Reconciliation of Performance Data for Incentive Purposes to GAAP Financials

Fred Cook is Chair of Frederic W. Cook & Co., Inc.

For a variety of reasons, most corporations use performance measures that differ in varying degrees from published GAAP numbers in their audited financial statements.  The variations may be relatively minor, such as adjusting diluted EPS for identified unusual items, or major, such as using financial measures like NOPAT or EBITDA that are not GAAP measures at all.

Compensation committees make bonus decisions at or shortly after year end using performance data provided by management.  Audited financials are not available at this time, but the financial data upon which the audits will be performed usually are available.

It is rare in my experience for a compensation committee to be provided with a reconciliation of the performance data it is using for bonus purposes to the GAAP performance results at the time bonus decisions are made, or even thereafter.  Thus, it is possible the performance results may be strong for bonus purposes but the GAAP results may be weak, or vice versa.  There may be nothing wrong with this per se.  The issue is that the compensation committee may not know this at the time.

The answer would be for the CFO to provide the Committee with a written memorandum or statement at the same time bonus decisions are made reconciling the bonus performance data to the GAAP financials that will be disclosed later.  And if adjustments are made to the financial results during the audit process that cause them to differ from those in the reconciliation statement, the committee should be notified so it can take any actions it deems appropriate.