Measuring Pay Against Performance: Are Shareholders Getting Their Money’s Worth?

Washington D.C.

Financial incentives drive how executives perform in their role as fiduciaries to companies and their shareholders. Understanding what those incentives are and whether they are actually working – that is, if and how they link to company performance – is critical for investors in evaluating a company’s compensation practices.

The Dodd-Frank mandate for a rule requiring companies to disclose the relationship between executive compensation actually paid and the financial performance of the company is among the most useful, straightforward, and commonsense provisions in that law. Yet, it has been over eleven years since Dodd Frank imposed that mandate, and over six years since the SEC proposed such a rule. In that time, executive compensation—and the gap between pay for executives and everyday workers—has grown tremendously.[1] Investors need to understand if that growth is concomitant with the value created. In other words, are shareholders getting their money’s worth? That question, central to good corporate governance, is what this proposed disclosure seeks to address.

I’m pleased that the Commission is preparing to finalize this rule. Today’s reopening of the comment file allows commenters a new opportunity to offer their views and the Commission the opportunity to ensure it is relying on current data. The reopening release highlights certain changes the Commission is considering to its proposed approach to help ensure the disclosure captures how companies actually link financial performance to executive compensation, while still preserving important comparability in disclosure from company to company. Specifically, the reopening release contemplates providing companies additional flexibility through disclosure of, in addition to the proposed performance metric of total shareholder return, other metrics of their choosing.[2]

The modern compensation landscape now encompasses enhanced reliance on performance metrics related to, for example, climate, diversity, and other company-specific ESG goals.[3] It would be helpful to hear from commenters on how the increased flexibility contemplated in today’s reopening release may facilitate investor analysis of the use of such metrics and targets in compensation plans, and how it may enable companies and investors to better evaluate the success of the many tailored and unique compensation plans companies employ.

In addition, the reopening release highlights certain changes in the regulatory landscape since the initial proposal. One such change relates to smaller reporting companies, which the Commission originally proposed to include in the rule’s requirements, but only on a scaled basis. Today’s reopening release explains that the Commission expanded the definition of smaller reporting company in 2018 and estimates that smaller reporting companies today would account for 45 percent of all companies that would be subject to the rule’s requirements.[4] That means nearly half of all reporting companies would be exempt from certain of the proposed disclosure requirements. It would be helpful to hear from commenters as to whether we should include exemptions for smaller reporting companies in the final rule and, if so, how best to calibrate them.

I look forward to reviewing comments on these and other aspects of the proposal as well as the new questions raised in today’s release. I thank the staff for their thoughtful work.

[1] See Lawrence Mishel & Jori Kandra, Economic Policy Institute, CEO pay has skyrocketed 1,322% since 1978 (Aug. 10, 2021) (showing average annual CEO compensation increasing from 2009 to 2020 by 130.3 percent, and the CEO-to-worker pay ratio increasing during the same time period by 97.7 percent); see also Theo Francis & Kristin Broughton, CEO Pay Surged in a Year of Upheaval and Leadership Challenges, Wall Street Journal (Apr. 11, 2021) (“Median pay for the chief executives of more than 300 of the biggest U.S. public companies reached $13.7 million last year, up from $12.8 million for the same companies a year earlier and on track for a record, according to a Wall Street Journal analysis. Pay kept climbing in 2020 as some companies moved performance targets or modified pay structures in response to the Covid-19 pandemic and accompanying economic pain. Salary cuts CEOs took at the depths of the crisis had little effect. The stock market’s rebound boosted what top executives took home because much of their compensation comes in the form of equity.”).

[2] The Commission originally proposed to use total shareholder return (TSR) as the measure of performance against which to assess compensation. The reopening release provides that the Commission is considering whether to require, in addition to TSR, the disclosure of additional measures of performance: pre-tax net income, net income, and a measure chosen by the company (the Company-Selected Measure). We are also considering requiring a company to list its five most important measures used to link compensation actually paid to company performance. See Reopening of Comment Period for Pay Versus Performance, Release No. 34-94074 (Jan. 27, 2022) [hereinafter Reopening Release].

[3] See Hazel Bradford, Executive pay increasingly tied to environmental, social performance metrics, Pensions & Investments (Nov. 12, 2021) (“Five years ago, of the 65 S&P 500 companies including E&S [environmental and social] metrics, less than 20% had more than one. By 2020, 100 S&P 500 companies included roughly 150 metrics.”); Emily Glazer and Theo Francis,CEO Pay Increasingly Tied to Diversity Goals, Wall Street Journal (June 2, 2021) (“By this spring, a third of S&P 500 companies had disclosed using a diversity measure in their compensation structures, or mentioned diversity in explaining executive pay.”). We know that compensation can work to help achieve any number of metrics and targets a company might set. Consider for instance academic research from 2019 demonstrating that airlines offering their executives bonuses for on-time flight arrivals did in fact achieve more on-time flight arrivals. SeeRajesh K. Aggarwal and Carola Schenone,Incentives and Competition in the Airline Industry, 8 Rev. of Corp. Fin. Studies 380 (2019). Even where, as in the airline example, the specific metrics may not be traditional financial metrics, they are still ultimately aimed at enhanced financial performance. With respect to ESG metrics and targets, there is increasing recognition of their relationship to long-term value. See, e.g., BlackRock Investment Stewardship, Global Priorities (Jan. 2022) (“Disclosure of material issues that affect the company’s long-term strategy and value creation, including material ESG factors, is essential for shareholders to be able to appropriately understand and assess how risks are effectively identified, managed and mitigated.”); Bank of America,2020 Annual Report(“As our Global Research team has found, companies that pay close attention to environmental, social and governance (ESG) priorities are much less likely to fail than companies that do not, giving investors a significant opportunity to build investment portfolios for the long-term. And — through research and our own lived experience — we know that ESG commitments can translate into a better brand, more client favorability and a better place for our teammates to work.”).

[4] See Reopening Release at n.5 (“Based on staff analysis of filings in 2019, approximately 45 percent of registrants subject to the Proposed Rules would be SRCs [smaller reporting companies] and thus would be exempt from the asterisked disclosure, compared to approximately 40 percent at the time of publication of the Proposed Rules.”). The proposal excluded foreign private issuers, registered investment companies, and emerging growth companies. It included smaller reporting companies, but only on a scaled basis, requiring them to disclose the relationship between compensation actually paid and TSR as a measure of performance, but limiting the time period of their disclosure and exempting them from disclosure of peer group total shareholder return, which non-smaller reporting companies would be required to disclose. The reopening release provides that the Commission is considering exempting smaller reporting companies from certain of the newly contemplated disclosure requirements, the Company-Selected Measure and top five performance measures.

Last Reviewed or Updated: Jan. 27, 2022