Companies use their annual reports to communicate performance and policies to shareholders. While many will simply fulfill their legal obligation by filing a plain document, an increasing number of companies use this report as an opportunity to demonstrate their commitment to investors with stylized and innovative documents that go above and beyond required disclosures, finding unique ways that best demonstrate how they align pay and performance.
Contributors
RON SCHNEIDER
Director of Corporate Governance Services
DONNELLEY FINANCIAL SOLUTIONS
CHRISTINE SKIZAS
Partner
PAY GOVERNANCE
In response to increased scrutiny on executive pay, the Compensation Discussion and Analysis (CD&A) has become arguably the most important section of the annual proxy statement for public companies in the U.S. The CD&A details what a company pays their executives, and how that pay reflects their performance.
Amidst a sea of information—whether meeting policy requirements or responding directly to specific shareholder requests—companies seem to continually add length to this section of the proxy. Excluding a dip in 2014, average CD&A word count increased every year, according to Equilar data, ultimately rising 5.2% from 8,930 words in 2012 to 9,403 words in 2016. While many of these additions respond to aforementioned regulatory requirements, many companies independently add new disclosures to better enhance how they communicate their pay strategy (Graph 1).
“Much of the added length comes from voluntary context in addition to SEC-required information, and we think that contextual information plays an important role in enabling thoughtful voting,” noted Ron Schneider, Director of Governance Services for Donnelley Financial Solutions, who contributed independent commentary to the recent Equilar report, Innovations in Proxy Design. “A frequent criticism of CD&As is that they contain a lot of ‘what’ but not as much ‘why.’”
Besides adding to overall CD&A size, innovative disclosures may make historically included information superfluous—however, companies can be reluctant to omit old content because their absence may unsettle or confuse investors, even though they were reiterated in a new disclosure.
Companies have had to do a better job than just relying on target compensation values to explain the relationship between pay and performance.
Companies are incorporating new disclosures that easily summarize information and provide quick access to specific sections. In this way, annual proxies are becoming reference documents that investors use to quickly find desired information, increasing the importance of navigational tools and summary information.
Compensation program checklists give readers a place where they can skim common governance practices and immediately identify whether or not the company uses it. Often, companies even enhance these graphics by adding navigational features, such as pagination that links to an expanded section. Since 2012, the prevalence of compensation program checklists in the S&P 100 increased from just over 5% to 66% in 2016. This jump dwarfs the prevalence growth of numeric, pay-related graphs. The disclosure type that saw the next largest growth was pay mix graphs, appearing in 64.3% of S&P 100 proxies in 2012 and 84.0% in 2016 (Graph 2).
Companies use these different pay graphs to best tell their pay story—while pay mix graphs have become a staple, alternative pay graphs and pay for performance graphs appear less commonly. The former clearly illustrates what components make up executive compensation, and how the size of each component compares to the others. Pay for performance graphs demonstrate the alignment between company performance and pay, and they often impact Say on Pay votes. In 2015, the SEC proposed a rule that would mandate this type of graph, and nearly one-quarter of the S&P 100 disclosed some form of it voluntarily in 2016. With that rule unlikely to be passed given the current state of flux in the SEC leadership, it will be interesting to see whether or not companies continue to include this information.
In addition, 40 S&P 100 companies incorporated alternative pay graphs to best represent their unique pay situation in 2016—these graphs typically use calculations that deviate from SEC standardized pay methodology. Realized and realizable pay representations fall into this category, and companies often use them to more accurately reflect earned compensation during the year.
“Supplemental graphs are needed to really parse out what you might describe as ‘real’ compensation from accounting descriptions, and they can move you in the direction of better relating pay and performance,” said Christine Skizas, a Partner at Pay Governance, during the Equilar webinar “Communicating Compensation: How to Use the Proxy to Tell Your Pay Story.” “Companies have had to do a better job than just relying on target compensation values to explain the relationship between pay and performance.”
Pay for performance remains a priority for shareholders, but because each company possesses unique business characteristics and operations, these differences create challenges when communicating company performance and how it relates to executive compensation. In these situations, companies often use non-GAAP reporting, as opposed to generally accepted accounting principles (GAAP). Non-GAAP reporting allows companies to design and report their performance according to their unique business and operation model, and then explain how it corresponds with executive payouts. Since 2012, the prevalence of S&P 100 companies reporting with non-GAAP increased from 61.2% to 75.0% (Graph 3).
“For many companies, using GAAP or as-reported results would not appropriately reflect the business’ performance, which is reflected by the fact that most S&P 500 companies utilize adjusted measures in their investor presentations and/or compensation programs,” said Skizas.
The annual proxy could be called the essential shareholder engagement document because it is the primary vehicle companies use to communicate their policies and performance to their stakeholders. In response to the financial crisis and the effects of Dodd-Frank, this document has evolved dramatically in the last five years as companies aim to increase transparency and accessibility while meeting policy requirements. And as these policies remain in flux today under the new administration, companies will face new opportunities to strategize how and what information they disclose.
Ryan Villard is a research analyst with Equilar. For more information on the research cited in this article, please visit equilar.com/reports.html.