive. The publicly available information to make these judgments is plentiful.
4. Enhance the information provided about the background of Board Members and Nominees to describe the particular experience and skills that qualify that person to serve as a director of the company and as a member of any committee that the person serves on.
We are not sure we would want to invest in a company that was not already demonstrably choosing board members qualified for their posts. If a company changes board members or chooses more wisely because of required shareholder disclosure – we would be selling.
5. Provide information about the Company’s leadership structure and the Board’s role in the risk management process. In particular, disclose whether and why they have chosen to combine or separate the principal executive officer and board chair positions.
See comment on Rule 4 above.
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Our general concern with increasing required disclosures is that after a certain point they run the risk of reducing Board and management accountability rather than enhancing it. Something along the lines of how credit card companies, by disclosing everything, disclose almost nothing.
Instead of focusing on results, Boards may be comforted by the ability to point to all the i’s they dotted and t’s they crossed. The executive pay program may have ineffective incentives and a counterproductive risk profile but the Board can point to the advice of a compensation consultant that has no conceivable conflict of interest and complete disclosure about their process for reviewing risk.
Companies must comply with the proxy disclosure requirements but it would be unfortunate if Boards let the disclosure rules distract them from the business judgments that they are paid to make.
