The Securities and Exchange Commission in August adopted final pay versus performance rules that require disclosure of the relationship between executive compensation actually paid and financial performance of a company.
The final rules, required by the 2010 Dodd-Frank Act, apply to all reporting companies with a few exceptions.
The long-delayed rules provide transparency between executive compensation actually paid and the company’s financial performance. Publicly traded companies must comply with the new disclosure requirements in proxy statements covering fiscal years ending on or after Dec. 16, 2022.
The rules also require companies to provide an unranked list of their three-to-seven most important financial performance measures that link compensation to performance. Companies may supplement their mandatory disclosures to include non-financial performance measures if those are among their “most important” performance measures.
Companies have an opportunity to highlight environmental, social, and governance measures as part of the “most important” non-financial performance measures that are used to link pay to performance.
This is in line with the SEC’s continued focus on addressing ESG, and the importance of a company’s internal controls and data management to assure its disclosures are accurate and reliable.
Disclosures and Executive Compensation
The SEC commissioners noted during the process of issuing the final rules that companies are increasingly linking executive pay to ESG measures. This allows companies to advance ESG goals, address stakeholders, and improve financial performance.
Given these developments and Dodd-Frank’s requirements, the SEC’s expanded disclosure provides investors and other stakeholders with more meaningful insight to a company’s financial performance, and its relationship with executive compensation actually paid.
The final rules also provide an opportunity for transparency. More than 70% of the S&P 500 companies incorporate ESG in their performance reward programs. A majority incorporate social goals in their short-term bonus programs and environmental goals in their long-term incentive plans.
With this increased ESG disclosure opportunity comes the need for more focused legal review to ensure all the company’s other ESG and sustainability statements are consistent, accurate, and in line with the company’s public filings.
The final rules allow companies to demonstrate how they create sustainable value for investors and other stakeholders by strategically incorporating ESG performance measures into executive compensation incentives.
With this new opportunity, it is important to obtain accurate ESG data for tracking and measuring progress toward incentive rewards and operational success.
Data Integrity Is Crucial
Disclosures should be based on solid data. The data collection, analysis, and internal controls process is critical to developing reliable quality disclosures that will ultimately impact a company’s ESG rating.
To reach the level of reliance that is expected by investors and regulators, companies must stress test that data to the same levels as financial data is tested. Companies will be held accountable.
Many companies are leveraging the Sarbanes-Oxley Act framework to assess financial data, enable transparency around calculation metrics of executive compensation payments, and measure progress against ESG strategy to the extent they are linked.
Regulators are focused on transparency of pay components to assess whether payments are fair, equitable, and aligned with company performance. They are also considering the reliability of frameworks for collecting data.
Employee Communication Is Critical
In addition, with transparency comes the need to manage the impact of public disclosures on existing employees. Companies should get ahead of such public disclosures to ensure employees understand the components of their pay, how those are measured, and their value.
This will minimize potential disruption, particularly around pay equity, an area that has risen to the top of the priority list for many companies.
Employee communication is key, as an adverse reaction could upend a company’s progress toward ESG goals.
With the expanded disclosures allowed by the final rules, companies will have an opportunity to showcase the importance they place on nonfinancial performance measures in their reward programs.
Impacted companies need to carefully review and discuss the final rules with their advisers to comply with the new requirements and provide the appropriate transparency and consistency in their public filings.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
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Candace L. Quinn is senior counsel at Seyfarth Shaw. She is an executive compensation and employee benefits attorney with significant international and domestic experience and LLMs in energy and tax.
Parmjit Sandhu is tax principal, global reward services, at KPMG.
John Tomaszewski is managing director, tax, at KPMG.