Getting Ready for Full CEO Pay Disclosure

from January/February 2007
by John R. Engen

If
you sit on a compensation committee, the coming months could be
particularly hairy. The Securities and Exchange Commission’s new
disclosure requirements promise more work than in the past—and much
more scrutiny. Even the best-prepared committees could face investor
backlash when this season’s proxies roll out.

The new rules,
sparked by shareholder outrage over the size of some big-company CEO
pay packages, require that proxy statements break down the total
compensation received by each of a company’s five highest-paid
executives. This means putting together a table that not only lists
their basic salary, bonus, and incentive-payment amounts but also gives
the cash value of such things as change-in-control agreements,
retirement benefits, and separation deals (voluntary or not). Let’s
face it, much of this has heretofore been hard for investors to grasp,
and just maybe for more than a few board members too.

Highlighting
the total number—and forcing companies to provide a philosophical
justification for each component in a detailed portion of the proxy
called compensation discussion and analysis, or CD&A—is meant to
shame boards into scaling back the most egregious components. “The goal
here is to hold the board’s feet to the fire and make them
accountable,” says attorney Chase Cole, a partner with Waller Lansden
Dortch & Davis in Nashville.

It already seems to be
working. Before the close of 2006, some boards—perhaps surprised by the
true size of compensation deals that emerged in initial mockups—had
quietly pared certain supplemental retirement benefits and perks to
keep them from going into print, says attorney Michael Melbinger, a
partner at Winston & Strawn in Chicago. “What I tell my
compensation committee clients is, ‘It’s him or you. Do you want to be
embarrassed by these numbers? Or do you want to force the CEO to make
some modest givebacks?’” It seems that a few publicity-shy CEOs were
glad to cooperate.

By now, comp committee members whose
companies are on calendar fiscal years should be doing dry runs,
looking carefully at what the proxy will disclose and reviewing
preliminary drafts of the CD&A. It’s well worth fine-tuning the
narrative to make sure it accurately reflects the company’s “broad pay
philosophy,” says Los Angeles-based George Paulin, chairman and CEO of
Frederic W. Cook & Co., a compensation consulting firm.

Sharpen
your pencils for this crucial editing assignment. The narrative must
cover a wide variety of topics, including such big-picture issues as
how the pay practices you’re using encourage better performance. In a
nod to recent backdating scandals, it also must address the timing of
option grants.

While HR departments, consultants, and lawyers
are responsible for producing the document, the comp committee must
sign off on it. If something jumps out—unusually high overall pay for
shoddy performance, sketchy timing on option grants, or day-care
payments for the CEO’s dog—the CD&A offers an opportunity, if not a
mandate, to explain the why and how. Expect to be paying special
attention to so-called back-end pay components, such as deferred
compensation or big severance deals, where specific figures have never
before been revealed—and are sometimes proving to be huge.

“Amalgamating
all the different forms of compensation will in many cases result in
numbers that directors and investors won’t be happy with,” Chase Cole
warns. “The legal requirement is that the reasons [for specific pay
components] be described. If you can’t do that, then you’ve got a real
issue.”

For some, the best advice may be to weather this
year’s certain storm and begin preparing for 2008. “There’s going to be
a lot of ‘I wish we hadn’t paid this’ kind of talk,” Michael Melbinger
says. “But if the year is over, there’s nothing you can do except
swallow hard and renegotiate for next year.”

http://www.boardmember.com/MagazineArticle_Details.aspx?id=287&ekfxmen_noscript=1&ekfxmensel=eeb11f83b_30_494

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