New SEC CEO Pay Rule Creates Tricky Stock Accounting Issues

The money paid to top corporate executives will get more sunlight this spring as public companies comply with new SEC pay-versus-performance rules for the first time.

Behind the scenes, however, accountants helping companies prepare their proxy statements are tackling some complex questions, including how to pinpoint the value of stock awards.

“It’s a lot of math; it’s a lot of tables; it’s a lot of tracking; and a lot of valuation specialists, particularly if you have very complicated awards,” said Alan Wilson, counsel at WilmerHale.

Companies already must disclose what they pay their top executives in their annual proxy statements, typically filed around the first quarter of the year, but those disclosures aren’t standardized. Under the long-awaited Securities and Exchange Commission rule, which was required in 2010 under the Dodd-Frank Act, companies will have to include metrics in their financial filings that link their financial performance and CEO pay, as well as demonstrate how a company’s official net income relates to top pay.

Companies will have to provide a table listing executive compensation and financial performance measures for their five most recently completed fiscal years. Public businesses that qualify as smaller reporting companies will need to provide the three most recently completed fiscal years.

Companies also will have to provide a list of three to seven financial performance measures that it determines are its most important measures for connecting executive compensation actually paid to company performance.

Navigating stock options

“Actually paid” is where things get tricky, particularly for pay packages that include stocks or options, and if those awards are contingent on the company meeting particular financial goals.

“The biggest questions I’m getting in terms of frequency is in calculating the compensation actually paid has to do with equity or options,” said Lauren Alexander, partner in Ernst & Young LLP’s national professional practice group.

Under US generally accepted accounting principles, companies calculate the fair value of stock awards at the time they are granted to employees so they can log an expense in their income statements. Companies do not typically re-measure award value. Now, they will have to reassess the value of those awards at the end of each year when they put together their proxy statements.

“So it’s something that you’re not doing in your GAAP financial statement that you’re going to be required to do incrementally for this table,” Alexander said.

Any time companies have to comply with new rules, there will be questions. The SEC released compliance and disclosure interpretations (CD&Is) late Friday to guide companies through some narrow, specific practice questions, although none specifically addressed accounting. The guidance tackles questions such as when to include specific footnotes, how to determine which industry peer companies to include for purposes of calculating peer group total shareholder return, and how to handle reporting stock options for an employee who became a top executive mid-year, among other questions.

That leaves companies and accountants to figure out the formulas as laid out by the SEC rule, said Wilson of WilmerHale.

“They’re just parsing the rules and making it work,” he said.