January 9, 2024
Non-GAAP: Why Performance Metric Adjustments Might Differ From “Financial Reporting” Measures
For at least the past few years, investors have been pushing for more transparency around non-GAAP adjustments that are made to performance metrics in order to calculate incentive payouts. ISS even included a question about this in the policy survey for this year’s voting policies – and even though there weren’t any formal policy changes on this point, the proxy advisor did update an FAQ to encourage detailed disclosure of adjustments. Glass Lewis also made a relevant clarification. So, the issue isn’t going away.
One question that often arises on the company side is, “What’s the big deal? The reconciliation is only a click away.” From the investor perspective, though, not only is it annoying to have to pull up a separate document, but there is also a recognition that the adjustments may not be exactly the same. This Pay Governance memo gives 5 reasons why there might be discrepancies between financial reporting & incentive adjustments:
1. Threshold amounts that seek to limit the number of adjustments to only those that are materially above a certain dollar amount (i.e., expenses or benefits above $5.0 million)
2. Expenses or benefits that are included in the annual business plan used to establish incentive targets (further adjusting actual performance would result in double counting)
3. Expenses or benefits that may be non-recurring and excluded for financial reporting purposes but still deemed within the control of management for incentive purposes
4. Optics and materiality where omitting a significantly large expense could lead to a severe misalignment due to an above target incentive payout and poor share price performance
5. Matter of importance — for example, foreign currency exchange rates that are used to adjust earnings for year-over-year comparability purposes but are not as important for incentive purposes
The memo goes on to share best practices & potential pitfalls to consider when making non-GAAP adjustments to payout calculations. Pay Governance will be following up with “Part 2” to this memo that will cover more complex issues with M&A-related adjustments as well as other issues.
– Liz Dunshee