In October 2022, the SEC issued a new rule, Item 402(v) of Regulation S-K, requiring registrants to include disclosures on pay versus performance (PvP) in their proxy statements. This requires companies to calculate Compensation Actually Paid (CAP) using the value of equity awards paid to named executive officers (NEOs) under a new, prescribed methodology. Registrants are also required to compare CAP to the shareholder return for both the registrant and peer group, to net income, and to a company-selected financial measure such as earnings per share.
Registrants excluding smaller reporting companies (SRCs) are only required to provide information for three years in Year 1, with one additional year presented in both Years 4 and 5, to eventually present at a total of five years in the PvP table. SRCs only have to present two years in Year 1.
Below are some observations on implementing PvP to date:
PvP Impacts Nearly All Public Companies
All public companies are impacted beginning with fiscal years after Dec. 15, 2022. However, emerging-growth companies, registered investment companies, and foreign private issuers are exempted.
SRCs and newly public companies get relief on the number of historical periods to include in the filing, but they are not exempt from this requirement.
The PvP Disclosure Is More Than Just One Simple Table
In addition to a detailed revaluation of compensation, companies must disclose multiple tables on the calculations of CAP, graphs on the relationship between PvP, and narrative disclosures. This requires collaboration between accounting, financial reporting, legal, and compensation teams.
Revaluing Equity Awards Under the SEC-Prescribed Methodology Is More Time-Consuming Than a Lot of Companies Expect
Companies will need to invest time and resources with the necessary skills to collect, analyze, and remeasure the equity award data accurately. In particular, the revaluation of stock options can be extra demanding as it requires updating assumptions, such as volatility and expected remaining term, for each measurement date.
Additionally, in Year 1, companies need to perform these calculations for three years of historical information (two for SRCs), adding to the demand on resources.
CAP May Be Negative for Companies With Declining Stock Prices
Especially if the NEOs are paid heavily in equity, CAP can be negative if the company has a declining stock price. Companies should still disclose the negative amount.
CAP Doesn’t Actually Reflect Compensation Paid to Executives
As noted above, CAP is based on a prescribed methodology and not tied to amounts actually paid to executives. While this may provide better consistency when assessing CAP across companies, it can create additional challenges for companies when describing their compensation strategies to investors.
Companies Have Flexibility on How to Present the Relationship Between Their Performance and Executive Pay
Companies have the option to present the relationship between their company’s performance and executive pay in a narrative or graphical format. However, the vast majority of companies are presenting graphically.
It Can Be Difficult to Identify the Financial Performance Measures in Year 1
Non-SRC companies must disclose the most important financial performance measure used to link CAP to the registrant’s NEOs, as well as an unranked list of three to seven other performance measures for the CAP to NEOs. There’s no one-size-fits-all approach, and different companies may use different performance measures, making it difficult to compare across industries. Additionally, companies may include non-financial performance measures if they are among the three to seven performance measures used by the company to link pay to performance.
If a company doesn’t use financial performance measures to link CAP to performance, no measures are required to be disclosed.
Controls and Procedures Should Be in Place for This Disclosure
While the PvP disclosures will not be included in or incorporated by reference into filings under the Securities Act of 1933 or other filings under the Securities Exchange Act of 1934 (e.g., Form 10-K), unless a registrant explicitly incorporates them by reference, companies should remain mindful that this disclosure could be subject to SEC review. There should not be inconsistent or potentially misleading information in relation to other disclosures which may result in SEC comment letters.
Further, although the PvP disclosure will likely not fall under SOX 404 certifications, it’s still important to establish controls and procedures to ensure information presented is accurate and reviewed appropriately.
Seek Expert Preparation Support
The challenges of preparing new disclosures – understanding what’s required, figuring out best practices, setting up processes and controls, and carving out time to get the necessary work done – make compliance no easy feat, especially when weighed against other priorities and responsibilities. Cross-functional technical accounting specialists at CrossCountry Consulting support organizations through the requirements, ensuring applicable deadlines are met and providing the additional solutions, such as:
- Revaluing applicable executive equity awards under new SEC-prescribed methodology;
- Preparing the Pay vs Performance table, including Compensation Actually Paid for the Principal Executive Officer (PEO) and average for non-PEO NEOs;
- Drafting the disclosure language for the Proxy Statement;
- Consulting on the peer group selection;
- Consulting on the Company Selected Measure (CSM) and other Financial Performance Measures;
- Providing required description of relationship between pay, performance, and required metrics either in graphical or narrative format based on company preference; and
- Setting up a repeatable process with controls that can be leveraged for the future.
For expert support meeting new PvP demands, contact CrossCountry Consulting today.