NACD Proposes Pay for Performance Principles and Standard Supplemental Executive Compensation Definitions | Practical Law

NACD Proposes Pay for Performance Principles and Standard Supplemental Executive Compensation Definitions | Practical Law

The National Association of Corporate Directors (NACD) released a perspectives paper in which it sets out certain principles that it believes should apply when assessing pay for performance and proposes standard supplemental executive compensation definitions.

NACD Proposes Pay for Performance Principles and Standard Supplemental Executive Compensation Definitions

by Practical Law Employee Benefits & Executive Compensation
Published on 18 Dec 2013 • USA (National/Federal)
The National Association of Corporate Directors (NACD) released a perspectives paper in which it sets out certain principles that it believes should apply when assessing pay for performance and proposes standard supplemental executive compensation definitions.
On December 16, 2013, the National Association of Corporate Directors (NACD) released a perspectives paper (used with permission from the NACD © 2013) on pay for performance principles and supplemental pay definitions.
In the paper, the NACD sets out the following four principles that it believes should apply when assessing and communicating the link between an executive's compensation and company performance:
  • Standard Definitions (with Flexibility). To enhance comparability of pay and performance disclosures, companies should adopt standard baseline definitions of pay and performance and a standard method of presenting their pay for performance analysis, with flexibility to present additional information when needed to more effectively communicate with investors and other stakeholders.
  • Consistent Time Horizons, Oriented to the Long Term. The time horizons for measuring pay and performance should be consistent, with a three- or five-year baseline generally recommended.
  • Disclosure Beyond the Chief Executive Officer (CEO). Companies should disclose two pay for performance calculations: one for the CEO and one for all other named executive officers (NEOs) as a group.
  • Informed Business Judgment and Company Context. Directors are responsible for exercising informed business judgment when promoting long-term value creation for the company.
The NACD emphasizes the need for a consistent approach to supplemental executive compensation definitions, a need that stems from the Dodd-Frank Act requiring companies to disclose information about the relationship between "compensation actually paid" to executives and the "financial performance" of the company without defining those terms. Companies have adopted divergent approaches to defining terms such as "realized" and "realizable" pay when including additional executive compensation information in their proxy statements, making comparisons among companies difficult.
The NACD proposes that the definition of realized pay, which is intended to capture what an executive actually made in a given year, include the following components:
  • Base salary.
  • Cash bonus and incentive awards.
  • Gains from stock option exercises during the specified time period (regardless of original grant date).
  • Value of restricted stock or restricted stock units if vested during the specified time period.
  • Value of performance shares or performance share units if vested during the specified time period.
Noting that this definition appears consistent with the Dodd-Frank Act's requirement to disclose "compensation actually paid," the NACD believes that realized pay would be useful in calculations such as the proposed CEO-to-median-employee pay ratio (see Legal Update, SEC Proposes Dodd-Frank Pay Ratio Disclosure Rules). However, because realized pay takes into account executives' investment decisions on when to exercise option awards, regardless of when the awards were granted, the NACD believes that realized pay should not be used in pay-for-performance analyses because pay and performance time frames could significantly differ.
The NACD proposes that the definition of realizable pay, which companies often use in their proxy statements to demonstrate the alignment between pay and performance, include the following components:
  • Base salary.
  • Cash bonus and incentive awards paid.
  • Long-term cash bonus and incentive awards granted but not yet paid.
  • Change in pension value and nonqualified deferred compensation.
  • Value of executive benefits and perquisites.
  • For stock options, the Black-Scholes value of stock options awarded during the specified time period (whether vested or unvested), using stock price at the end of the time period.
  • For restricted stock, the value of shares awarded during the specified time period (whether vested or unvested), using stock price at the end of the time period.
  • For performance-based equity awards, the value of shares earned during the specified time period, using stock price at the end of the time period.
While there is widespread agreement that base salary, cash bonuses and incentives and long-term incentives granted but not yet paid should be included in the definition of realizable pay, views differ regarding whether certain non-compensatory benefits (such as deferred compensation, change in pension value and perquisites) should be included. The NACD believes that these additional components are important to include because they are meaningful to executives when considering their compensation.
The NACD believes that if reporting companies are willing to adopt these standard definitions for their proxy statement disclosure, communications between directors and investors can be enhanced.