New Scrutiny of C-Suite Pay

Executive pay, already a hot topic of debate between companies and stakeholders, may soon get a lot more contentious. 

Under a new rule adopted by the US Securities and Exchange Commission, companies will now have to include data tracking executive pay against certain financial metrics over a five-year period. Supporters of the measure say it will give investors and watchdog groups more transparency around how increases in the compensation for CEOs and other top executives compares to growth in net income, total shareholder return for the company against its peer group, and more. Critics, however, argue the rule is just another burdensome reporting requirement similar to disclosing pay ratios between CEOs and the average employee that will generate negative media headlines but do little to change actual behavior. 

While the new rule puts more context around how executive compensation is determined, for instance, the metrics being highlighted are only some of the factors compensation committees use to calculate overall pay, says Todd McGovern, senior client partner in the Executive Pay and Governance practice at Korn Ferry. Other factors, such as progress towards climate and diversity goals or whether the company is in turnaround mode as it navigates through a crisis like COVID, also play a significant role. “To pull these metrics out and put them front and center doesn’t tell the entire story,” McGovern says. 

The so-called pay versus performance rule is the latest in a series of hotly debated—some say aggressive—measures adopted by the SEC. Other recent rules adopted or proposed by the SEC include requiring Nasdaq-listed companies to have at least two directors from underrepresented groups on their boards, enhancing disclosures around climate-related risks and goals, and management of cybersecurity.

While mandating more transparency from companies aligns with the purpose movement among investors, McGovern says the recent push by the SEC could be an attempt to tie up loose ends left open during the previous administration. “They are trying to make as much progress as they can while they still can,” he says. 

The pay versus performance rule traces its roots back to the 2010 Dodd-Frank Act. It was first put to a vote in 2015 but wasn’t adopted. Underscoring the controversial nature of the proposal, the most recent vote passed by a slim 3-2 margin, with the SEC’s two republican commissioners opposing its adoption. They cited concerns around the relevancy of the financial metrics and the cost and complexity of implementing it for companies. Between say-on-pay, CEO-to-employee pay ratio, and the latest rule, “there are a lot of tricky new disclosure requirements falling onto the plates of CFOs to figure out,” says Jeff Constable, coleader of the Global Financial Officers practice at Korn Ferry.   

But one of the biggest concerns companies have around the new rule, says Constable, is that it gives more ammunition to activist investors to launch campaigns against companies. After staying on the sidelines for much of the pandemic, activist investors have stepped up their campaigns against companies this year. According to data from financial advisory firm Lazard, activist investors launched 126 campaigns globally during the first half of 2022, a 34% increase from the 94 global campaigns launched last year, and the most through the first six months of any year since 2018. Highlighting outsized executive pay is one of the easiest and most frequent targets for activists, in part because it plays right into the media’s narrative. Or, as Constable more diplomatically puts it, “Activist investors tend to get involved in companies where there is a historically poor correlation between executive pay and company performance.”

There is, however, an upside to the adoption of the pay versus performance rule that could work in the favor of companies and compensation committees. In addition to showing how executive pay aligns with performance, companies will also have to detail in writing the relationship between the two. That means they have the opportunity to explain not only how compensation was determined but also create their own narrative around why it settled on a particular figure. “Companies can stymie criticism with clear and compelling reasons for why an executive is getting what they are getting,” says McGovern.

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