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Beller Examines SEC Executive Compensation Disclosure Proposal

The broad purpose of the SEC's proposed executive compensation proposal is to create a value-free disclosure framework to provide investors with complete and accurate information that they can use as they see fit, according to Alan Beller, former director of the Division of Corporation Finance. He added that the proposal was not designed to lead to a particular result regarding executive compensation. The proposal is also value free because it captures all compensation. Beller's remarks were delivered at a seminar sponsored by the Rock Center for Corporate Governance at Stanford University. The transcript of his remarks was attached to a comment letter on the proposal submitted by former SEC Commissioner Joseph Grundfest.

In Beller's view, an overriding purpose of the proposed new regime is to provide clear disclosure on the objectives for which directors desire to compensate their management and how the compensation decisions and strategies will deliver on those objectives. Directors should be able to pick the objectives for which they want to compensate their executives, he said. The proposal will require disclosure of what those objectives are and how the compensation decisions and strategies will deliver on those objectives. Beller said the SEC is creating a value-free system of disclosure broad enough to cover all of the potential objectives that a board of directors might be trying to reward as opposed to guiding the disclosure towards one or two objectives.  

Since executive compensation is used by academics and others to produce comparative studies across companies, Beller said there is an interest in having rules that permit such comparability. Comparability is one of the reasons for highly formatted tables, according to Beller, but it sometimes bumps up against the utility of getting material information out to investors.  

A central goal of the proposal is to have a single number reported for total compensation. This creates what Beller called an "apples-versus-oranges" issue in which current compensation is relatively easy to provide but long-term incentive compensation is more difficult to calculate on a current basis. 

Under the proposal, equity-related long-term incentive payments, such as stock options, are dealt with by using the FAS 123R methodology for valuation determined by the FASB. Beller pointed out that FAS 123R was intended to determine the cost expense to companies, not the value to executives and therefore is an inappropriate methodology for valuing option payments. He cautioned that dismissing FAS 123R out of hand would ignore two realities. First, it provides a methodology which otherwise does not exist. Second, there are a number of executive compensation disclosure calculations, both in the existing rules and in the proposal, where the incremental cost to the company is the measurement methodology. 

Regarding non-stock-related long-term incentive payments, there is no methodology comparable to FAS 123R. The proposal treats those payments the same way as the current rules, as current compensation when earned, but that is inconsistent with the grant date methodology for stock options. Given that there is no generally recognized methodology for non-equity related payments, the SEC, at the proposal stage, decided to go with the current methodology. Some have urged the Commission to come up with a methodology that permits grant date valuation of the non-equity related payments as well. Beller described this as a tall order, but also as an issue that has to be looked at, and was looked at during the proposing stage. 

Beller also analyzed the proposal within the context of principles-based versus prescriptive disclosure. In many respects this is a false debate, he said, because almost all of the SEC's rules come down somewhere in between with a combination of the two. In the executive compensation proposal, the debate focuses on compensation disclosure and analysis. The proposal takes a very principles-based approach to that area, he noted, which envisions a narrative overview explaining material elements of the company's compensation for executive officers.

Prescriptive rules produce disclosure on specific issues that are of paramount interest at the time the rule is drafted. Beller said that is good, but it may be easier for issuers not to disclose things that are covered by the prescriptive rules even though they might be material to investors, which is not so good. It is also problematic when times change and other major issues become important that are not covered by the prescriptive rule.

The SEC has had great success with its most principles-based set of rules, which is management's discussion and analysis ("MD&A"), according to Beller. Disclosure under those rules has evolved to meet changing conditions, he said, and enforcement has been successful in addressing serious deficiencies as they have evolved over time even though they were not covered by prescriptive rules.

Beller noted that MD&A has required ongoing Commission attention, including a number of interpretive releases on the subject. To the extent that compensation disclosure and analysis ends up being more principles-based, he said, it is going to require similar ongoing SEC involvement, both in terms of the comment process and in terms of appropriate interpretations by the Commission as it gains experience with those rules. That is one of the consequences of a successful principles-based framework, he concluded.

James Hamilton