RSM Resources

Determining the appropriate level and type of executive and director compensation is a challenge for many organizations. If your business is facing these issues, you’ll be interested in a new set of benchmarks from the U.S. Securities and Exchange Commission (SEC).

The new SEC rules — adopted in August 2006 and affecting filings on or after Dec. 15, 2006 — require publicly held companies to not only report more data about executive compensation but explain how they arrived at it.

New narrative disclosures, or "compensation discussion and analysis," reflect the SEC’s effort to increase the transparency of executive compensation. In plain English, companies must describe the levels and forms of compensation they offer as well as what performance it’s designed to reward. Through SEC filings, you now can learn more about the thought processes behind the compensation packages that your publicly traded competitors provide to executives and directors.

What’s reported, where to find it

Publicly held companies must report the annual total compensation of the primary executive and financial officers, the three other-highest paid executives serving at year-end, and all directors. The requirements affect disclosures in proxy statements, annual reports, registration statements and Form 8-K reports.

The rules expand the already-required summary compensation table. The revised table reports annual compensation for each listed officer during the past three years. Compensation disclosures include:

• Annual salary and bonus (both of which were previously required).
• Stock and option awards granted or modified, including restricted stock and phantom stock awards.
• Option awards, including stock appreciation rights and other stock-based compensation.
• Incentive plans that are not equity-based.
• Increases in the present value of awards made within defined benefit pension plans and non qualified deferred compensation.
• All other compensation, such as company contributions to defined contribution plans, tax reimbursements, life insurance premiums, and any perks or personal benefits.

Any perks valued at$10,000 or more must be identified in footnotes. Previously, companies had to disclose perks only if the value was the lesser of $50,000 or 10percent of the total annual salary and bonuses. Perks that require disclosure include:

• Club memberships not used exclusively for business entertainment.
• Personal financial or tax advice.
• Personal travel using vehicles the company owns or leases.
• Housing and other living expenses (including relocation assistance).
• Security provided at a personal residence or during personal travel.
• Commuting expenses (regardless of whether it was done for the company’s convenience or benefit).
• Discounts not generally available to employees.

Companies do not need to restate information for prior years; they must report only the most recent fiscal year.

In addition to the summary compensation table, the newly required narrative must describe the company’s compensation objectives: what the compensation is designed to reward, the specific amount and type of compensation, why the company is paying each type, how the company determines the value of each type, and how the compensation packages fit the company’s objectives. Companies don’t have to release specific performance targets or any other confidential information that might adversely affect the organization.

What it means for private companies

The new disclosures give business leaders an opportunity to better understand the competitive compensation climate, if only as it relates to public companies. They may also learn more about the culture and philosophy of other companies.

The new SEC rules are not mandatory for private companies, who may nonetheless want to make such disclosures to their shareholders as best practices. After all, some private companies (particularly those with many shareholders) are choosing to adopt principles from the Sarbanes-Oxley Act of 2002 (SOX),modeling their financial reports on the requirements of publicly held companies. Some private companies may not follow the new executive compensation rules in order to save time and money.

The heightened focus on executive compensation at public companies may prove to be a recruiting advantage for their private counterparts. In the struggle to attract, retain and motivate executives, private companies will have more competitive information — without having to disclose their own compensation practices. In addition, candidates for executive positions might wish to maintain their privacy by avoiding positions with companies that publicly disclose their compensation packages.

Other effects

The new disclosure requirements could become burdensome — perhaps even the proverbial"straw that breaks the camel’s back" — for small public companies that are examining whether to go private. Since the passage of SOX, an increasing number of companies turned private to avoid costly and time-consuming reporting requirements. In 2006, 129 U.S. public companies went private. That was up from 68 such transactions in 2005,according to Small Business Times.

Conversely, the new standards are an additional hurdle to clear for companies considering going public and may discourage them from doing so — particularly since there’s abundant available capital from private equity firms.

In addition, private companies contemplating selling themselves to public companies don’t need to adopt the compensation disclosure practices prior to going on the market, but they should anticipate addressing compensation issues during due diligence.

Finally, changes incompensation programs are likely to trigger federal and state tax consequences. Include your compensation consultant or tax professional in early-stage discussions about program changes to help you create the most effective compensation package for your executives and your company.