User’s Guide to SEC Pay-disclosure Rules

Under the new Securities and Exchange Commission requirements, ''you've got to employ some gymnastics'' when calculating total compensation, says a co-author of the new guide from Moody's.

As CFOs tussle this proxy season with the complexities of the Securities and Exchange Commission’s new disclosure rules for executive pay, Moody’s Investors Service is coming out with a user’s guide to help shareholders benefit from the disclosures.

By calling for more information from companies, the SEC rules reveal “the way performance incentives influence management behavior and retention of top-level executive talent,” said Mark Watson, managing director of the rating service’s Corporate Governance Group and a co-author guide. “We believe compensation is a determinant of management behavior that indirectly affects credit quality.”

A major investor benefit of the new rules, Watson said in an interview, is that they require CFO pay to be disclosed, even if the finance chief isn’t among the five highest-paid corporate employees. At some companies, he noted, “the well-paid people tend to be the business-line heads,” leaving the chief financial officer down in the pack, with a pay package that in the past might not be detailed. From an investor’s standpoint, he said, it is especially valuable to know how the finance chief is compensated.

“The numbers signal how important an individual is to an organization,” Watson observed. “Now, we’ll also be able to see if it’s giving the CFO a lot of options, and how the finance chief’s pay, both short-term and long-term, compares with what CFOs earn at peer companies.

“Before,” he said, “you just weren’t able to look at that.”

For the most part the new rules increase the transparency of executive pay. And Moody’s believes its 13-page “User’s Guide to the SEC’s New Rules for Reporting Executive Pay” will impart to investors the lessons learned by the service’s nine-person corporate governance team since its creation in 2003. The group, which works with Moody’s analysts to make governance issues a stronger part of credit ratings, has provided about 500 individual corporate assessments, according to Watson. Now it is able to do more-thorough pay analyses because of the SEC-mandated changes.

But the guide, which Moody’s plans to announce Tuesday, also is geared to helping investors work through some shortcomings the rating service sees in the regulations. For one thing, Moody’s has low expectations for the new “compensation discussion and analysis” report that corporate boards must file, with CEO and CFO certification.

The guide warns that “the additional legal burden attributed to filing the CD&A will encourage companies to veer towards legalese and boilerplate disclosures.” Many proxy statements already filed with the SEC this year “include long and often convoluted CD&As,” the guide says. ” It’s clear that many companies are letting lawyers have the final say on the CD&A.”

In other areas, the rating service suggests, the rules may have as many complexities for shareholders as for the companies that must now break out additional executive-pay data. From an investor perspective, for example, Watson said that the rules require too little data about equity-based awards and create difficulties when investors try to determine final payout amounts, especially when estimating the value of the long-term-incentive-plan components within total pay. The Moody’s guide offers a formula for applying target numbers that may provide an equivalent value “close enough” to allow an understanding of the amounts that a board intended for the executive to earn.

Watson observed that in the new SEC rules, as written, “you’ve got to employ some gymnastics when it comes to calculating total pay.” Further, the application of a Financial Accounting Standard 123R fair-value number for equity-based awards requires “a little bit of math” before investors can determine certain hidden values in the compensation amounts.

“The transparency around incentive payments has gone down tremendously,” he added. Because most are based on stock values, the new rules — while not leading to any material understatement or overstatement of prospective incentive-plan payments — “just make them more complex.” Moody’s recommends that further improvements be made in the rules, said Watson, and would like to see “full disclosure of the final payouts from all kinds of long-term incentive plans.”

“What we’re trying to do,” he said, “is get a bird’s-eye view of what the compensation committee was thinking.”

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