The US Securities and Exchange Commission(SEC) has proposed a rule which would require companies to disclose the link between their financial performance and their executives’ compensation.

Proposed under a requirement of the 2010 Dodd-Frank Act on Wall Street reform and consumer protection, the rule is aimed at promoting transparency and allow shareholders to make informed decisions when voting on executive appointments and compensation.

The rule would require companies to disclose executive pay and performance information in an interactive data format.

The company would also have to report its total shareholder return (TSR) as a measure of performance.

As well as its own data, under the new rule the company’s report would have to also include equivalent information for companies that form part of a peer group.

If the rule is approved by the SEC, companies will be required to disclose the relevant information for the last five fiscal years, with the exception of smaller reporter, who will only have to provide the past three years’ worth of information.

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The decision reflects calls from the public and some business leaders to link c-suite remuneration to business performance.

Introducing the proposed legislation yesterday, SEC chair Mary Jo White said: "These proposed rules would better inform shareholders and give them a new metric for assessing a company’s executive compensation relative to its financial performance."

Cautious welcome
Speaking to The Accountant today, Chartered Financial Analyst (CFA) director of capital markets policy in the Americas Matt Orsagh said that although the CFA had yet to express a formal judgement of the proposal, the SEC’s move towards increased information should be welcomed.

"I hope this encourages them to give more information about if they think there are other metrics that are more representative, it would be great if they gave that information as well," he said, "this may spur that kind of disclosure and I think that would be a positive."

However, he added: "It’s important to understand that this is something that a lot of investors, and especially large institutional investors, are already getting."

Further, he cautioned: "The devil is in the detail and I would caution any investor making an investment decision or voting decision, to base that decision on as wide a range a data and as deep an understanding as they can."

"I would say it’s going to be more useful information over a five year horizon than over a one year horizon, but I would also like to look at a lot more data," he added.

"On the whole, I think it is a nice piece of information to have, I would caution investors not to base choices until they know the whole story of the company."

Criticism from within the SEC
Others have been decidedly more sceptical. At an open meeting on the proposed regulation yesterday, SEC commissioner Michael Piwowar criticised the proposed regulation as a "questionable and imprudent use of agency resources".

He added he would not support the proposal in its published form as he found it to be "highly prescriptive" and overly reliant on the measure of TSR.

"This one-size-fits-all approach assumes that, for all companies and all shareholders, one-year TSR is the only metric that matters," Piwowar explained, "Other metrics and disclosures would be relegated to block-tagging in a form not conducive to comparative analysis."

According to Piwowar, analysis carried out by SEC economists in the division of economic and risk analysis had shown that, depending on the company, it can be difficult to determine both which performance metrics should be considered and how compensation should vary with them.

Piwowar said the research also noted that "available performance statistics may not adequately measure a given executive’s contribution to a registrant’s performance," for example when their performance is strongly connected to external factors unrelated to skill or managerial effort, such as commodity prices or market movements.

He added that the issues were particularly evident in the case of smaller companies and said: "I am greatly disappointed that the proposal does not exclude smaller reporting companies from the disclosure requirement."

As shares in smaller companies are generally less liquid than those of larger businesses, he explained, "estimates of one-year TSR for smaller reporting companies may be less precise and less readily available, potentially making pay-versus-performance comparisons based on this metric less meaningful."

Piwowar also warned that maintaining the focus solely on TSR as a measure of performance may incentivise executives to increase debt, cut research and development, or engage in stock buy-backs to drive up stock prices in the short-term to the detriment of long-term performance.

"On the other hand," he argued, "a principles-based approach would reduce the risk that the disclosure requirements could lead registrants to game their compensation structures."

The proposal will be open for comments to be received within 60 days of publication in the Federal Register.

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