Academic journal article Journal of Accountancy

Why Compensation Committees Need Your Help: CPAs Can Play an Important Role in Developing Effective Pay Policies

Academic journal article Journal of Accountancy

Why Compensation Committees Need Your Help: CPAs Can Play an Important Role in Developing Effective Pay Policies

Article excerpt

Companies have yet to solve the riddle of executive compensation--at least to the satisfaction of investors and legislators. Dismayed by reports of CEOs cashing in stock options worth millions of dollars amid a tumbling stock market and a rash of corporate scandals, Congress and financial market regulators have introduced new rules designed to make it harder for top executives at public companies to reap windfall profits at shareholders' expense.

Executive stock option programs--hailed in the 1990s as the best way to align the interests of executives with those of shareholders--face a growing public outcry. This new climate presents a raft of challenges for board members who serve on compensation committees and for the CPAs who advise them. Whether working in the finance department of a public company or acting as an outside consultant, CPAs are in a unique position to guide compensation committees in their role as corporate overseers and to help them design and implement pay packages more in line with shareholder interests.


Compensation committees draw their members from the ranks of nonmanagement directors. They are responsible for setting the compensation packages of the CEO, other senior executives and for the directors themselves. In addition, they approve the size of the bonus pool for the remainder of the workforce, allowing management to decide how to allocate that money. The committee also determines how far down in the employment ranks to extend incentive compensation such as stock option awards. Finally, compensation committees must decide how to use a company's pay philosophy to best advance its overall business principles and goals.

CPAs who advise compensation committees can add value to these undertakings in four distinct areas:

* Helping to ensure the committee acts in compliance with the latest laws and regulations.

* Setting the performance goals and benchmarks that are the basis for the incentive portion of most executive pay packages.

* Calculating the value of traditional stock options for the growing number of companies electing to treat the issuance of options as an expense on their income statement.

* Considering alternatives--in terms of their costs and tax implications--to traditional stock option awards.


Compensation committees work in a complex and ever changing environment and need expert accounting and legal advice. Thus a critical task for CPAs who counsel them is to keep abreast of pertinent laws and regulations. Compensation committee conduct became even more sharply circumscribed on July 30 when President Bush signed the Sarbanes-Oxley Act of 2002. Besides sweeping reforms affecting public company audits and how such companies conduct business, the act bans a formerly common practice whereby companies granted, and their boards approved, loans to executives. (For more information see "Regulations Under the Sarbanes-Oxley Act," JofA, Oct.02, page 33.)

Under section 402(a) of the act, it is illegal for public companies to extend credit, directly or indirectly, to directors or officers, except for certain loans available to the general public in the ordinary course of the company's business. (A bank, for example, can still provide mortgages to its officers and directors.) But virtually all of the loans commonly found in executive compensation packages appear to be prohibited, such as those made to help an executive purchase company stock, fund a split-dollar life insurance arrangement, meet an extraordinary expense or relocate. Because the specific intent of the act is unclear in this area, CPAs must wait for interpretive guidance from regulators.

If a company must restate its financial statements due to its failure to comply with disclosure requirements, section 304 of the act requires the CEO and CFO to forfeit any bonuses, incentive or equity-based compensation, as well as any profits from the sale of the company's securities, within the year after the company issues any noncompliant financial statement. …

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