Decoding New CEO Pay Disclosures: Seven Things to Keep in Mind
The Securities and Exchange Commission's new rules on executive compensation disclosure aim to give shareholders a more comprehensive picture of CEO pay. However deciphering the new disclosures can be challenging. This article emphasizes seven key takeaways: reading footnotes, understanding companies' prioritization of climate/compensation links, and the influential role of shareholders in promoting best practices.
1) The newly required chart “How Pay Elements supports our strategy” is the most revealing new component. This is how companies let us know what their priorities really are. If, for example, reducing their impact on climate change or adapting to the impact of climate change really matters to them, we will see them discuss how they are preparing for a transition.
As we noted in our Pay for Climate Performance last year, while many companies report that they use climate as an element of compensation too often the metrics are qualitative, confusing and de minimis. Here is a new place to look in the proxy to use to assess focus. It doesn’t guarantee, by any means, that a company is a making meaningful progress but it does give them a chance to say what they believe is important and what they are willing to be measured by, internally and externally.
Thus far in the proxies we have reviewed – and the season is young -- companies almost entirely simply list financial metrics.
Some examples of companies that have disclosed:
Marathon Petroleum states that it has an ESG metric, with quantitative goals tied to greenhouse gas (“GHG”) emissions intensity, safety and diversity, equity and inclusion, that comprises20% of the Annual Cash Bonus program
Centerpoint notes that its Performance Share Units (PSUs) which have three-year cliff vesting, and are subject to carbon emissions reduction goals “Align with the Company’s long-term net zero and decarbonization goal.” The company adds, ”PSUs based on carbon emission reduction goals account for 5% of the total award.”
Note that one of these is in the PSUs and the other in the annual bonus.
2) “Compensation Actually Paid” does not mean what you might think it does.
While the new disclosure presents clearer information on how executives’ wealth may have changed in the past year, its name is a misnomer and until we get used to it, it may be more confusing than illuminating.
The true value of any equity-based award cannot be known until the executive exercises options and/or sells stock. No one, even someone who won the Nobel in math, has come up with a way to value options because by definition it is predicting the future. The “change in value of equity awards,” number is not definite on those awards until the executive exercises options and/or sells stock. So, the same awards may be valued very differently in different years. The new disclosure is still useful and important, and will become more so, particularly when several years of data are disclosed. Many companies are already disclosing three years, though I haven’t ascertained whether this is a requirement. This is also worthwhile to compare CEO compensation to other executives named. It will give you a thumbnail look at how much movement of the stock price effects pay for the entire group. Generally, best practice is for the CEO to have the highest proportion, but if you see wildly disproportionate figures, then this might be worth a second look.
As always, the language after the disclosure may be more interesting. As Marathon Petroleum put it: “For LTI awards made in 2022 that were outstanding as of December 31, 2022, the fair value of these awards as of December 31, 2022. This value was not received in 2022 but is representative of estimated potential value that may be received in the future.”
General Electric has the most detailed chart I’ve seen yet this year. In teeny-tiny fonts disclose 10 adjustments between summary compensation table data and the “actual” pay. More disclosure is always good, but it can add more ways to be confused.
3) There has never been a case where the CEO paid the company: don’t be fooled by negative numbers.
You may see numbers in parenthesis in the negative numbers in the actually paid column. Heavy losses in equity value (which again are not fixed or permanent) do not mean the CEO wasn’t paid. You can see the cash component of pay with a quick look at the summary compensation table. Do not waste pity on the executives, whose stock or option value may look worse this year, even negative. That does not mean they’ll be writing a check to the shareholders.
General Electric is, again, a good example. Here’s how it is described in the proxy statement. “In Mr. Culp’s case, it reflects the loss of his 2022 equity awards canceled last month as well as $27.4 million in other losses on equity awards from prior years.” He was reported to have an actual pay of ($23,798,500).
He should be fine though. His “actual pay” two years ago was $115,891,919.
It is worth bearing in mind that the salary of Lawrence Culp is among the highest of S&P 500 companies, at $2.5 million. He gets that salary no matter what happens. This year he also received a non-equity incentive plan payment - i.e. a cash bonus. [So, what makes it an incentive?]
4) Timing is everything
This is always true with CEO pay, but more so with the new disclosure. Fluctuations in equity prices will have an outside effect on the so-called “actual” pay.
5) Generally the peers that companies choose to show performance are not the peers they calculate pay by
Like all data points, these are best considered in context and carefully. Without taking the time and reading some of the details, without understanding the company, there’s a limit to what you can infer from this data. But on some level that’s true of everything in the proxy statement.
Here’s how Textron discloses its peers:
“As shown in the chart below, the Company’s cumulative TSR is correlated with the S&P 500 Industrials index cumulative TSR. It is not as closely aligned with the S&P 500 A&D index cumulative TSR. Because Textron is a multi-industry company with businesses in the aerospace and defense industry as well as other industrial manufacturing businesses, both indices are relevant for comparison, although neither is an ideal peer group. Due to consolidation in the A&D industry, that index reflects the results of only ten companies, including Textron, making each company’s impact arguably outsized, especially the impact of large companies, given that the returns shown are weighted based on market capitalization. Since the S&P 500 Industrials index includes a greater number of companies than the S&P 500 A&D index, using this index for comparison mitigates the effect of companies with outlying performance.”
Here’s how it described peers used for executive compensation:
“The compensation consultant has advised the Committee that size appropriateness, based upon both revenue and market capitalization, and industry/business fit are the most important factors in establishing this group of companies to provide appropriate references for target direct compensation levels, followed by global reach. As part of the 2021 review of the talent peer group companies, the compensation consultant conducted its annual review of other companies that use Textron as a peer company for compensation purposes, as a well as an additional level of review which included evaluating whether the pandemic had permanently impacted any of the peer companies such that they were no longer suitable as a peer.”
The company discloses, as required, the names of the companies in the compensation peer group. There’s nothing glaringly problematic (i.e. the time Schlumberger added Netflix to its peer group, subsequently removed after shareholders’ objected); I do wonder though if General Dynamic isn’t quite a bit larger than Textron?
6) You need to read (or at least skim) carefully
It has been my experience, having now been reading proxies for 35 years, is if the news is good for the company and makes it look like the CEO pay is appropriate, then it is easy to find. If it is bad news it will be buried in run-on sentences in a tinier font. Always read the footnotes.
7) There is not much consistency in disclosure yet. Shareholders have an important role to play in helping with the evolution of best practices
These new rules are intended to give shareholders a more complete picture of executive compensation, and to help them make more informed decisions about how they vote on compensation-related matters. The SEC believes that greater transparency around executive compensation will help to promote accountability and better align the interests of executives with those of shareholders. Specific disclosure practices will evolve. This is the year that companies (or more likely their consultants) are choosing how data should be presented. They’ll be looking to see how everyone else is doing it. Shareholders will need to highlight positive disclosure (see point one) and make additional clarifying requests (seems to me it would be good to have companies tell us how many of their compensation peers are their performance peers, and vice versa).