The Advisors' Blog

– David Schmidt, James F. Reda & Associates

Short-term incentive plans enhance executive performance, but very little is revealed to investors about them, according to new research by our New York-based firm. And while companies are disclosing more about their plans, they have a long way to go before reaching full compliance with the SEC’s new rules.

The SEC asserts that if executive compensation performance targets are central to a company’s decision-making process, they must be disclosed to investors. The new proxy disclosure rules require that all performance measures and goals must be released and compared with actual results. This disclosure requirement includes both short- and long-term incentive performance measures.

There is evidence that some companies are resisting the SEC. Though the SEC’s requests seem straightforward, implementation is proving to be difficult. Indeed, many companies are simply not bothering to comply. At least that’s the conclusion of a study by our firm that analyzed a representative sample of the medium-size companies in the Standard & Poor’s MidCap 400 group.

According to the most recent proxy filings, which covered 2007 results, only 47% of the companies made the required disclosures concerning short-term incentive pay. While this figure is substantially higher than the 23% that complied with the rule in 2006, it is nonetheless distressing.

On long-term incentive pay, for those companies with long-term incentive plans, compliance was a more robust 62% last year. In 2006, only 41% of companies complied. Long-term incentive compliance is generally higher than for short-term incentives as companies find it less threatening to report the relative goals typical of many long-term incentive plans.

When it devised its disclosure rule, the SEC gave companies a sizable loophole, excusing them from detailed disclosure of targets if they believed that publishing such figures would put them at a disadvantage in their industry. Many companies are using potential competitive harm from disclosure as a reason for not disclosing.

This argument of competitive harm would seem to be a pretty weak one. Is it the case that companies don’t want the bright light to be shone on their situation because it gives them the flexibility to give a bonus when it isn’t earned?

Others are disclosing the performance measures and the weights on each measure (but not the levels). Make no mistake: the SEC requires the full disclosure of goals, and performance measures, including weights and levels in comparison with actual performance and its effect on the executive’s compensation.

Even when companies have included discussion of performance goals in their proxy statements, the SEC has not been entirely satisfied with the results. That’s because after examining hundreds of proxy statements during last year’s proxy season, the SEC determined that the specifics of executive compensation decisions and policies need to be explained in clearer language for investors.

Most companies are disclosing the performance measures (but not the levels). Earnings are the number one performance measure across all industries, and companies appear to be setting more difficult goals as goal achievement declined in 2007. Thus, the new rules have more closely aligned pay and performance and have informed shareholders of important performance goals.

Companies may be choosing not to disclose specific benchmarks because those figures may be significantly different from financial targets that executives at these corporations have promised Wall Street analysts and investors — indicating that the boards in question are setting their bars too low and generating bonuses too easily.

The study also examines how often the CEO meets or exceeds goals. In proxies from both 2006 and 2007, some 60% of companies met or beat their targets, generating short-term payouts. This might be an indication that goals are often being set too low. A review of 2009 proxies will be very interesting on this point.

We are in the final stages of analyzing large cap companies with small companies to follow later.

For more, please refer to this article by Gretchen Morgenson published in the New York Times this past Sunday, “If the Pay Fix is In, Good Luck Finding It.”