“Pay Versus Performance” Rule Proposed by SEC Under Dodd-Frank

Joseph E. Bachelder is special counsel in the Tax, Employee Benefits & Private Clients practice group at McCarter & English, LLP. The following post is based on an article by Mr. Bachelder which first appeared in the New York Law Journal. Andy Tsang, a senior financial analyst with the firm, assisted in the preparation of this column. Related research from the Program on Corporate Governance about CEO pay includes Paying for Long-Term Performance (discussed on the Forum here) and the book Pay without Performance: The Unfulfilled Promise of Executive Compensation, both by Lucian Bebchuk and Jesse Fried.


“We are drowning in information, while starving for wisdom.” —E.O. Wilson [1]

On April 29, the Securities and Exchange Commission announced its proposal to add a new Item 402(v), captioned “Pay versus Performance,” to Regulation S-K. [2] The SEC announced the proposed rule pursuant to Dodd-Frank Section 953(a). [3] Section 953(a) directs the SEC to adopt rules requiring that proxy statements and certain “consent solicitation material” [4] provide “information that shows the relationship between executive compensation actually paid and the financial performance of the issuer, taking into account any change in the value of the shares of stock and dividends of the registrant and any distributions.” This is in addition to information already provided under Item 402 of Regulation S-K.

Under the proposed rule, registrants would be required to show the relationship over a period of years between the pay of certain senior-level executives and the total shareholder return (TSR) for the registrant. [5] Each registrant also would be required to compare, over the same period of time, its TSR with that of a peer group. A new table would be required to provide the data on which such relationships and comparisons can be made (Pay/TSR Table). Displayed below are column headings for that table.

Pay Versus Performance
Year (a) Summary Compensation Table Total for PEO (b) Compensation Actually Paid to PEO (c) Average Summary Compensation Table Total for non-PEO Named Executive Officers (d) Average Compensation Actually Paid to non-PEO Named Executive Officers (e) Total Shareholder Return (f) Peer Group Total Shareholder Return (g)

Item 402(v), including the Pay/TSR Table, would represent the latest proliferation in executive pay data inundating shareholders in proxy statements. This proliferation of data far exceeds the original purpose of proxy statements: to reasonably inform shareholders as to matters scheduled to be voted on by them, or that reasonably relate to such matters, at annual and special meetings. This subject is further discussed in the last section of the column.

The release containing the proposed rule does not state when the rule, if adopted, would become effective. Comments on the proposed rule should be received on or before July 6, 2015.

Highlights of Proposed Rule

  1. Periods for which pay and TSR are required to be shown. Subject to a transition rule, for most registrants covered by the proposed rule the data would have to be shown for the five most recent fiscal years. Under the transition rule, only the three most recent fiscal years would have to be included for the first year of disclosure. For the second year the four most recent fiscal years would have to be shown and thereafter the five most recent fiscal years. [6]
  2. Executives for which pay is required to be displayed. The executives for whom information would be required are the Named Executive Officers (NEOs) as shown in the Summary Compensation Table (SCT) of the proxy statement. The new Pay/TSR Table divides the NEOs into two categories: first, the PEO (meaning “principal executive officer,” ordinarily referred to as the chief executive officer or CEO) and, second, all the NEOs other than the PEO (Other NEOs).
  3. Actual Pay versus SCT Total Pay. Following the language of Dodd-Frank Section 953(a), noted above, the Proposed Rule creates a new category of pay: “compensation actually paid” (Actual Pay). The Pay/TSR Table compares the SCT total pay (SCT Pay) with the Actual Pay for the PEO and the Other NEOs. This “pairing” is shown first for the PEO (columns (b) and (c) of the table) and then, as averages, for the Other NEOs (columns (d) and (e)). Actual Pay is the same as SCT Pay except for two categories of pay: equity awards and pensions. [7]
    1. Equity awards. These awards include stock options, restricted stock, restricted stock units, performance shares and performance stock units. Instead of the aggregate grant-date fair value for equity awards granted to the executive in the fiscal year being reported, as reported in the SCT, Actual Pay includes the aggregate vesting-date fair value for the executive’s equity awards that vested in such fiscal year. [8]
    2. Pensions. Instead of the aggregate year-over-year increase in actuarial present value of the executive’s accumulated benefit under all defined benefit and actuarial pension plans for the fiscal year being reported, as reported in the SCT, Actual Pay includes the actuarial present value of the executive’s benefit under such plans attributable to services rendered by the executive during such fiscal year. [9]
  4. Changes in the PEO and Other NEOs during the period. If there were a change in the PEO, the proposed rule would require the pay for each PEO to be included in the PEO pay for the fiscal year in which the change occurs. For Other NEOs, the proposed rule calls for an average of the pay for the Other NEOs, not based on positions but, rather, on individuals holding positions, for each fiscal year.
  5. Total Shareholder Return (TSR). The proposed rule would require that for each fiscal year, under the Pay/TSR Table, the cumulative TSR value for the registrant and for its peer group be shown. The cumulative TSR value would be for the period from the beginning of the earliest fiscal year appearing on the table to the end of the respective fiscal years being shown in the table. [10]
  6. Additional explanation following the Pay/TSR Table. The proposed rule would require registrants to provide a clear description (according to the preamble this may be in narrative and/or graphic form) of (i) the relationship between the Actual Pay of the PEO and the average Actual Pay of the Other NEOs, on the one hand, and the registrant’s TSR, on the other hand, for each of the five fiscal years, and (ii) the relationship between the registrant’s TSR and its peer group’s TSR using the information provided in the Pay/TSR Table. The Preamble to the Proposed Rule indicates the explanation is to follow the table.
  7. Data format. Registrants would also have to tag the disclosure required under the proposed rule in an interactive data format using the eXtensible Business Reporting Language (XBRL). [11] (This would be the first time that a proxy statement disclosure is required to be provided in such format.)

Criticisms of Proposed Rule

  1. Shareholders and other readers of proxy statements would have to deal with two definitions of pay: “Actual Pay” versus “SCT Pay.” Which definition will surveys use in developing compensation data? Or will they present two sets of data—one using SCT Pay and the other Actual Pay?
  2. The lining-up of pay data (ultimately five years for most registrants) without making allowance for differences between years due to one-time circumstances could result in significant distortions of pay changes from one year to another. [12] One example would be a “doubling up” of PEO data in one year, each PEO receiving one-time payments (e.g., severance to a departing CEO and a sign-on award to a new PEO) in addition to each PEO’s ongoing compensation (e.g., salary) for the portion of the year employed. Another example of potential distortion, particularly relevant in comparing Actual Pay to TSR, would be acceleration of vesting of equity awards in a particular fiscal year. This acceleration may have nothing to do with TSR or other corporate performance criteria for that particular year.
  3. TSR, while a factor that should be taken into account while making executive pay decisions, is only one of many factors that need to be taken into account. TSR generally represents change in stock price plus dividends paid between two dates (reinvestment of dividends is assumed for purposes of the calculations). TSR is not a valid guide to how well a company is performing on factors that will determine its value as an enterprise over the longer term. [13]
  4. Meaningful explanation of the relationship between Actual Pay and TSR for particular fiscal years would be very difficult. This is because most of the underlying factors that determine Actual Pay and TSR for particular years are not really comparable.


The Pay/TSR Table should be deleted and disclosure required pursuant to Dodd-Frank Section 953(a) should be limited to narrative and/or graphic disclosure. That disclosure, without the Pay/TSR Table, would give shareholders a satisfactory description of the registrant’s senior executive pay relative to corporate performance. The author has noted above his reservations regarding use of TSR as the proposed corporate performance measure. The registrant could add to the narrative its comments regarding performance criteria other than TSR and, also, special circumstances (if applicable and appropriate to disclose) unrelated to corporate performance.

If, however, a Pay/TSR Table is to be required, why require it to be in the proxy statement? As noted in the next section, the table could be included in the Form 10-K, as part of its section on executive pay. There is nothing in Dodd-Frank Section 953(a) that requires such a table in the proxy statement.

Proliferation of Data

The proliferation in proxy statements of information about executive compensation often has produced complexity and confusion instead of clarity. It is doubtful that it has added much to the understanding of executive pay by the majority of shareholders. The proposed new rule under Dodd-Frank illustrates the point.

A reasonable estimate of the average length of the executive compensation section of the proxy statement 25 years ago for corporations in the top 500 would be five to 10 pages. Today, the average length of the executive compensation section of the top 500 appears to be in the range of 40 to 50 pages. At this rate, in another 25 years the average executive compensation section for the top 500 will be over 200 pages!

Who is benefitting from the proliferation of pay data? It is doubtful that significant numbers of individual shareholders spend very much time reading the detail in the executive pay section of the proxy statement. Individual managers at institutional shareholders probably spend more time reading it than individual shareholders. It appears, however, that many of those managers rely heavily on analyses and recommendations that are contained in reports of proxy advisers like ISS and Glass Lewis.

In addition to shareholders, the registrants themselves—meaning their boards of directors and their management including the staff responsible for preparing the proxy statement—read the executive compensation section. Advisers to all the above (including lawyers, accountants and consultants) as well as members of the academic community, the press and the media read the proxy statement.

This means that the extraordinary volume of executive compensation information in proxy statements is being studied by a population that is a small percentage (perhaps less than 1 percent) of the population of shareholders, direct and indirect, of U.S. public corporations. It is for the latter—the shareholders—that the proxy statements are intended as a guide to assist in the casting of their votes (or of votes by their proxies) at annual meetings.

If we need to provide the limited population noted above with approximately 40 to 50 pages of tables and analyses on executive pay (compared to approximately five to 10 pages 25 years ago) why can’t we put some of this added information into Form 10-K? (To the extent a statute like Dodd-Frank requires proxy statement disclosure, that disclosure must be provided. But meeting a statutory requirement like Dodd-Frank Section 953(a) would take up far less space than currently is taken up by the executive compensation section of the proxy statement.) Those interested in such detail and analysis can see it in the 10-K without ballooning our proxy statements into encyclopedias on executive pay.


[1] “Consilience: The Unity of Knowledge,” by Edward O. Wilson, 1998 (Vintage).
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[2] See Pay Versus Performance, SEC Release No. 34-74835; File No. S7-07-15 (April 29, 2015), 80 Fed. Reg. 26330 (May 7, 2015). The release contains the proposed amendment to Regulation S-K, adding Item 402(v).
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[3] Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), Public Law No. 111-203, §953(a), 124 Stat. 1376, 1903 (2010), as amended by the Jumpstart Our Business Startups Act (JOBS Act), Public Law No. 112-106, §102(a)(2), 126 Stat. 306, 309 (2012). Dodd-Frank Section 953(a) amended the Securities Exchange Act of 1934 (Exchange Act) by adding Section 14(i) (codified as amended at 15 U.S.C. 78n(i)).
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[4] The release covering the proposed rule expands on the statutory reference to “consent solicitation material.” It states that “[t]he proposed disclosure would be required in proxy or information statements in which executive compensation disclosure pursuant to Item 402 of Regulation S-K is required.” In Footnote 30 of the Preamble to the Proposed Rule the SEC states that proxy statement disclosure rules (including the proposed rule) apply to information statements required pursuant to Section 14(c) of the Exchange Act, and Schedule 14C pursuant thereto, even though no solicitation is involved.
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[5] Emerging growth companies (as defined in Section 3(a) of the Exchange Act (15 U.S.C. 78c(a)), foreign private issuers (as defined in Rule 3b-4 under the Exchange Act (17 CFR 240.3b-4)) and registered investment companies would be exempted from the proposed disclosure requirements.
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[6] Smaller reporting companies (as defined in Item 10 of Regulation S-K (17 CFR 229.10(f)(1)) would be required to disclose information for the two most recent years in the first year and information for the three most recent years in the years thereafter.
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[7] The proposed rule would also require that for each item of Actual Pay shown in the table, the registrant must disclose in a footnote to the table each of the amounts deducted from, or added to, the corresponding SCT Pay item in deriving the Actual Pay.
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[8] The proposed rule would require, for each equity award vesting in each of the fiscal years being shown in the table, a footnote disclosure of any valuation assumption made for the vesting-date fair value that differs materially from any corresponding valuation assumption made for the grant-date fair value.
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[9] Smaller reporting companies would not be required to include the pension value component in Actual Pay. (They currently are not required to report pension values in the SCT.)
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[10] The proposed rule would require the TSR for the registrant and for its peer group be calculated in the same manner as provided under Item 201(e) of Regulation S-K (17 CFR 229.201(e)). The proposed rule, for purposes of determining the peer group’s TSR would require that the peer group be comprised of either (A) the same index or issuers used for purposes of its Performance Graph disclosure under Item 201(e)(1)(ii) or (B) the companies in its peer group for purposes of the Compensation Discussion & Analysis in its proxy statement. A smaller reporting company, however, would not be required to disclose the TSR of its peer group. (Smaller reporting companies currently are not subject to Item 201(e).)
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[11] XBRL is a globally used, standards-based way to communicate or exchange business information such as financial statements and other business information. Smaller reporting companies would not be subject to the XBRL requirement until the third filing in which the disclosure is required.
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[12] It may be clear in the Summary Compensation Table what is going on but not in the columns of the Pay/TSR Table which do not include a breakdown of the components of Actual Pay.
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[13] For further discussion on TSR, see prior NYLJ column, Sept. 27, 2012.
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