On January 27, the Securities and Exchange Commission issued a release reopening public comment on a seven-year-old proposal to require disclosure of the relationship between executive pay and company financial performance. The pay-for-performance rule was proposed in 2015 to implement Section 14(i) of the Securities Exchange Act, enacted by the Dodd-Frank Act of 2010, which directs the SEC to adopt rules relating to how executive compensation actually paid by a registrant relates to the financial performance of that registrant. The 2015 version would have required a table showing the relationship between compensation paid to named executive officers and company performance, as measured by the company’s total shareholder return (TSR) and by peer group TSR. The comment period on this proposal closed in July 2015, but the Commission has never taken further action on it.
While the SEC has invited views on all aspects of the original proposal, the thrust of the new release is whether the metrics for company performance should be expanded beyond TSR. Additional performance measures the Commission is considering include pre-tax net income and reported net income; a “Company-Selected Measure” representing the metric that the company deems to be the most important performance measure used to link compensation to company performance; and a list of the five most important performance measures used to determine compensation actually paid.
The Commission’s consideration of a broader range of performance measures and their impact on compensation potentially highlights the stakes involved in the selection and integrity of ESG metrics. In her statement supporting the reopening of comment, Commissioner Lee noted that additional metrics may help to illuminate the link between executive pay and corporate ESG goals:
“The modern compensation landscape now encompasses enhanced reliance on performance metrics related to, for example, climate, diversity, and other company-specific ESG goals. It would be helpful to hear from commenters on how the increased flexibility contemplated in today’s reopening release may facilitate investor analysis of the use of such metrics and targets in compensation plans * * *.” (footnote omitted)
If publicly disclosed ESG metrics play a role in determining executive compensation, the audit committee may want to work with the compensation committee in considering the selection, disclosure, and control framework for the relevant ESG performance measures.