On a panel of leading executive compensation experts, Margaret Engel discusses some of the top executive compensation issues and trends including: the current public mistrust of executive compensation programs, the importance and the rigorous process of target goal setting, the challenges that many companies face with long-term performance awards, and the likely increase in the use of performance-based stock options in the future.

Setting goals for long-term incentives has been a persistent problem for companies and Compensation Committees ever since the reliance on long-term performance plans has increased. However, the results of the recent election take the uncertainty to an entirely new level, right around the time when companies are starting to think about setting goals for their upcoming long-term incentive cycle. Examples of challenges various industries will face include:

Energy & Utilities

  • Volatility of energy prices given the views on natural gas and oil
  • Environmental regulations (i.e. carbon dioxide emissions)
  • Traditional sources of energy vs. renewables

Financial Services

  • Dodd-Frank implications
  • Movement in interest rates
  • Return of Glass-Steagall

Industrial and Materials Companies

  • Investment in large infrastructure projects
  • Renegotiation of trade deals and increased tariffs on goods

None of the above even touches on the implications for businesses if the administration implements a broad-reaching immigration initiative which can have implications on labor costs or if President-elect Donald Trump is successful at dramatically lowering the corporate tax rate.

In many ways, it is similar to the level of uncertainty companies and Boards were dealing with during and immediately following the financial crisis. As Compensation Committees and management plan for 2017 and beyond, a challenge will be setting goals in a company’s 1- and 3-year incentive plans. As such, Compensation Advisory Partners (“CAP”) outlines four things to think about when setting goals to avoid unintended outcomes and maximize flexibility and accountability.

  1. Scenario Testing – Run scenarios to test sensitivities and potential outcomes. For example, test what will happen if energy prices go up/down/stay flat and what will happen to payouts under the varying scenarios. Discuss this analysis with the Compensation Committee and establish guiding principles for what is a reasonable payout under the varying scenarios.
  2. Retrospective analysis – Over periods of uncertainty, companies can meet or miss their goals for many reasons. If the next four years are as volatile as currently expected, Compensation Committees should encourage management to do a retrospective analysis at the end of each performance cycle comparing actual performance to expected performance when goals were set. For example, if the company ultimately delivers $3.00 EPS and the goal was $2.50, did the company get there through true outperformance, because of changes in non-controllable events or because corporate tax rates declined? This retrospective analysis can help guide the Compensation Committee in determining how challenging the goals wound up being and if appropriate, make necessary adjustments to payouts.
  3. Wider range As the ability to predict the future diminishes, it can often be helpful to rethink the range around target that justifies a threshold and maximum payout. For example, if a company has a high level of confidence in the ability to achieve planned performance, then they might set a relatively narrow range around target (e.g., 95% of plan for threshold and 105% of plan for maximum). However, if the company has less confidence in the ability to set its plan, a wider range (e.g., 90% of plan for threshold and 110% of plan for maximum) may be more appropriate such that deviation from plan does not have as much as much of an impact on payouts.
  4. 162m Umbrella Plan – With significant uncertainty it may be challenging to predict what, if any, adjustments a Compensation Committee may want to make to their annual or long-term performance plan. This would be a good time to consider implementing, if you have not already, a 162m umbrella plan to provide the Compensation Committee with flexibility to make adjustments and maintain tax deductibility. An umbrella plan is a structure whereby a bonus is effectively “over-funded” for the Named Executive Officers (“NEOs”) such that the Compensation Committee can determine the final payout with some flexibility as long as the final payout is below the umbrella funded amount. For example, in order to qualify as performance-based compensation, a company could establish a maximum to be paid equal to 3% of net income and specify a percentage of the award pool for the each NEO (excluding the CFO). The Compensation Committee then retains negative discretion to pay less than the maximums established. These umbrella plans are very common for annual incentives, but are less common for long-term plans, though this might be a good time to consider whether one might be appropriate.

There are many other ways of addressing uncertainty around goal setting, but these four tips should help maintain a pay for performance structure, hold management accountable and provide Compensation Committees with appropriate flexibility.

Today, Institutional Shareholder Services (ISS) announced a methodology update to its CEO pay-for-performance assessment for U.S. companies. Beginning February 1, 2017, ISS proxy research reports will include a new standardized comparison of a company’s financial performance relative to its ISS-defined peer group.

This is a departure from ISS’ sole reliance on Total Shareholder Return (TSR) as a metric. ISS will measure multiple financial metrics which may include Return on Equity, Return on Assets, Return on Invested Capital, Revenue growth, EBITDA growth and Cash Flow (from Operations) growth; these metrics will supplement TSR, but only in the qualitative assessment. ISS will calculate a weighted average of select financial metrics; measures (and weightings) will be based on a company’s four-digit GICS industry group. For 2017, the new financial assessment will not be included in the quantitative assessment although ISS may incorporate a company’s relative financial performance in its qualitative discussion.

This is a significant change to ISS’ pay-for-performance methodology which primarily assesses performance based on Relative TSR. While the additional financial metrics will not be included in the quantitative assessment for the 2017 proxy season, it can provide shareholders with additional context of a company’s overall financial performance. The implication is that TSR will still drive a company’s specific level of concern in the quantitative tests. However, if the company’s financial metrics are not aligned with their stock performance, it could weigh heavily on whether they receive a “For” or an “Against” recommendation from ISS on the Say on Pay vote. Examples where this new policy could help a company is if the market has overreacted to news or industry shifts, but the underlying financials are still relatively strong. When ISS releases the details on the definition and weightings of each financial metric, it will be important for a company to model the financial performance relative to the ISS-defined peer group to understand how its performance will be viewed relative to comparators.

With this updated methodology, however, realizable pay will become increasingly more important in a company’s overall pay-for-performance assessment. By taking a more holistic look at stock and financial performance, ISS may more appropriately capture the linkage between actual compensation earned and the underlying financial performance.

Additionally, ISS has historically relied on S&P to provide financial data, which does an effective job at creating comparability across companies financials. However, they are typically limited in the adjustments they can make across companies (ISS will likely use GAAP definitions, where applicable) and, therefore, a company’s view of its relative performance (which may include adjustments) could differ from ISS. This could be true where there are significant differences between a company’s peer group and the ISS peer group, particularly for companies with a cross-industry peer group (which are more commonly used with large cap companies).

In addition to incorporating financial performance metrics, ISS also announced that it will no longer include companies with less than two years of TSR and pay data in the Relative Degree of Alignment (RDA) assessment. This change will only impact newly public companies.


Overall Findings

  • Performance: 2015 performance (based on Revenue growth, Pre-tax Income growth, EPS growth and 1-year Total Shareholder Return or TSR) was weaker than 2014 performance.
  • CEO Pay: Median CEO pay was up 13% from 2014, driven by significant increases in the grant date value of long-term incentives (LTI) which are typically granted during the beginning of the fiscal year.
  • Annual Incentive Payout: At median, annual incentive payouts (as a percentage of target) were lower in 2015 than the prior year. Additionally, there was more variability in payout around target compared to 2014 demonstrating a directional alignment between pay and performance.
  • LTI Payout: Performance share plans paid out at target for the 2013-2015 performance period despite strong median 3-year cumulative TSR performance of 56%.
  • Disclosure: Companies generally did not make wholesale changes to their proxy statements. Some enhanced their disclosure through the use of charts and graphs to make the proxy statement a communications document for shareholders.

2015 PERFORMANCE

2015 was a year that included an increase in the value of the U.S. dollar, volatility in foreign currency exchange rates and a slowdown in economic growth overseas (particularly in China). These factors contributed to 2015 performance being weaker than 2014 performance. CAP reviewed Revenue growth, Pre-tax Income growth, EPS growth and TSR performance for the Early Filers and the S&P 500. For the measures reviewed, 2015 performance was generally flat (0 – 3% growth) compared to the strong performance of 2014.

Financial Metric

2014 Median 1-year Performance

2015 Median 1-year Performance

S&P 500

Early Filers

S&P 500

Early Filers

Revenue Growth

5.6%

5.7%

0.8%

2.4%

Pre-Tax Income Growth

8.6%

6.4%

0.2%

1.2%

EPS Growth

10.6%

10.4%

2.6%

3.2%

TSR (1)

16.3%

14.1%

2.3%

0.3%

(1) TSR for the S&P 500 is as of September 30, 2014 and September 30, 2015. TSR for Early Filers is as of each company’s fiscal year end.

CEO TOTAL DIRECT COMPENSATION

Among Early Filers with CEOs in their role for at least two years (n=42), 2015 actual total direct compensation increased 13% over 2014 pay levels. 2015 annual incentive payouts were down 3% reflecting weaker financial performance compared to the prior year. LTI grants in 2015, however, were significantly higher than 2014. This finding is likely reflective of the timing of LTI grants (typically in the first quarter of the fiscal year) and companies likely providing larger grants in 2015 because of the strong performance in 2014. Consistent with the expected salary increases, 2015 base salary was 3% higher than 2014.

Compensation Element (n=42)

2014 Median

($000)

2015 Median

($000)

% Increase

Base Salary

$1,000

$1,031

3.1%

Actual Annual Incentive

$1,791

$1,731

-3.4%

Total Cash

$2,836

$2,663

-6.1%

Long-Term Incentive (LTI)

$5,468

$6,896

26.1%

Total Direct Compensation

$8,290

$9,399

13.4%

INCENTIVE COMPENSATION

Annual Incentive Plan Payout

As mentioned above, actual annual incentive payouts in 2015 were lower than 2014. At median, 2015 payouts were 101% of target vs. 2014 payouts which were 111% of target. At the 25th percentile, 2015 payouts were much lower (76%) than 2014 (99%) but were more in line with 2013 and 2012 payouts which is indicative of a return to more normalized distribution of payouts in 2015.

Summary Statistics

Annual Incentive Payout

as a % of Target

2012

2013

2014

2015

75th Percentile

130%

127%

135%

133%

Median

100%

95%

111%

101%

25th Percentile

72%

75%

99%

76%

As expected, performance was noticeably stronger for companies with an annual incentive payout that was at or above target. Conversely, performance for companies with a payout below target was weaker in 2015. These results are similar to 2014 performance, although TSR was stronger for companies with below target payout in 2014 (+7%) compared to 2015 (-11%).

Financial Metric

2014 Median 1-year Performance

2015 Median 1-year Performance (1)

Below target payout (n=15)

At or above target payout (n=35)

Below target payout (n=24)

At or above target payout (n=24)

Revenue Growth

3.6%

6.3%

-4.0%

7.0%

Pre-Tax Income Growth

-2.9%

12.7%

-7.2%

11.7%

EPS Growth

-3.4%

13.5%

-2.9%

13.9%

TSR (2)

7.2%

16.0%

-10.7%

12.6%

(1) Excludes 2 companies that had spin-offs during 2015.

(2) TSR for Early Filers is as of each company’s fiscal year end.

Overall, 50% of companies provided a payout at or above target in 2015 (consistent with 2013 and 2012) which is much lower than 2014 (70% of companies); as a result, there was more variability in payouts relative to target in 2015 than in 2014. Additionally, the number of companies providing a payout between 100 – 150% of target in 2015 is approximately half of what it was in 2014. Interestingly, nearly the same number of companies provided a payout of 150% and above in both 2014 and 2015. Finally, the number of companies not providing an annual incentive payout in 2015 increased (4 companies in 2015 vs. 1 company in 2014).

Long-Term Incentive Plan Payout

Three-year (2013 – 2015) performance was strong among Early Filers and the S&P 500. Cumulative Revenue growth was 11% (or 4% per year) for both Early Filers and the S&P 500. Cumulative EPS growth was very strong (21%) for the S&P 500 and more modest (11%) for the Early Filers. Overall, companies in both groups had significant stock price appreciation over the three-year period; 3-year cumulative TSR was 48% for the S&P 500 and 56% for the Early Filers.

Financial Metric

Median 3-year Cumulative Performance

S&P 500

All Early Filers (1) (n=42)

Revenue Growth

10.9%

11.0%

Pre-Tax Income Growth

15.6%

12.1%

EPS Growth

21.3%

10.9%

TSR (2)

48.0%

55.7%

(1) Reflects only those companies with a performance share plan.

(2) TSR for the S&P 500 is as of September 30, 2015. TSR for Early Filers is as of each company’s fiscal year end.

Despite strong TSR performance over the three-year period, and even with 60% of companies using Relative TSR as a performance metric, median LTI payout was around target (98%). Median LTI payout for companies that use Relative TSR was slightly below target (95%); however, a majority of these companies (60%) use TSR in conjunction with other financial metrics.

Summary Statistics

LTI Payout as a % of Target

All Early Filers (n=42)

Early Filers with TSR as a Metric (n=26)

75th Percentile

128%

119%

Median

98%

95%

25th Percentile

54%

54%

PROXY STATEMENT DISCLOSURE CHANGES

Since Say on Pay was adopted in 2011, companies have incorporated many new features to make their proxy statement a communications document for shareholders by including a proxy summary, an executive summary in the CD&A and highlighting good governance practices, just to name a few. While Early Filers generally did not make wholesale changes to their proxy statement in 2016, some companies enhanced their disclosure with additional charts and graphs. Some examples include:

  • Deere & Co, which has annual incentive performance goals that can vary depending upon the company’s sales volume, added a graph to explain the performance goals, actual results and how each related to the actual sales volume achieved;
  • Jabil Circuit, Jacobs Engineering Group and TE Connectivity added a list of corporate governance best practices (i.e., “what we do and what we do not do”);
  • Starbucks added a picture describing their shareholder outreach process and topics discussed with shareholders.

We would expect that companies will have more significant changes to the proxy statement as more rules under Dodd-Frank (e.g., pay ratio and pay vs. performance) are finalized and implemented.

CONCLUSION

2015 was not as strong of a performance year as 2014. Given weaker 2015 performance, annual incentive payouts declined from 2014 levels resulting in a directional alignment between pay and performance. 2016 is already shaping up to be an interesting year given recent declines in stock price, currency fluctuations and overall uncertainty given the U.S. Presidential election. Many companies will be making their annual equity grants at depressed stock prices, so we may potentially see a year over year decline in LTI grant values particularly for those companies that grant awards based on a fixed number of shares. From an executive compensation perspective, we expect that the SEC will come out with final rules for the clawback, hedging and pay vs. performance in October 2016 which could have an impact on 2017 and 2018 disclosure.

We believe Mr. Fink raises an important point on linking incentives to business strategy. A clearly communicated business strategy would help to avoid pitfalls that we see frequently today. These include incentives that are designed primarily to respond to pressure from proxy advisory firms, often driving a “one size – fits all” approach or encouraging short-term thinking.

“We are asking that every CEO lay out for shareholders each year a strategic framework for long-term value creation. Additionally, because boards have a critical role to play in strategic planning, we believe CEOs should explicitly affirm that their boards have reviewed those plans. BlackRock’s corporate governance team, in their engagement with companies, will be looking for this framework and board review.”
Larry Fink, BlackRock CEO

As highlighted by our articles Are You Rewarding Short-Termism? in The Corporate Board and Balancing pay for performance with shareholder alignment in the Ethical Boardroom, it is important that compensation, in particular long-term incentive compensation, links directly to the company’s strategy. We agree that providing shareholders with a voice on compensation programs through Say on Pay has been beneficial, but we have observed a chilling effect on creative compensation programs. Today most public companies are very reluctant to be an outlier on compensation. If we look at CAP’s sample of 100 large market cap companies, 51% use Total Shareholder Return (TSR) and 34% use EPS as metrics in their long-term incentive plans. Are these universal metrics appropriate in almost any situation? We question that premise. Why do so many companies have similar metrics when they have unique business strategies, operate in diverse industries and are positioned at different points in their lifecycle?

The good news is that we have observed modest increases in the use of return metrics, from 41% in 2011 to 47% in 2014 (e.g., return on assets, return on capital and return on equity). In several cases, activist investors have intervened to champion the adoption of return metrics. Traditional institutional investors with concerns over the effectiveness of corporate business strategies have also been vocal in encouraging companies to focus on returns. Both camps frequently push companies to move to adopt balanced metrics that encourage profitability in combination with growth as opposed to growth alone.

The chart below provides a snapshot of how long-term incentive plan metrics have evolved over time. Use of TSR has grown most since 2011, from 36% to 51% and this is after dramatic increases prior to 2011. We believe this is the direct outcome of the influence of proxy advisory firms, who have pushed hard on companies to incorporate relative TSR in their programs. The good news is that since 2011, the number of companies relying on a single metric has declined, with over 1/3 of companies using 3 or more metrics which may indicate they are tailoring plans more to their specific situation.

# of Metrics

2011

2014

1

33%

26%

2

40%

37%

3 or More

27%

37%

While EPS and TSR may make sense for many companies, companies should consider various factors when selecting measures, including:

  • Is relative TSR the best answer for your company? We see it as an outcome-oriented metric that lacks a clear linkage to strategic priorities and is not well suited to driving behaviors that create shareholder value.
  • Does over-reliance on TSR encourage risk-taking behaviors? Companies may make decisions that drive TSR in the short-term (e.g., share buybacks or higher dividends), rather than identifying better uses of capital that can lead to sustained long-term growth.
  • Does an EPS metric create an incentive to buy back shares rather than re-investing for growth? Financial experts have mixed views on the utility of share buybacks. The jury is still out.
  • Are the current time horizons for TSR performance optimal? Almost all plans measure TSR over 3 years. Why is a 3-year time frame the default for most companies? Since TSR is usually defined as a relative metric, eliminating the need to set goals in advance, should companies be evaluating longer timeframes that align with their business cycles?
  • If relative TSR is your company’s metric, where are you in the cycle? Companies and boards need to ask and analyze whether relative TSR goals will pay out for sustained long-term stock price appreciation or for volatility in relative stock price performance. Companies and boards need to understand whether the stock is only recovering from earlier losses that occurred prior to the start of the performance period.

We don’t believe that either EPS or TSR are inherently poor metrics. In many cases, it makes sense for companies to incorporate these metrics into their overall incentive framework. However, it is critical to determine if these metrics are right for a particular company at a -particular time in its life cycle. Keep in mind that long-term incentives are the largest component of pay for many executives. As companies and boards design long-term incentives, they should consider the following questions:

  • Does the compensation program support our strategy and do the metrics and goals align with our long-term business plan?
  • Can we communicate clearly and succinctly how the program ties to our strategic framework for both shareholders and program participants?
  • What behaviors, good or bad, could the design encourage? For example:
    • Does it send clear signals throughout the organization on the strategic priorities?
    • Is short-term upside emphasized at the expense of long-term sustained value?
    • Do we encourage growth at the expense of returns that exceed our cost of capital?
  • Does the program encourage excessive or inappropriate risk-taking?
  • For metrics other than TSR, will achievement of goals lead to company and shareholder value creation?
  • Are there alternative metrics, including strategic metrics (e.g., increase in market share, diversification of revenue, etc.) that might be better indicators of successful execution of the strategy?

Overall, we think Mr. Fink’s commentary on the importance of defining and communicating a company’s strategic framework for value creation serve shareholders well. His comments point to a fundamental principle of compensation design: incentive compensation should be used to reward the company’s success in achieving its strategy and creating long-term value for shareholders. The performance measures used to determine incentive compensation need to track progress on the strategy over the near term and over the long-term. We believe we will see a migration in this direction as long-term incentives evolve, companies continue to dialogue with their shareholders and perhaps as they enhance disclosure around their strategic framework as Mr. Fink suggests.

Proposed amendments to Item 402 of Regulation S-K outline additional disclosure requirements designed to implement Section 14(i) of the Securities Exchange Act of 1934 (the “Exchange Act”), as added by Section 953(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”).

On Wednesday April 29, the SEC held an open meeting and approved by a vote of 3-2 a staff proposal to amend Section 14(i) of the Securities Exchange Act of 1934 to expand disclosure requirements for executive compensation. The proposed amendment was added by Section 953(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The proposed rules will require clear disclosure of the relationship between executive compensation actually paid and company financial performance.

The SEC’s objectives – enhanced disclosure, more transparency, alignment of pay and performance – are praiseworthy, but some of the new rules are complex. CAP predicts that compliance will prove to be burdensome for most companies.

Highlights of the Proposed Rules

Publication of a New Table: The proposed rules add a new table to the current disclosure on executive compensation. This new table will include:

  • Executive compensation actually paid for the principal executive officer and the average amount actually paid to the remaining named executive officers. For purposes of the table, compensation actually paid is total compensation as disclosed in the summary compensation table with adjustments to the amounts included for pensions and equity awards.
  • The total executive compensation reported in the summary compensation table for the principal executive officer and an average of the reported amounts for the remaining named executive officers.
  • The company’s total shareholder return (TSR) on an annual basis as presented in the existing stock performance graph. The definition of TSR is provided for the stock performance graph in Item 201(e) of Regulation S-K.
  • The TSR of the companies in a peer group or index, using either the peer group identified by the company in its stock performance graph or in its compensation discussion and analysis.

CAP predicts that graphic representations, similar to the Stock Performance Graph, will be a popular approach.

Additional Disclosure: In addition to the new table, companies will be required to provide a clear explanation for the relationship between compensation actually paid and the company’s TSR performance. An explanation of the company’s TSR performance and the TSR performance of the peer group or index is also required. Companies will have the flexibility to provide this explanation as a narrative, in a graph or by using both.

Adjustments to Calculate Compensation Actually Paid: Companies will need to make two adjustments to total compensation reported in the summary compensation table to calculate compensation actually paid. The adjustments relate to equity award values and pension values. Companies will be required to disclose the adjustments to the compensation reported in the summary compensation table in a footnote.

First, the reported grant date value of equity will be subtracted from reported total compensation and the fair value of equity vesting in that year and re-valued on the date of vesting will be added to calculate compensation actually paid. Companies will need to disclose the vesting date valuation assumptions if they differ materially from the assumptions used for financial statements as of the grant date.

In the second adjustment, the reported change in pension value will be subtracted from reported total compensation and the change in pension value attributable to the actuarially determined service cost for services rendered by the executive during the applicable year will be added.

Time Period Covered: The disclosure will be required for the last five fiscal years, provided a company was subject to disclosure rules during this period.

Interactive Data Format Required: Companies will be required to tag the disclosure in an interactive data format using eXtensible Business Reporting Language, or XBRL.

Covered Companies: The proposed rules apply to all reporting companies, except that foreign private issuers, registered investment companies and emerging growth companies are exempt.

Transition Period: The proposed rules provide a phase-in for all companies. In the first year, companies will be required to provide the information for three years. The fourth and fifth years of disclosure will be added in each subsequent year’s annual proxy filing that requires this disclosure.

Rules for Smaller Reporting Companies: These companies are required to provide disclosure for only the last three fiscal years, rather than for five fiscal years. Smaller reporting companies will not be required to include peer group TSR, since they do not disclose either a stock performance graph or a compensation discussion and analysis. In addition, smaller reporting companies will not be required to make adjustments to pension amounts because they are subject to scaled compensation disclosure requirements that do not include disclosure of pension plans. The requirement to tag disclosure in an interactive data format will also be phased-in for smaller reporting companies, so that they will not be required to comply with the tagging requirement until the third annual filing in which the pay-versus-performance disclosure is provided. Initially, smaller reporting companies will provide the information for two years, adding an additional year in the next annual proxy or information statement.

Process: The proposed rules will be published on the SEC’s website and in the Federal Register. The comment period for the proposed rules will last for 60 days after publication in the Federal Register.

Adjustment to equity award values adds complexity and creates disconnects. By revaluing equity on the date of vesting, timing differences between the TSR calculation and the date(s) of vesting will occur. In addition, compensation actually paid will include tranches of different awards that happen to vest in a particular year so Board decision-making on pay and performance in the year of grant will be unclear.

CAP’s Initial Assessment of the Proposed Rules

We applaud the SEC’s attempt to improve disclosure and we agree that pay and performance alignment is critical to good governance and effective executive compensation programs. We also agree that some standardization is necessary. Our research indicates that approximately 15% to 20% of S&P 250 companies provide supplemental disclosure of either realized or realizable pay. Currently, there is no standard definition for either formulation of total compensation. Supplemental pay disclosure is frequently compared to TSR performance, but a consistent approach that can be compared across companies does not exist. The proposed rules impose a standard approach, but at what cost?

We are concerned that the proposed rules are too prescriptive and overly complex. Implementation will burden many companies. The proposed definition of compensation actually paid stands out as our biggest concern. The SEC proposal requires companies to re-value equity awards that vest in each year as of the date of vesting. This approach instantly creates timing differences between the stock prices used in the TSR calculation and the stock prices on the date(s) of equity award vesting. Vesting dates occur throughout the year, but occur most frequently in February – April for calendar year companies. As a result, the proposed approach allows for a re-valuation of equity awards at a more current stock price, but that stock price will likely not correlate with the fiscal year end stock price used in the TSR calculation. This is an obvious disconnect.

In addition, the re-valuation of equity awards for most companies will be composed of tranches of different awards that were granted in different years — likely spanning a three to five year period — that happen to vest in a single year. This approach contributes to confusion around the Board’s thinking on pay and performance alignment, rather than increasing clarity. Instead of focusing on the date of vesting, a better approach would be to re-value equity awards granted in a single year using a year-end stock price consistent with the TSR calculations.

Finally, to the extent that a company uses stock options, updating the assumptions used in option pricing models, such as Black-Scholes, to reflect the date of vesting will be time-consuming at best. This means that stock options will not only be re-valued at a new stock price, but that other assumptions, such as expected life, volatility, dividend yield and risk-free rates, must also be updated.

Two other aspects of the proposed rules contribute greatly to the compliance burden. First, the requirement to include compensation of the average of the remaining named executive officers in the new table in addition to the compensation of the CEO will be very complicated for companies to work through. Publication of this average based on equity grants made over a three to five year span to at least four executives for five years potentially requires dozens of calculations. The SEC should have limited the new disclosure to the CEO since that would greatly reduce the compliance burden and arguably allow for a simpler and more targeted explanation of the Board’s thinking. After all, the CEO normally sets the tone for the entire organization!

The second aspect of the proposed rules that increase the compliance burden is the decision to publish five years of information, rather than three years. Arguably longer time frames are positive when assessing TSR performance, but the summary compensation table shows three years of compensation. Most supplemental disclosure of realized and realizable pay out there today incorporates only three years of compensation and performance data. Even though the SEC provides transition relief, building out the new table to cover five years will be burdensome.

Adjustment to change in pension value is appropriate since it eliminates the impact of changes in assumptions for mortality and discount rates.

We will refine our initial assessment and provide more finely tuned comments back to the SEC during the public comment period. We would not be surprised if the SEC backs off on the date of vesting re-valuation of equity in favor of date of grant re-evaluation. Many will recall that when the proxy disclosure rules were initially proposed, equity award values reflected the amounts recognized for financial reporting purposes. After much public discussion and pushback, the SEC amended the disclosure rules in 2009 to incorporate the grant date fair value of equity awards.

More to come on these points in the next few months! We hope that the SEC achieves consensus on effective pay and performance disclosure before the 2016 proxy season begins.