First year wisdom for next year's disclosure

FINANCIAL OVERSIGHT First year v\dsdom for next year's disclosure A checklist to help boards master their 2008 executive compensation disclosures under the new SEC rules. BY DIANE DOUBLEDAY AND AMY KNIERIEIM N ow THAT THE first proxy season under the SEC's new executive compensation disclosure rules has ended, it is time for companies to assess their experience with the new requirements and analyze how they will affect fu- ture compensation decisions. Despite their many challenges, the new rules had several positive effects on the executive compensa- tion-setting process, including: • Most compensation committees were very en- gaged in preparing the Compensation Discussion and Analysis (CD&A), explaining the rationale for each pay element. • The process of preparing the CD&A strength- ened the relationships between the finance, human resources, and legal departments. • The expanded tables provided detailed infor- mation on pay levels allowing better assessment of a company's pay-for-performance strategy. • The rigor of preparing the disclosure forced compensation committees to de- velop a better understanding of their companies' executive pay programs. In preparing their disclosure for 2008, compensation committees should con- sider this list of 10 disclosure tips, based on lessons learned during the first proxy season under the new SEC rules and the SEC staff's initial round of comments on the proxy statements filed during 2007. While the decision to address some of these items will depend on how material they are to a fair understanding of the compensation program, the staff's comments strongly suggest that the items listed below are central to a comprehensive set of disclosures. 1. Share performance targets In 2007, less than half of companies disclosed the specific performance targets used in their incentive compensation plans. Companies that did not dis- close their targets must be prepared to demonstrate that disclosure would result in competitive harm and must state how difficult it would be to achieve the undisclosed targets. Many companies overlooked this latter requirement and, even when addressed, provided only vague statements, such as "challenging but achievable" or "intended to encourage superior performance." If targets are not disclosed, companies should consider discussing their historical perfor- mance against target in detail. Diane Doubleday (left) is a worldwide partner in the human capital business of Mercer She consults on executive remuneration and is the global leader of the executive remuneration service segment. Amy Knieriem is a member of Mercer's Washington Resource Group, a national legal resource for Mercer consultants and clients on legislative and regulatory developments in compensation, taxes, and benefit plan design and administration. 4O DIRECTORS ft BOARDS FINANCIAL OVERSIGHT 2. Identify benchmarks and peer groups Companies should identify any benchmarks or peer groups they use for pay comparisons. While most companies identified their benchmarks, the disclosure varied dramatically — with some pro- viding detailed lists of their indices, peer groups, and benchmarks, and others making only general statements about their competitors. Companies should explain in detail why the individual peer companies were appropriate comparators for their business. 3. Explain management's role in setting pay Companies should describe the role their execu- tives played in determining executive compensa- tion. While most companies acknowledged that their CEO was involved in setting pay, many did not offer much detail about that role. Companies should state how the CEO shaped or influenced specific decisions, particularly his or her role in calling or attending committee meetings, working with compensation consultants, and crafting com- pensation packages. 4. Explain how incentive payouts are determined Companies should explain how they determined the payouts under their annual and long-term in- centive plans to each of the Named Executive Of- ficers (NEOs). They should also disclose the fac- tors (such as company or individual performance) that were considered in making each award payout and explain why these amounts were appropriate in light of these factors. Companies should use a similar approach to describing their equity award decisions. 5. Identify material di^erences in individual compensation Where the compensation of the NEOs "material- ly" differs (either in form or amount), companies should explain the reasons for these differences. Also, where a company's policies relating to the compensation of an individual NEO are materially different than the policies for other executives, the differences should be discussed on an individual- ized basis. 6. Enhance plan-based and equity award tables The Grants of Plan-Based Awards Table serves three distinct purposes: to quantify the equity awards reported in the Summary Compensation Table, report the range of payout opportunities for incentive awards, and highlight stock-option grant practices. To make the table easier to read, compa- nies should consider specifically identifying each reported award to simplify the understanding of the information that is being disclosed. Also, the Outstanding Equity Awards at Fiscal Year-End Table no longer includes disclosure of the unrealized appreciation in stock options that are outstanding at fiscal year end. Companies should consider including this information (in a separate table or footnote) since investors find it useful. 7. Enhance pension table Companies should consider adding columns to the Pension Benefits Table, which reports the actuar- ial present value of a NEO's accumulated pension benefits. For example, additional columns showing Companies that did not disclose their specific performance targets must be prepared to demonstrate that disclosure would result in competitive harm. the value of the benefits as a single-life annuity at normal retirement age, or the amounts that would be payable as of the end of the last completed fiscal year (assuming retirement) as an annuity and in a lump-sum, would he helpful in cnablijig inves- tors to assess the value of the NEOs' retirement benefits. 8. Evaluate nonqualified deferred compensation liability Investors should be able to track changes in a NEO's accumulated nonqualified deferred com- pensation (NQDC) account balances from year to year through the Nonqualified Deferred Com- pensation Table. Thus, the table's Earnings column should disclose the appreciation (and depreciation) on deferred amounts invested in securities, as well as interest and dividends paid or accrued during the year. Companies should use this information to review their NQDC plans to ensure they are com- fortable with the amount of liability they pose. 9. Disclose severance and change-in- control benefits in tabular form Companies should consider using a table to report their severance and change-in-control payment and benefit estimates. Companies may use a single table or several executive- or event-driven tables. This disclosure may be enhanced with information FOURTH QUARTER 2007 41 FINANCIAL OVERSIGHT intended to provide a fliller picture of the economic impact of leaving the company, showing both the amounts that NEOs would forfeit or receive under each termination scenario. Also, given the empha- sis on quantifying severance and change-in-con- trol payments, companies should reassess their arrangements and ensure they can justify the po- tential benefits. 10. Write in plain English There are several ways to present the disclosure in "plain English," including using concise language, tables and graphics, headings and bulleted lists, and various colors of type. Other effective meth- ods for simplifying the CD&A are to include an ex- ecutive summary or overview to provide investors with a helpful roadmap to the disclosure and to highlight key features, and using a question-and- answer format. In addition to these tips, companies can benefit from reviewing other companies' 2007 proxy state- ments to find other approaches for disclosing their executive compensation programs in 2008. Compensation committees can also use the new disclosure information to assist in evaluating execu- tive performance, weighing appropriate rewards, and refining executive pay programs going forward. • The authors can be contacted at djane.doubleday® and, The authors have provided this Information solely in their capacity as compensation consultants, and it is not intended as legal advice. Matters of a legal nature, and any specific issues, should be reviewed with competent legal counsel. e- o o o c rO^^ .6:- O lO or ^•;) I 42 DIRECTORS S BOARDS

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