On August 25, the US Securities and Exchange Commission (SEC) adopted new rules, implementing the much delayed “measures of pay versus company performance” disclosures.
These final rules require public companies to disclose executive compensation alongside their financial performance and compare the pay with that of a tightly defined set of peers. All this together with a commentary on how the compensation paid to its senior executives relate to the company’s financial performance. These measures are expected to cover a five-year period — with three years for smaller companies.
True, most US public companies already include pay-for-performance disclosures in information statements. And the final rules are similar to the analysis that is currently performed by proxy advisory services. Still, the current pay-for-performance disclosures will likely need to be re-worked in order to comply with these new rules.
For one, the SEC has now standardised and codified the disclosures and extended the rules to all “named executive officers”. The SEC disclosure rules require companies to report no less than three (and no more than seven) financial measures, which are the most important metrics used by the company to determine pay. This enables an IT company to report margins and revenue growth, while a bank can report net non-performing loans. Companies can additionally give non-financial measures — although not in a table format.
It bears emphasising that the SEC, uncharacteristically, has chosen not to pursue a wholly principles-based approach as this “would limit comparability across issuers and within issuers’ filings over time, as well as increasing the possibility that some issuers would choose to report only the most favourable information.” The SEC Chair Gary Gensler too saw merit in harmonising these disclosures.
Mr Gensler said, “The rule makes it easier for shareholders to assess a public company’s decision-making with respect to its executive compensation policies.”
“This rule will help investors receive the consistent, comparable, and decision-useful information they need to evaluate executive compensation policies,” he added further. There is merit in having standardised data in one place.
This focus on compensation came about following the 2007-08 US-led financial crisis, which is now believed to be as much a consequence of misalignment of incentives as of lax lending standards that fuelled a housing price bubble. During the years leading up to the crisis, executives received multi-million dollar pay packages for taking excessive risks, which, when the bets turned sour, had the public taxpayers cleaning up after. The “fix” was the Dodd-Frank Wall Street Reform and Consumer Protection Act, which rooted for greater oversight over the financial system as well as transparency in opaque areas, which included compensation.
Since then, the US market has asked for disclosures on the ratio of the median annual total compensation of employees to the annual total compensation of the chief executive officer. The rules also provided for what is referred to as “say-on-pay”, a non-binding shareholder vote on executive compensation, at least every three years. The new “pay versus performance” rule should be seen as part of a series of steps taken to strengthen the compensation-linked practices.
As in the US, Indian companies disclose the CEO compensation relative to the median employee pay. And unlike the “say-on-pay” rules, which, given their non-binding nature, are in practice nothing but an opinion poll on the CEO’s salary, boards need shareholder approval before they cut the cheque. Despite these tighter voting norms, CEO salary in India exceeds revenue and profit growth. This is because “promoters” get to vote on their salaries. No surprises, then, that all vote “I am worth it.”
Even as Indian listed companies have strengthened their overall disclosures substantially, even being ahead of the global norms in some respects, they lag behind on compensation related disclosures.
Globally, there is a far more open discussion regarding the compensation and its various elements: Fixed, variable, retirals, long-term incentives. What are the parameters that determine the payout, including the performance, both quantitative and qualitative? Who are the peers? They invariably have a provision and disclose the circumstances under which salary will be clawed back. In contrast, the sweeping compensation approvals Indian companies seek — amounts, annual increases, bonuses, stock-options — have investors struggling to unpack what the underlying logic of the pay-outs is. This gets all the more troubling given the sums involved.
The trajectory of recent rules has not been to regulate the salary paid or the way a company incentivises its leadership. This greater freedom and flexibility must go hand in hand with more robust compensation related practices and disclosures. And as global investors get attuned to the new SEC rule-linked disclosures, the more progressive Indian companies will voluntarily adopt these, and others will start to do so under pressure from investors or risk getting left behind — which cannot be worth it.
The writer is with Institutional Investor Advisory Services India Limited. The views are personal.
@AmitTandon_in