Pay and Display: The Securities and Exchange Commission Is Planning to Force US Companies to Disclose More Information on Executive Reward. Neil Hodge Explains the Implications for Firms and Investors

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Executive pay has long been a contentious issue, especially in the US. The lack of transparency at senior management level, underlined by high-profile financial scandals at WorldCom, Enron, Tyco and Xerox over the past five years, has fuelled investor anger about the complexity of remuneration policies and how they are structured.

US investors have frequently criticised large rewards for poor performance, although little has been done about the issue. But things came to a head in December 2002 when telecoms company WorldCom, which was struggling with a 25bn [pounds sterling] debt resulting from an accounting fraud, was forced to cut the proposed salary of its incoming chief executive, Michael Capellas. US federal judges ruled that the reward package was "grossly excessive". After much wrangling, it was allowed to pay him a mere $8m over three years, as well as $12m in restricted stock once the company emerged from bankruptcy, with the potential for another $6m if he demonstrated "exemplary" performance as chief executive during the bankruptcy process.

This deal represented a 23 per cent reduction on the original package, but Capellas need not have worried. The company, which changed its name to MCI, was bought by Verizon Communications in November 2005 for $6.75bn. WorldCom's debts were effectively absorbed as a result of the takeover, so Capellas was duly rewarded for finding a buyer.

Investors--particularly institutional investors--are less concerned about massive salaries if they are clearly linked to improved business performance and are easy to understand. Henderson Global Investors, speaking for the majority view, considers large rewards acceptable as long as the company performs well. As part of its investment criteria, Henderson states that it "expects performance conditions to be attached to all elements of remuneration that provide real incentives for high achievement. Substantial payments in situations where executives leave the company after its performance has been poor--'payment for failure'--should be avoided at all costs."

It is not surprising, therefore, that pension funds and major investors have broadly welcomed proposals by the US financial regulator, the Securities and Exchange Commission (SEC), to amend its executive compensation disclosure requirements to improve transparency. These proposals, if approved, would result in changes to form 8-K, the "current report" that companies must file with the SEC to announce major events to shareholders. This would require that all disclosure relating to compensation should be contained in a single item and be written in "plain English".

Under the proposals, corporate compensation disclosures would start with a new section under the heading "Compensation discussion and analysis". This is intended as an overview in which companies would explain their executive compensation policies and address questions such as the objectives of pay policies, the achievements these are designed to reward and how remuneration is structured. The proposals would require companies to explain how they set compensation levels for named executive officers ie, those deemed to be the most important people (not necessarily directors) working in the company. They should also identify how each element of compensation fits into their overall compensation scheme.

In addition, the proposals amend the definition of "named executive officer" to include the principal executive officer, the principal financial officer and the three most highly compensated executive officers other than them. There was also a suggestion at an SEC open meeting that companies should disclose the compensation paid to up to three other employees who are not executive officers, but whose total compensation is higher than that of any of the executive officers mentioned. These individuals would not have to be identified by name; companies would be required only to disclose total compensation and provide a job description. …