The SEC released its pay vs. performance (PvP) proxy disclosure rule on August 25, 2022. Since then, it’s been a nonstop sprint for companies to prepare to comply. On February 10, 2023, the SEC released its Compliance & Disclosure Interpretations (C&DIs), which addressed some open questions, created new ones, and left many others unanswered.

As of March 3, 2023, at least 36 companies have published their year-one PvP disclosures. We’re collecting and studying these disclosures to assess trends, best practices, and common omissions. As we learn more, we’ll update this article. Meanwhile, here’s a series of insights from the very first group of filers, including the decisions they’re making and common errors or shortcomings we’ve observed.

Descriptive Statistics on Early Filers

Let’s begin with some basic statistics on the filers in this report. (For the full list, download the PDF version of this article via the request form at right, then see the appendix.)

Filer Type

Unsurprisingly, a majority of the filers are large accelerated filers (Figure 1). Some smaller reporting companies (SRCs) also provided early filings, usually due to a constraint or cause for urgency.

Figure 1: Filer Type

Market Capitalization of Filers

Consistent with the filer types, we also have a wide range of market capitalizations.

Figure 2: Market Capitalizations of Companies

Decisions and Trends

Now let’s look at the decisions companies made where the PvP rule affords flexibility. This includes topics like the peer total shareholder return (TSR) group used, the location of the disclosure, and the number of metrics listed in the tabular disclosure.

Proxy Location

The PvP rule provides discretion as to where to locate the disclosure within the proxy. The three common choices are outside of the Compensation Discussion and Analysis (CD&A) and at the back next to CEO pay ratio, alongside the other proxy tables like the summary compensation table, or within the CD&A. Most companies went with the first option (Figure 3). (Not all proxies are structured identically, so we made some judgment calls in categorizing some of the disclosures.)

Figure 3: PvP Disclosure Location

We don’t expect any companies to include PvP within the CD&A, except by accident. Unless a company truly expects to structure pay decisions in the context of insights revealed by their PvP calculations, the CD&A is the wrong place. Remember, the CD&A is intended to resemble what you’d hear if you sat in on the compensation committee’s discussions about how to set and structure executive compensation. While committees are obviously looking at PvP disclosures, we’re unaware of any that are changing the number of metrics or shifting quantum up or down based on the outputs of their PvP calculations.

Initially we thought a reasonable disclosure location would be alongside the other proxy tables. If the summary compensation table explains the value at grant, it could be logical to cover PvP immediately after that since PvP explains the value evolution post-grant. However, there are two problems with this thinking. First, most companies have rejected the idea that PvP explains value evolution since the information is such a broad amalgamation of new awards, in-flight awards, and settling awards. So many moving parts make the measure too noisy.

Second, while Item 402 of Regulation S-K doesn’t create a direct connection between the CD&A—which is Item 402(b)—and the detailed tables, there’s some presumed implicit connectivity between the two. This motivates companies to locate PvP as far down as possible to visually demonstrate the separation from the CD&A.

Supplemental Disclosure

A second, rather lopsided, decision is to provide a supplemental disclosure. We generally advise against doing so unless is the company has a unique and specific message it wishes to deliver. But supplemental disclosure is allowed as long as three criteria are satisfied: 1) it’s not more prominent than the required disclosure, 2) it’s clearly labeled as supplemental, and 3) it’s not misleading.

Consistent with expectations, Figure 4 shows that very few companies have elected to provide a supplemental disclosure.

Figure 4: Supplemental Disclosure

One of the companies providing a supplemental disclosure failed to adhere to the three criteria. If presenting a supplemental disclosure, be sure it’s labeled as such, is not more prominent than the required content, and is not misleading. We’re often asked what the definition of “misleading” is. In short, it means to not directly contradict or undo the construct that’s required by the core PvP rule or to waffle between different constructs over time. The SEC’s C&DIs on non-GAAP metrics provide a flavor for how they think about the definition of misleading.

Peer TSR Group

While smaller reporting companies (SRCs) are exempted from selecting a peer group whose TSR they compare to their own, all non-SRC filers must do so. The final rules provide flexibility to use any non-broad index used for Item 201(e) purposes or the CD&A peer group.

There’s been no shortage of controversy here. For example, the PvP rule points to the index or group of companies selected under Item 201(e)(1)(ii), which excludes any broad market index. Broad market indices are allowed under Item 201(e)(1)(i), which isn’t listed anywhere in the PvP rule. Similarly, there’s been confusion as to the suitability of different peer groups disclosed in the CD&A, such as peer groups not explicitly flagged as having been used for benchmarking or a peer group used within a relative TSR award. The SEC partially addressed these topics in its recent C&DIs.

As anticipated, a majority of companies have chosen to use their Item 201(e) group (Figure 5). This is simpler and easier to roll forward than using the CD&A peer group. Out of interest, we’ve separated the CD&A group between the regular group used for compensation planning and the TSR peer group, should such a group exist and be different from the regular CD&A peer group.

Figure 5: Peer TSR Group

Tabular List

The Tabular List is required under Item 402(v)(6), which instructs companies to provide a list of at least three, and up to seven, performance measures that are used in the current year’s incentive plans. At least three must be financial performance measures. Non-financial measures are allowed, but only after three financial measures are listed; if there are fewer than three financial measures, then those should be listed. If there are no financial measures, then there will not be a tabular list. SRCs are not required to produce a tabular list.

Most companies provide the minimum number of financial metrics and disclose either zero non-financial metrics or only one (Figure 6).

Figure 6: Metrics Disclosed in the Tabular List

Ostensibly, the Tabular List should be mechanically constructed based on the metrics in the annual plan and long-term incentive plan. There shouldn’t be much judgment involved. From our sample, 11% of companies who aren’t SRCs omitted a Tabular List without explanation.

Company-Selected Measure

We studied the selection and use of company-selected measures (CSMs) in a few ways. First, we looked for companies that are required to disclose one, but chose not to for one reason or another (Figure 7). The rules are clear: a CSM is required for non-SRCs unless no metrics meet the requirement of being a financial metric used in the current year’s incentive plans.

Figure 7: CSM Disclosure (for Non-SRCs)

The next item we looked at is the type of CSM disclosed. Since the metric labels ran the gamut, we categorized them into our usual group of sales, earnings, return, cash flow, and stock price metrics (Figure 8).

Figure 8: CSM Metric Types

It may be surprising to see stock price metrics bringing up the rear, especially given that over 70% of companies use relative TSR in their long-term incentive plans. Many companies are confused by the SEC’s guidance on using relative TSR as their CSM. Would this be too similar to the TSR metrics already in the PvP table? Would it be confusing (or even allowable) to display a one-year relative TSR metric as the CSM now that three-year metrics are not permitted? These concerns have clearly prompted a shift toward simpler accounting-based metrics.

Relationship Disclosures

Item 402(v)(5) relationship disclosures have emerged as one of the most hotly debated areas during the final few steps of preparation. We covered the topic extensively in a three-part blog series (see part 1) and webcast. Our contention is that graphing is virtually essential because the PvP rule has no bright-line explanation of what constitutes an adequate narrative disclosure. Because graphing is a sufficient condition to compliance, it can be done on its own or in concert with targeted narrative prose that drive home a very specific point or theme.

As expected, very few companies adopted a narrative-only approach. A majority adopted a graph-only approach (Figure 9). The ideological lenses of management teams and their advisors explain these differences. Many companies are viewing this as strictly a compliance exercise, whereas others wish to take the liberty to explain and contextualize.

Figure 9: Relationship Disclosure Approaches

Over 90% of companies use the dual axis graphing construct referenced in the PvP rules. Different companies render graphs differently, some being clearer and more elegant than others, but the general approach is by far the norm.

We also studied the narrative disclosures and classified them into one of four categories: deep analysis, shallow analysis, percentage change, and other (Figure 10). Although subjective, we distinguish between a deep analysis and shallow analysis based on whether the copy rehashes information already present (shallow analysis) versus offering up new information as to why the numbers in the PvP table are what they are (deep analysis). A percentage change approach illustrates the slopes or percentage changes across PvP table variables, thus offering an extra layer of insight and clarity without being a full-blown analysis.

Figure 10: Assessment of Narrative Relationship Disclosures

Note that some of these are combo cases where the bar for how much narrative to provide is nil (because the graphing already checks the compliance box). We classified 100% of the narrative-only cases as shallow.

Common Mistakes and Misconceptions

Although the PvP rule affords considerable flexibility in methodology, some of its components are prescriptive and there are not competing interpretations. As we collect disclosures, we’re working to identify common errors so that later filers can improve their disclosure quality. None of this is to suggest that the disclosures are harmful or misleading. We offer these points in the spirit of improvement and refinement.

Granular Equity Award Calculations

In December 2022, the SEC gave a talk on how they expect companies to disclose the six sub-components used to calculate compensation actually paid (CAP) for equity awards:

The SEC confirmed this perspective in Question 4 of its C&DIs. We automate this process for our clients, but it may be tougher to get to this level of granularity if using spreadsheets to perform the calculations.

As of March 1, 2023, almost half of filers omitted the granular equity calculations required (Figure 11).

Figure 11: Granular Equity Adjustment Calculations

Most filers had gone to print or were close to it when the SEC released their C&DIs on February 10. We assume these statistics will skew toward the granular equity calculations as time passes and companies updated their processes and drafting in light of the C&DIs.

Valuation Assumption Disclosures

The SEC’s guidance is ambiguous about valuation assumption disclosure. Item 402(v)(4) instructs companies to disclose in a footnote “any assumption made in the valuation that differs materially from those disclosed as of the grant date of such equity awards.” Most companies have elected not to provide any such disclosures (Figure 12).

Figure 12: Assumption Disclosure Prevalence

The guidance quoted above is from the final rule incorporated into Item 402 of Regulation S-K. All 233 pages of the SEC’s release are in the federal register, but the rule itself that is incorporated into Item 402 is of course much shorter. To this end, when you read all 233 pages, there’s quite a bit of commentary suggesting that disclosure of the valuation assumptions may be appropriate to disclose more often (e.g., pages 64, 144, 147, and 155).

Even so, there’s no bright line. For example, interest rates have undoubtedly changed between the date of grant and the point of revaluation, but the effect on total value is usually small. Expected term estimates on options also won’t be the same due to the passage of time and moneyness of the awards being valued.

While we tend to lean toward over-disclosure, our advice is to document (internally) a point of view to create contemporaneous evidence in support of the approach you take. If you define materiality in the context of an overall effect on value, don’t just rely on the assumptions developed at the point of grant. Run some comparison analytics to assess how sensitive the final values are to the actual assumptions.

Other Areas of Risk or Potential Misconceptions

We’ll end with the top five areas of risk we noticed during data collection.

1. Failing to provide Item 402(v)(5) relationship disclosures altogether
2. Omitting one of the required Item 402(v)(5) relationship disclosures (such as the company TSR to peer TSR comparison)
3. Adding supplemental disclosure that violates the requirement that any supplemental disclosure be clearly labeled as supplemental, not be made more prominent than the required disclosure, and not be misleading
4. Including a non-financial measure in the Tabular List prior to providing three financial measures (e.g., there are two financial measures and one non-financial measure)
5. Using an Item 201(e) peer group that is a broad market index and therefore falls within Item 201(e)(1)(i) but not the requirement that it fall within Item 201(e)(1)(ii), which excludes any broad market index

Wrap-Up

Stay tuned as more disclosures are published and we update our database and this article. We’re amazed by the collective mobilization corporate legal, HR, and finance departments have shown in executing under such unprecedented timelines. There’s bound to be quality and stylistic differentials in the disclosures, giving rise to important planning and reflection once this year’s proxy season is over and we shift our sights to next year’s season.

And, of course, we know all the non-calendar year companies are intently monitoring these trends as they gear up to produce their first PvP disclosures. We invite you to reach out should you have any questions or comments about the contents discussed here.