As the SEC continues to review the first round of proxy statements filed last spring under the new executive compensation rules, publicly traded companies should consider thinking about how to improve disclosures for next year.
The importance of analyzing compensation decisions, as opposed to merely stating what types of compensation are paid, is evident by the language of the rules for drafting the Compensation Discussion & Analysis (CD&A) section of the proxy statement. The rules require that the following material elements of compensation for named executive officers be discussed, described, and explained:
- the objectives of the compensation program;
- what the compensation program is designed to reward;
- each element of compensation;
- why the company chooses to pay each element;
- how the company determines the amount/formula for each element; and
- how decisions regarding each element fit into the compensation objectives.
The following are suggestions for improved disclosure, as prompted by the new rules:
- Keep detailed minutes throughout the year regarding not only what compensation decisions are made but why they are made. When compensation decisions are made, the compensation committee should articulate, in writing, as many aspects of elements (1) through (6) above as possible. This allows an understanding of compensation decisions to develop throughout the year as opposed to at the last minute when it comes time to draft the proxy.
- Amend the compensation committee charter to state that the committee will review and discuss disclosures in the CD&A with management and recommend that such disclosures be included in appropriate filings.
- Draft a related party transactions policy. The new rules require companies to explain how such a policy is evidenced if not in writing. This policy will be the responsibility of either the audit committee or the nominating committee and will describe the policies for review, approval, and ratification of any related party transactions required to be disclosed.
- Monitor perks paid to executives and directors throughout the year to avoid embarrassing items that are hard to justify.
- Draft future stock option plans to ensure that a stock option’s exercise price is the same as the company’s stock price on the date of grant. Increased disclosure is required if this is not the case, including a description of the company’s methodology for determining the exercise price.
- Draft future employment agreements in a manner that makes it easy to determine what executive officers will be paid upon a hypothetical termination or change in control. Determining what executives will be paid at termination is a necessary exercise for both public and private companies that use employment agreements, but the provisions that control payments are often unclear.