A little more than 12 years after the 2010 Dodd-Frank Act was signed into law, the SEC has issued final rules on the topic. This was expected after the SEC re-opened the comment period on Pay Versus Performance disclosure in January. Intended to standardize the presentation of existing information related to the relationship between executive pay and company performance for investors, the final rules may also pose a new and significant burden on some companies with respect to their equity valuation processes and are substantially different from the proposed rules.

Dodd-Frank 953(a) requires issuers to show “…the relationship between executive compensation actually paid and the financial performance of the issuer…” The SEC’s definition of “compensation actually paid” is far removed from how many would interpret this term, particularly for equity-based compensation. It has decided to use an approach for equity-based compensation similar to “realizable pay” and essentially “marks to market” outstanding and unvested equity awards on a “fair value” basis from the grant date to the vesting date. This approach effectively accrues the equity value over the vesting period, with the heaviest impact on value likely to be in the year of grant. It is a fundamentally different approach from the proposed rules of 2015 where the value of equity would have been recognized in its entirety upon vesting, similar to existing definitions of “realized pay.”

The Pay Versus Performance requirements are meant to enable shareholders to directly compare executive compensation with company financial performance over a multi-year period. In the SEC’s view, assigning the burden of computing this relationship to investors is costly and inequitable. Therefore, the SEC implemented rules to standardize information presentation without, in its view, imposing unusual additional expense on issuers.

The new required disclosures are effective for filings at the next annual meeting for companies with fiscal years ending on or after December 16, 2022, so for calendar year companies, the next proxy will have to include the new disclosure.

CAP submitted comments to the SEC on the 2015 Proposed Rules, and our statement can be found here.

Overview of Final Rules under Section 953(a)

The final rules require companies to prepare a table disclosing compensation actually paid to the Named Executive Officers (NEOs) next to Summary Compensation Table totals and key metrics, over a five-year history (Exhibit 1). The metrics required to be disclosed in the table are as follows:

  • Company’s indexed total shareholder return over the period1
  • Indexed total shareholder return of peer group
  • GAAP net income
  • A financial metric of the company’s choosing

Exhibit 1

Year Summary Compensation Table Total for PEO Compensation Actually Paid to PEO Average Summary Compensation Table Total for Non-PEO NEOs Average Compensation Actually Paid to Non-PEO NEOs

Value of Initial Fixed $100 Investment Based On:

Net Income (Loss) Company Selected Measure
Total Shareholder Return Peer Group Total Shareholder Return
(a) (b) (c) (d) (e) (f) (g) (h) (i)
Year 1
Year 2
Year 3
Year 4

To be required in the 2024 proxy statement

Year 5

To be required in the 2025 proxy statement

To supplement this tabular disclosure, companies will need to describe the relationship between compensation actually paid and each of the financial metrics included in the table, using a graphical and/or narrative approach. Finally, companies must provide a list of three to seven metrics they deem most important in making executive compensation decisions, which may include non-financial measures, if a minimum of three are financial metrics (Exhibit 2).

Exhibit 2

3-7 Most Important Company Performance Measures for Linking Executive Compensation to Company Performance (For PEO & Other NEOs)

The rules require a three-year history in the proxy statement for fiscal year ended on or after December 16, 2022, a four-year history in the 2024 proxy and a full five-year history in 2025 and beyond. Smaller Reporting Companies (SRCs) will have pared-down requirements. The new Pay Versus Performance disclosure may be located anywhere in the proxy or information statement; it does not need to be incorporated into the Compensation Discussion & Analysis.

Pay Versus Performance Table

Compensation actually paid to the Principal Executive Officer(s) and other NEOs is intended to reflect a fair value assessment of compensation lined up with the most recent fiscal year. At a high level, the calculation for compensation for the PEO and other NEOs will be as follows:

  • Cash compensation will likely mirror the Summary Compensation Table for most situations
  • For companies with a defined benefit pension, the amount in the “change in pension value” will be replaced by the amount that is reflective of only the service cost for the respective year2
  • And now for equity…. this is where it gets complicated!!! In contrast to the proposed rules, companies will need to revalue equity at the end of each year and report the change in value. Each in-process award will be “re-valued” (see details in exhibit) and vested awards will be valued based on the vesting date
    • Awards with performance conditions deemed improbable to be achieved will be subtracted from the total, potentially giving shareholders insight into expected performance sooner than they would have received in the past since most companies did not disclose expected payouts until the end of the performance cycle

In response to sentiment that TSR does not capture the full financial picture of a company, and the reality that other metrics are consistently used in long-term performance share awards, the final rules require disclosure of TSR, TSR for the company-disclosed peer group3, GAAP Net Income and a third metric defined by the company. TSR is calculated as the value of a $100 fixed investment over the measurement period. The company-selected measure is intended to be a financial performance metric that the company finds represents the most important performance metric not already shown in the table for evaluating the link between compensation actually paid and company performance.

Key Performance Metrics Table

In the second required table, companies must report at least three and up to seven performance metrics that inform actual compensation decisions during the period. Three of the metrics must be financial performance metrics and any additional metrics may be non-financial measures if the company deems them among the seven most important measures impacting compensation actually paid. The company-disclosed metric in the pay versus performance table must be one of the metrics included in this table. The measures do not need to be ranked, a modification from the proposed rules in response to the complexity of determining rankings.

The SEC believes this disclosure will provide investors with visibility into which performance measures most strongly impact actual compensation paid and help investors assess whether compensation programs appropriately incent executives without undue burden or tedious complexity for issuers. With this list, the SEC aims to help companies reduce the risk of misrepresenting or providing an incomplete picture of pay versus performance alignment.

In practice, we anticipate that the listed metrics will align with the metrics used in the annual and long-term incentive awards. Companies will then have the opportunity to discuss the rationale for the metrics and how they influence compensation.

Description of Relationship between Actual Compensation and Financial Performance

Companies must substantiate the relationship between executive compensation actually paid and net income, and between executive compensation actually paid and the company-selected metric through graphs, charts and/or narrative text. Since GAAP metrics are used in the table and many companies use non-GAAP metrics in their compensation programs, this component is a key opportunity for issuers to provide compelling rationale for the measures and approaches used in their program that differ from GAAP net income.

Equity Valuation Under the Final Rules

The SEC has implemented equity valuation standards that present a departure from normal processes for most companies.

Under the Final Rules, equity awards are valued annually until vest to illustrate mid-cycle changes in fair value. The rules follow a syntax of addition and subtraction to produce a value of total equity earned by the executive that aligns with the financial performance measurement year4. Companies subtract the equity award values reported in the Summary Compensation Table and adjust based on the following:

  • Fair value of equity awards granted, outstanding and unvested in the covered fiscal year as of the fiscal year end
  • Change in fair value during covered fiscal year of awards granted in prior years that remain outstanding and unvested as of the end of the fiscal year
    • For performance-contingent equity awards, fair value as of the end of the fiscal year based on probable outcome
  • Change in fair value from end of prior fiscal year to vesting date for awards granted in prior years that vest in the covered fiscal year
  • Fair value on date of vest for awards granted and vested in the same covered fiscal year
  • Dollar value of any dividends or other earnings paid on stock or option awards in the covered fiscal year prior to vesting that are not otherwise reflected in fair value assessments of such awards

The implications of this methodology are aptly described in the following table produced by Equity Methods, a leading firm in the equity valuation space. See Equity Methods’ blog post for more detail on this topic and how companies should prepare for this disclosure.

Use Case Treatment Comments and Description
1) Equity awards granted during the year that are outstanding and unvested Year-end fair value
  • For options, this may require using a lattice-based modeling approach
  • For TSR awards or any awards with a market condition, the Monte Carlo simulation used to initially value them must be retooled to produce an interim period fair value
  • For awards with a performance condition, the fair value will be the stock price as of the fiscal year end, provided that the performance condition is deemed probable as of this date
  • For stock awards (including performance-based and market-based awards), the value of dividends or dividend equivalents accrued through the end of the fiscal year
2) Awards granted in prior years that are outstanding and unvested Change in fair value
  • Same treatment approaches as above, except the comparison is to the change in fair value
  • Suppose an award was granted in 2021 with an interim fair value as of 12/31/2021 of $15 and an interim fair value as of 12/31/2022 of $18, then the differential of $3 would be used
  • For awards with performance conditions that are deemed probable at the end of the year, the consideration will be they will be measured as if they are probable at the beginning and end of the period
3) Awards granted and vesting during the year Change in fair value through vesting date
  • For standard full-value awards, this will be the realized pay amount as of vesting (e.g., no Monte Carlo simulation for TSR metrics)
  • For options where the award is vested but still exercisable, this may involve modeling as described above
4) Awards granted in prior years that vest during the year Change in fair value
  • Combination of use cases #2 and 3 in that the fair value as of the vesting date is used
5) Awards granted in prior years that do not vest Change in fair value
  • This would include a forfeiture or award with a performance condition where the vesting is reclassified to be "improbable"
  • This same outcome will automatically happen to an award with a market condition in the Monte Carlo simulation as the condition becomes increasingly unattainable
6) Dividends or similar paid on stock and options that are not embedded in the fair value Actual amounts paid
  • These are actual amounts delivered to the employee, but should not be counted if the fair value estimates in the prior calculations also capture these same amounts


Companies with fiscal years ending on 12/31/2022 will need to disclose this new information in their 2023 proxy statements. Given the complexity of the new rules and the requirement to provide supporting narrative disclosure that explains the relationship between compensation actually paid and financial performance, we recommend you begin the process of putting together the table now, recognizing you will not be able to finalize some items until after the end of 2022. We recommend that you do the following things between now and the end of the year:

  • Identify data requirements for the new table (e.g., required equity valuations at the end of the year and at vesting dates, pension plan service cost, TSR, peer TSR, net income, etc.)
  • Agree on peer group to be used for TSR
  • Establish an approach to be used internally to determine the additional financial metric and the list of the three to seven most important financial metrics
  • Reach out to internal/external advisors to help compile required information (e.g., finance/accounting, external equity valuation experts, actuaries)
  • Develop initial mock-up of table with placeholders for year-end 2022 compensation and performance values
  • Develop draft narrative disclosure describing the historical relationship between compensation actually paid and company performance
  • Review draft disclosure with management and Compensation Committee

Given the newly required tables, companies will need to re-think the format of their disclosures to comply with the requirements and make the narrative easy to read for shareholders.

1 Total shareholder return indexed to $100 invested at the beginning of the period the table covers

2 This will also include prior service cost if a plan is amended in such a way that impacts service cost in prior years

3 The peer group may be the same as the one used in the 10-K or an alternative peer group, such as the one used for benchmarking purposes. The rationale for the peer group and any changes year over year must be provided as well as the impact of changing the peer group on the relative TSR calculation

4 Equity awards granted prior to the base measurement year (prior to 2020) will not be included in the calculations.

The Dodd-Frank Wall Street Reform and Consumer Protection Act allows public company shareholders to vote on Named Executive Officer (NEO) compensation arrangements related to a merger and acquisition (M&A) transaction. This vote, required beginning in 2011, is also referred to as say on golden parachute. Similar to say on pay, these votes are advisory and non-binding. The say on golden parachute proposal must be in the same merger-related proxy in which shareholders are approving the deal. Companies are required to disclose all compensation that may be paid to the NEOs because of the transaction as well as the conditions under which they become payable.

Both parties of a deal are required to have a say on golden parachute proposal for shareholder approval. However, if a company’s executive compensation program has already been voted on by shareholders and the pay levels and program design are unchanged from the last shareholder vote, the company does not need to submit a say on golden parachute proposal; this typically applies to the surviving entity only.

Companies put golden parachutes in place for the most senior executives so they can continue to make decisions that are in the best interest of the company. These arrangements also encourage executives to stay through the close of the transaction. Over the past ten years, many companies have adopted shareholder-friendly practices, such as double-trigger vesting of equity (i.e., change-in-control occurs plus termination of employment) and removing excise tax gross-ups, given increased shareholder scrutiny and the advent of the say on pay vote.

Say on Golden Parachute Vote Outcome

In 2021, the majority of say on golden parachute proposals received shareholder support. Three-quarters of these proposals received 80% support or higher (average support is approximately 85%). Around one in ten proposals received less than 50% support.

1%1%2%4%4%4%3%6%12%63%0-9%10-19%20-29%30-39%40-49%50-59%60-69%70-79%80-89%90-100%Percent SupportShareholder Support for Say on Golden Parachute in 2021 (n=164)Received < 50% shareholder supportReceived ≥ 50% shareholder support

Source: Proxy Insight

Proxy Advisors Perspectives

Proxy advisory firms, such as Institutional Shareholder Services (ISS) and Glass Lewis (GL), give investors a say on golden parachute vote recommendation. While these firms assess proposals on a case-by-case basis, they outline criteria used for the evaluation. ISS, for example, has multiple criterions used in their evaluation, but only note three that will most likely result in an against recommendation:

  • Excise tax gross-ups
  • Cash severance payment upon change-in-control without termination of employment (i.e., single-trigger)
  • Single-trigger vesting of performance-based long-term incentives (LTI) with above target payout, unless there is a compelling rationale disclosed

Unlike ISS, Glass Lewis does not note any specific factors that could result in an against recommendation. Instead, they list criteria considered when evaluating the proposal including (but not limited to) the value (or magnitude) of payments, excise tax obligations, tenure and position of executives, use of single-trigger vesting, etc.

Shareholder Perspectives

CAP reviewed shareholder concerns from five recent acquisitions that failed their say on golden parachute proposal. Among these five companies, single-trigger vesting of LTI was the most common concern followed by excise tax gross-ups and large CEO retention bonuses. Shareholders are particularly concerned with single-trigger LTI vesting because executives could receive a windfall without termination of employment.



ISS Rec’d

GL Rec’d

% Support

Commonly Disclosed Shareholder Concerns


Specialty Retail




  • Single-trigger equity vesting
  • Large CEO retention award in connection with transaction

Extended Stay America, Inc.





  • Single-trigger equity vesting
  • Excise tax gross-up

Covanta Holding Corp

Waste Management




  • Single-trigger equity vesting
  • Excise tax gross-up

Kansas City Southern





  • Single-trigger equity vesting
  • Excise tax gross-up
  • Large CEO retention award in connection with transaction

Five9 Inc

Software – Application




  • Excise tax gross-up

Source: Proxy Insight

While not commonly cited, some shareholders were critical of how the equity vests at time of termination. Specifically, some were critical of accelerated or continued vesting (i.e., no pro-ration) of time-based equity while others cited above target payouts of unvested performance plans. It is unlikely that these provisions alone would result in an against say on golden parachute vote. Regardless, a company should provide a rationale for pay decisions, particularly if providing one-time retention awards or when deviating from previously disclosed shareholder-friendly practices.

Implications of Failing Say on Golden Parachute

Say on golden parachute votes are one-time, advisory, and non-binding but companies should be aware that there could be consequences of failing for the surviving entity. Beginning with the 2021 proxy season, Glass Lewis stated that they may recommend against the next say on pay vote or compensation committee members of the acquirer if an excise tax gross-up is introduced. To-date, we have not seen many shareholders vote against say on pay proposals of the surviving entity. Given continued scrutiny, we anticipate companies will carefully weigh the pros and cons of implementing non-shareholder-friendly provisions at the time of the deal; for those that do, we would expect to see robust disclosure on the rationale.

Say on Pay arrived in 2011, born out of the SEC’s rule-making efforts to reform corporate governance under Dodd-Frank after the financial crisis. This non-binding advisory vote, which is an annual event at most companies, allows shareholders to cast votes for or against Named Executive Officer (NEO) compensation. While earning simple majority support is technically a passing result, most companies strive for and achieve significantly higher levels of support. Investor support of compensation programs is influenced by many factors, which primarily include magnitude of pay, pay practices, and stock price performance.

In 2020, COVID-19 significantly disrupted the global economy, causing many companies to re-evaluate their compensation programs. Proxy statements filed in 2021, which will discuss compensation during the COVID pandemic year, will depart from previous norms. In anticipation of these filings, CAP has reviewed Say on Pay voting results at Russell 3000 companies in 2020, and since inception, to gauge the current landscape with an eye on what may occur with 2021 Say on Pay results.

Say on Pay Overview

Russell 3000 Historic Results

2020 marked the 10th year of Say on Pay voting. To date, voting results have generally been very consistent over time. Median support among Russell 3000 companies has been approximately 95% in each of the past 10 years. Most companies receive support from over 90% of shareholders, with an average of 74% of companies receiving support in the 90-100% range. Consistent vote outcomes are seen at the top and the bottom end of the range. The percentage of companies falling in each range shown below has been consistent throughout the 10-year history of Say on Pay voting.

All Companies


2011 – 2020



Median Level of Support



94.7% – 95.6%

>90% Support



70.0% – 76.8%

2%2%3%1%2%2%2%2%2%2%2%2%2%2%2%2%2%2%3%2%3%4%4%4%4%3%4%4%3%4%5%6%5%5%6%6%6%7%7%8%14%12%11%11%13%12%13%13%13%15%74%74%75%77%74%76%74%73%72%70%0%10%20%30%40%50%60%70%80%90%100%20202019201820172016201520142013201220110% - 50%50% - 60%60% - 70%70% - 80%80% - 90%90% - 100%Level of Support - All Companies

Only 2.2% of companies failed to receive majority support for Say on Pay votes in 2020. The number of companies that have failed the Say on Pay vote has also been very consistent over the 10-year period, with an average of 2.0% of companies failing over the past 10 years. For companies that failed in 2020, the median level of support was approximately 38%, mirroring historical results.

All Companies – Failed Say on Pay Vote


2011 – 2020



% of Companies Failing



1.4% – 2.4%

Median Level of Support



33.1% – 42.7%

Proxy Advisor Impact

Proxy advisors have a substantial impact on the Say on Pay vote for companies. The most influential proxy advisory firm is Institutional Shareholder Services (“ISS”) which grades companies on a pay-for-performance scale to determine if, in their view, CEO pay and company performance are well-aligned. ISS will then issue a recommendation “For” or “Against” the NEO compensation program, ISS’ vote recommendation often has a substantial impact on the vote result, as outlined below.

The two main inputs that ISS looks at are CEO compensation and Total Shareholder Return compared to an ISS-defined peer group based on company size and industry. Companies will then receive a “Low”, “Medium” or “High” concern level that determines whether ISS performs a qualitative evaluation of the compensation program. The overall concern level drives ISS’ ultimate recommendation For or Against the Say on Pay resolution. Historically, approximately 95% of companies with a Low concern receive support from ISS, compared to about two-thirds of companies rated Medium concern and roughly half of the High concern companies. Often, shareholders will reference the ISS recommendation (i.e., For or Against) when casting their vote on Say on Pay; however, many institutional investors have their own proprietary tests to evaluate compensation programs at companies.

ISS has consistently recommended Against Say on Pay for approximately 12% of companies per year, over the last decade. Among companies that have failed Say on Pay, the vast majority, 96% on average, have received an Against recommendation from ISS. In 2020, roughly 20% of companies that received an ISS Against recommendation ultimately failed the vote and for all companies with an Against recommendation from ISS, the median level of support was only 67%.

ISS Against Recommendation Impact


2011 – 2020



% of Companies with ISS Against Recommendation



10.0% – 13.5%

% of Companies with ISS Against Recommendation Failing Say on Pay



10.6% – 21.5%

Median Level of Support



65.1% – 70.4%

As shown below, the percentage of companies with an ISS Against recommendation, at each support level range, has been generally consistent since the Say on Pay vote was established.

20%19%18%11%14%23%17%17%18%13%15%16%17%12%19%15%15%18%23%16%25%26%26%26%24%23%22%22%16%21%21%24%23%24%20%20%21%22%23%23%12%10%10%17%16%14%16%13%11%17%8%6%7%10%7%5%10%8%8%10%0%10%20%30%40%50%60%70%80%90%100%20202019201820172016201520142013201220110% - 50%50% - 60%60% - 70%70% - 80%80% - 90%90% - 100%Level of Support - Companies Receiving an ISS Against Recommendation

Expectations for 2021

Institutional Shareholder and Proxy Advisor Commentary

2021 proxy statement disclosures will reflect the impact of COVID-19 on company performance which influenced both executive compensation in 2020 and the development of 2021 incentive programs. While the degree of impact will vary by industry and company, many more companies than usual will disclose adjustments to their compensation programs than in past years. During 2020, shareholders and proxy advisors provided some general guidance on how they will be assessing and evaluating these unique circumstances.

Institutional shareholders and proxy advisors have both stated that they recognize that 2020 was a more challenging year than most due to the impact of COVID-19. Because of this, they will review companies on a case-by-case basis, evaluating the facts and circumstances that went into any adjustments that were made. Guidance has generally encouraged proactive, enhanced disclosure that clearly explains the situation and rationale for COVID-related changes as opposed to generic descriptions of a challenging year, which may be viewed as insufficient.

How shareholders and proxy advisors interpret and assess the COVID-related disclosures and adjustments will ultimately influence Say on Pay votes and recommendations. While ISS and Glass Lewis did not make wholesale changes to their pay-for-performance evaluations for 2021, ISS did call out key disclosure items that would help investors evaluate COVID-related changes. This indicates that there may be more discretion and flexibility applied for companies with more robust disclosure. Even with greater flexibility in the qualitative evaluations, pay-for-performance misalignment will continue to be the main driver for Against recommendations from ISS in the broader market.

CAP Expectations

Since pay-for-performance is expected to remain the primary driver for proxy advisor recommendations, Say on Pay results will continue to depend on the magnitude of pay, pay practices and stock price performance. For companies that may have a pay and performance misalignment, we expect reduced shareholder support if a company has not provided sufficient rationale for the following actions:

  • Annual and long-term incentive plan adjustments
  • Major employee actions (e.g., layoffs)
  • Performance that is dramatically below investor expectations
  • Low relative financial performance
  • Above-target discretionary adjustments to payouts that previously missed threshold performance
  • Awarding one-time special cash/equity grants

Shareholder outreach will be more important in 2021 as companies can use these discussions to supplement their required disclosures. Proactive outreach may help to prevent a significant impact on the Say on Pay result even if proxy advisors recommend Against a company’s compensation program. There will also likely be more disclosure on go-forward incentive programs, as the impact of COVID-19 lingers into 2021.

Say on Pay results in 2021 will likely depart from prior norms. Even if the percentages of Against recommendations and companies passing remains relatively consistent with historic levels, we expect to see a downward shift in the median level of support and in the percentage of companies receiving at least 90% support. For companies that do receive an Against recommendation from proxy advisors, the level of support may decline compared to historic norms if disclosures do not sufficiently justify the actions taken.


2021 Say on Pay results will likely test the “steady state” seen over the previous 10 years. While the full picture will not be clear until later this year, CAP has begun to look at companies with fiscal years ended in late 2020 to get an early read. We will continue to monitor Say on Pay results throughout the year to see how the COVID-19 pandemic shapes these results.

Principal Shaun Bisman discusses the renewed investor and public interest of clawbacks and that companies are beginning to broaden their policies beyond a financial restatement.

On August 21, 2018, the IRS issued long-awaited guidance on the amendment of Section 162(m) made in the Tax Cuts and Jobs Act (TCJA).

This initial guidance is limited in scope and intended to respond to comments requesting clarification on the amended rules for identifying covered employees and the operation of the grandfather rule applicable to written binding contracts in effect before November 2, 2017. The initial guidance contains commentary, as well as numerous examples, on:

  • The definition of publicly held corporations covered by Section 162(m);

  • The definition of covered employees;

  • The definition of applicable employee remuneration;

  • The grandfather rule for compensation arrangements made under a written binding contract; and

  • Material modification of written binding contracts.


The most important highlights include:

  1. The definition of publicly held corporations covered by Section 162(m) is broadened.
  2. The definition of covered employees is modified to better align with current proxy disclosure rules, although differences continue to exist primarily because the “end-of-year” requirement is eliminated for purposes of Section 162(m).
  3. The definition of covered employees is expanded to include chief financial officers, former covered employees and payments to a covered employee’s heirs and estate.
  4. The tax deductibility of compensation is preserved if the compensation is paid under a written binding contract in effect on November 2, 2017 and not materially modified after that date.
  5. The ability to use negative discretion to reduce compensation under such an arrangement is likely sufficient to limit tax deductibility, since the contract is not binding. We expect companies to test this concept in the courts over time.
  6. A material modification increases compensation, or provides additional compensation, on substantially the same elements or conditions.
  7. Additional payments equal to or less than reasonable cost of living adjustments do not result in a material modification.

Amendments to the Definition of Publicly Held Corporation

The TCJA amendment broadened the definition of publicly held corporations covered by Section 162(m). Rather than limiting the scope to companies issuing common equity securities, the new definition includes “any corporation:

  1. Which is an issuer the Securities of which are required to be registered under section 12 of the Securities Exchange Act of 1934 (the 1934 Act), or
  2. That is required to file reports under section 15(d) of the 1934 Act.”

The new definition expands coverage to companies issuing various equity securities and publicly traded debt, as well as companies that may be otherwise exempt from filing a proxy statement. For example, the executive officers of a public company that delists its securities, thus eliminating the requirement to file a proxy statement and disclose executive compensation, would be covered employees for tax purposes and subject to the amendment’s limits on tax deductibility.

Amendments to the Definition of Covered Employee

Under the TCJA, the definition of covered employees is modified to better align with current proxy disclosure rules. Under the new definition, a covered employee means “any employee if:

  1. Such employee is the principal executive officer (PEO) or principal financial officer (PFO) of the taxpayer at any time during the taxable year, or was an individual acting in such a capacity,
  2. The total compensation of such employee for the taxable year is required to be reported to shareholders under the 1934 Act by reason of such employee being among the three highest compensated officers for the taxable year other than any individual described in (a), or
  3. Such employee was a covered employee of the taxpayer (or any predecessor) for any preceding taxable year beginning after December 31, 2016.”

Importantly, the initial guidance clarifies that a covered employee is not limited to only those serving in their role at the end of the year. By eliminating the end-of-year requirement, disconnects between the individuals reported in the proxy statement and actual covered employees may occur. The IRS notes that SEC rules do not constitute the sole basis for interpreting Section 162(m).

By including covered employees for any preceding taxable year beginning after December 31, 2016, the initial guidance clarifies that the pre-amendment rules for identifying covered employees will apply for taxable years beginning during 2017. These employees will be wrapped in under the amendment, with tax deductibility strictly limited beginning in taxable years beginning in 2018 and beyond.

Amendment to the Definition of Applicable Employee Remuneration

Applicable employee remuneration was defined, under Section 162(m), as the total amount allowed to be deducted for the tax year. Prior to the amendment to Section 162(m), applicable employee remuneration excluded commission-based and qualified performance-based compensation. The amendments to Section 162(m) removed these exclusions from the definition. The Act also added a rule that limits the deductibility of applicable employee remuneration even if the compensation is paid to a beneficiary in the event of the death of a covered employee.

Application of the Grandfather Rule

The amendment to Section 162(m) allows for the tax deductibility of compensation to be preserved (in other words “grandfathered”) if the compensation is paid under a written binding contract in effect on November 2, 2017 and not materially modified after that date. The initial guidance preserves the pre-amendment definitions of “written binding contract” and “material modification” as first detailed in the original 1993 grandfather rules included when Section 162(m) was added to the Internal Revenue Code.

Written Binding Contract

The initial guidance defines a written binding contract as a contract that requires the company under applicable law (for example, under state law) to pay compensation if the employee performs services or satisfies the vesting conditions attached to the compensation. If a contract contains elements that are binding and other elements that are discretionary, the amounts that are binding will continue to be deductible under the grandfather rule, absent a material modification, and the discretionary amounts will be subject to the amendment's limits on tax deductibility and not grandfathered.

Grandfathering is not available to contracts that are renewed after November 2, 2017. Instead, these are treated as new contracts. If a company has the right to cancel or terminate a contract without the executive’s consent after November 2, 2017, the loss of grandfathering occurs as of that date and the amendment’s limits on tax deductibility apply at that point and going forward. One common scenario plays out when a contract contains a notice period. For example, if a company can give notice of non-renewal after a defined initial term ends, or annually thereafter, the contract is treated as a new contract when the notice period ends or upon renewal, if earlier.

There are important caveats to this rule to keep in mind. If a contract can only be cancelled or terminated by ending the employment of the executive, the contract does not lose grandfathered status. Similarly, if the executive has the unilateral right to cancel the contract after a certain date but chooses not to do so, the contract does not lose grandfathered status after this date.

Consensus has developed that the ability of the board or compensation committee to exercise negative discretion and adjust payments down to zero makes a compensation plan or arrangement non-binding. This results in a loss of grandfathering and limits on tax deductibility under the amendment to Section 162(m).

We expect this position to be tested by issuers in tax court and/or state court. For example, if performance metrics and targets are clearly articulated in a contract or award agreement and the company has no history of actually applying negative discretion, a case could be made that the executive has a valid claim to receive that compensation. We will monitor developments on this point, since negative discretion is built into the majority of executive incentive plans.

Finally, if a compensation plan or arrangement is binding, the amount that is required to be paid as of November 2, 2017, will be grandfathered with no loss of tax deductibility, provided the executive was employed on that date by the corporate sponsor or the employee had a written binding contract as of that date. Supplemental executive retirement plan (SERP) benefits are a good example of this. If an executive has a binding right to receive SERP benefits, the accrued benefit as of November 2, 2017 will continue to be deductible when paid in the future, while amounts accrued for service after that date will be subject to the amendment’s limits on tax deductibility.

Material Modification

The IRS defines a material modification as an amendment that increases the amount of compensation payable to the executive, or provides additional compensation, on substantially the same elements or conditions. If a material modification occurs, amounts received prior to the date of the modification are grandfathered and amounts received after that are not grandfathered, but rather subject to the amendment’s limits on tax deductibility.

Another aspect identified by the IRS as a material modification to a written binding contract includes the acceleration of the timing of a payment unless the payment is discounted to reasonably account for receiving the compensation early. The IRS notes that modifying a contract to defer a payment does not constitute a material modification as long as the excess amount payable is based on a reasonable rate of interest or the rate of return of a predetermined investment.

The adoption of a supplemental contract that increases compensation or provides for an additional payment is a material modification, when the facts and circumstances demonstrate that the “compensation is paid on the basis of substantially the same elements or conditions as the compensation that is otherwise paid pursuant to the written binding contract.”

On the other hand, companies may increase compensation to offset the impact of cost-of-living without loss of grandfathering. The guidance clarifies that an additional payment that is less than or equal to a reasonable cost- of-living increase (for example, a modest salary increase) would not be a material modification.

Effective Date

According to the guidance, the amendment to Section 162(m) applies to taxable years beginning on or after January 1, 2018. The regulators anticipate that the guidance will be incorporated in future regulations and will apply to taxable years ending on or after September 10, 2018. The IRS also notes that any future guidance or regulations that address issues covered in the guidance that would broaden the definition of covered employee or limit the definition of written binding contract would apply prospectively only.

IRS Request for Comments

Treasury and the IRS expect to issue additional guidance on Section 162(m) and is requesting comments on other aspects of the amendments to Section 162(m) that should be addressed. These include a number of highly technical points, such as:

  • The definition of “publicly held corporation” applicable to foreign private issuers,
  • The definition of “covered employee” to an employee who was a covered employee of a predecessor of the publicly held corporation,
  • The application of Section 162(m) to corporations immediately after an initial public offering or a similar business transaction, and
  • The application of the SEC executive compensation disclosure rules for determining the three most highly compensated executive officers for a taxable year that does not end on the same date as the last completed fiscal year.

Written comments are being requested through November 9, 2018.


The IRS has provided initial guidance on key questions from practitioner after the TCJA passed. Plenty of examples as to how the new rules would be applied going forward are provided. However, the guidance is complex. Companies should evaluate how the rules apply by consulting internal and external subject matter expert that understand compensation, as well as the tax and legal perspectives. We will keep clients informed as consensus develops on various aspects of the guidance and as the IRS issues further guidance on Section 162(m).

Beginning with fiscal years ending on or after December 31, 2017, companies are required to disclose the ratio that compares the compensation of the CEO to the compensation of the median employee (pay ratio). This disclosure was part of the Dodd-Frank Wall Street Reform and Consumer Protection Act signed into law in 2010.

Compensation Advisory Partners LLC (CAP) researched early pay ratio disclosures. As of March 9, 2018, we obtained pay ratios from 150 companies with a median revenue of $2.1B from a cross-section of industries.

Pay Ratio

The median pay ratio disclosed by these companies is 87x. The lowest ratio is 1x (Apollo Global Management, Dorchester Minerals and The Carlyle Group) and the highest ratio is 1465x (Fresh Del Monte Produce Inc.).

Summary Statistics Median Employee Pay Median CEO Pay Pay Ratio
75th percentile $88,612 $10.5M 172x
Median $58,256 $5.6M 87x
25th percentile $43,966 $2.5M 36x

As expected, the pay ratio correlates with company size, with larger companies disclosing higher ratios. CEO pay varies greatly depending on the size and complexity of the organization. Employee pay has less variability since it reflects the job function and does not vary significantly based on the size of the organization. The median ratio in our sample of 150 companies ranges from 20x for companies with revenue less than $500M to 218x for companies with revenue greater than $15B.

20x 54x 84x 157x 183x 218x <$500M $500M-$1B $1B-$5B $5B-$10B $10B-$15B >$15B Median Pay Ratio by Revenue Size

Few companies, 15, disclose a supplemental pay ratio with only a handful of companies (three) disclosing more than one additional ratio. These companies with supplemental ratios are typically adjusting the CEO’s pay which may exclude anomalies such as a one-time special bonus or equity award. Interestingly, three companies disclosed a higher supplemental pay ratio likely to provide context for a large year over year increase in the 2019 proxy statement.

Location of Disclosure

Nearly 70% of companies disclose the pay ratio after the Potential Payments upon Termination or Change in Control section of the proxy statement. Approximately 25% of companies disclose the pay ratio just before or after the Summary Compensation Table and a small minority, 5%, disclose it in the Compensation Discussion and Analysis (CD&A).

Pay ratio is typically not disclosed in the CD&A, signaling to shareholders that the pay ratio is not used to determine CEO pay levels. Additionally, around 25% of companies include language in the disclosure that the ratio should not be used to compare pay levels to other companies within the industry, region of the country or revenue size.

Measurement Date

The SEC’s final rules give companies the flexibility to use any date within the last quarter of the fiscal year to identify the median employee. Companies most commonly used the last day of the fiscal year or a date within the last month of Q4. It is also common for companies to use a day within the first month of Q4 to identify the median employee.

Measurement Month Prevalence Measurement Date Prevalence
First Month of Q4 29% Last day of Q4 44%
Second Month of Q4 8% First day of Q4 17%
Third Month of Q4 57% Other 33%
Not Disclosed 6% Not Disclosed 6%

Exclusions from Median Employee Determination

Approximately one-third of companies excluded a portion of their workforce when determining the median employee. The most common rationale is the de minimis exemption (approximately 55%) whereby a company can exclude up to 5% of its non-U.S. employee workforce. Companies also commonly cited an acquisition or corporate not responsible for setting pay (e.g., independent contractors) as rationales for excluding certain employee groups.


As more companies continue to file their proxy statements in the coming weeks, we will likely see larger pay ratios, particularly as companies with a significant part-time workforce begin to disclose their ratios. We do not anticipate an increasing trend in the number of companies filing supplemental pay ratios though it will be interesting to see the rationale for those that do. We expect to continue to see companies placing the pay ratio outside of the CD&A with most disclosing it after the Potential Payments upon Termination or Change in Control section.

CAP reviews proxy disclosures of S&P 500 companies on a weekly basis as part of an on-going Say on Pay study. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”) mandates that public companies provide shareholders with a non-binding vote on executive compensation every one, two or three years. This study tracks all Say on Pay and Say on Frequency related proposals and the corresponding vote results.

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