Amid an explosion of proposals to limit and regulate executive compensation, public-company finance chiefs face a double whammy: the prospect of new constraints on their own earnings and new responsibility for providing an unprecedented level of disclosure about compensation in financial statements.
This month, the Senate is expected to take up a bill passed by the House of Representatives that would require public companies to give their shareholders a nonbinding “say on pay,” and to do a better job explaining how pay practices affect their overall level of risk. Big financial institutions would face special scrutiny from federal regulators, who would determine whether their incentive structures — even commissions — are “aligned with sound risk management.”
The legislation builds on Securities and Exchange Commission proposals (open for comment until September 15) that include provisions for disclosing more to shareholders about the credentials of company directors and about potential conflicts of interest that exist for any independent compensation consulting firms advising the board. The SEC and other regulators would have nine months after enactment to issue final say-on-pay rules — making it unlikely that they will go into effect during the next proxy season.
CFOs can anticipate substantial changes to the compensation disclosure and analysis section of annual reports. Regulators “have fought like crazy to get meaningful, in-depth discussion from companies,” says John Martini, chairman of the executive-compensation practice at Reed Smith.
In addition to providing numbers — typically a table listing the compensation packages of the five top executives — the report would also have to explain the objectives behind the structure of any incentive-pay schemes that might have an impact on the company’s risk management. “The idea is that transparency will put the brakes on bad behavior,” says Ann Graham, professor of law at Texas Tech University’s law school.
Behaviors already seem to be changing. Paul M. Ritter, head of the executive-compensation practice at Kramer Levin, points out that Swiss banking giant UBS has announced that it will delay management bonuses for three years so as to discourage short-term risk-taking. “CFOs and other top executives may not like it, but that is going to be a best practice going forward,” says Ritter.
Whatever their effectiveness, the measures come as little surprise to many CFOs. “We’ve dealt with a lot of reform,” says Kevin Rhodes, CFO of Edgewater Technology, a $75 million IT consulting firm. “For the government, the challenge is to balance its heavy policy-making hand against the need to treat well-run companies fairly. Here, I think they have found the right balance.”