The proposed rules would require a new table in the proxy statement and a graphic or narrative description of the relationship between pay and the company’s total shareholder return (TSR) and the company’s TSR and peer group TSR (smaller reporting companies (SRCs) would not be required to provide the peer group TSR disclosure). The table would be required to be provided in machine-readable format (i.e., tagged in interactive data format using XBRL).
Among other data points, under the proposed rules, the new table would disclose for the past 5 years (3 years for SRCs):
- the actual compensation paid to the company’s principal executive officer;
- the average of the actual compensation paid to the company’s other named executive officers;
- the company’s TSR for the applicable fiscal year; and
- the TSR for the company’s peer group.
The proposed rules were adopted by the SEC’s Commissioners on a 3 to 2 vote, with Commissioners Gallagher and Piwowar dissenting. In Commissioner Gallagher’s dissent, he made clear that he believes that the proposed rules are “another trudging step on the path towards completing Dodd-Frank’s — and thus the federal government’s — intrusions into the realm of corporate governance.”
While the SEC’s proposed rules were mandated by the Dodd-Frank Act (which directed the SEC to adopt rules requiring a company to disclose the relationship between executive compensation actually paid and the company’s financial performance), many believe that the proposed rules are too rigid and will have unintended consequences. Commissioner Gallagher touched upon the concerns that many share regarding equating TSR with company performance:
As a stock price-based measure, TSR may be gamed by any of the usual corporate strategies for boosting stock prices in the short term — for example, cutting spending on R&D projects to inflate net profit, or focusing resources on a corporate strategy that pays off in year 3, at the expense of one with a much larger payoff in year 10. Thus, the [SEC’s] chosen metric risks exacerbating the current overemphasis on short-term performance at the expense of long-term shareholder value creation. Moreover, a simple TSR-based comparison is likely to produce an excessive number of false positives. It will show companies where pay seems to be out of alignment with performance, based on this simplistic metric, but where a more nuanced evaluation would show that pay is actually well-aligned with performance.
The backwards-looking nature of TSR will leave companies in the uncomfortable position of defending in the narrative disclosure to the new table why their pay decisions in one year resulted in actual compensation in a subsequent year that appears to be disconnected from TSR. Commissioner Gallagher expressed his concern about this matter, noting that any such narrative disclosure will be misunderstood by retail investors:
Specifically, I worry they will think the [SEC] believes TSR is the best way to measure performance, and that they will not appropriately credit the company’s explanations for why TSR has produced a false positive in the company’s particular circumstances. They will view them as excuses, rather than essential supplements to the [SEC’s] mandated standard.