Investors are getting access to clearer and more detailed information from public companies on their top executives’ pay packages and perks under new federal rules that took effect Friday.
Companies’ 2006 annual reports issued early next year will reflect the changes, which were ordered by the Securities and Exchange Commission in July in a major overhaul of disclosure rules for executive compensation.
The new requirements include disclosure of the dating of stock-option grants to executives. Companies must provide detailed information on how they determine when executives receive option grants and, if they do so, how and why they backdate options. Suspect timing of option grants has turned into corporate America’s scandal of the year, with more than 100 companies under investigation by the SEC or the Justice Department, more than $5 billion in profit erased by restatements and 18 CEOs swept out of office.
An academic study completed this fall found that corporate executives gained an average of $600,000 a year each from backdating of stock options between 2000 and 2004. By contrast, shareholders were hurt by an average loss in market value of 8 percent, or $500 million, for each affected company from the negative publicity of being under government investigation, the researchers at the University of Michigan found.
When stock options are backdated, they are issued retroactively to coincide with low points in a company’s share price — fattening profit for options recipients when they sell their shares at higher market prices.
Backdating options can be legal as long as the practice is disclosed properly to investors and approved by the company’s board. In some cases, however, the practice can run afoul of federal accounting and tax laws.
For the first time, under the new disclosure rules, companies are required to furnish tables in annual filings showing the total yearly compensation for their chief executives, chief financial officers and the next three highest-paid executives. Most of the disclosures, in annual reports and other regulatory filings, must be written in plain English.
The rules were designed to enhance corporate accountability and address an issue that has angered company shareholders and the public: lavish compensation for executives, unrelated to their performance, even as companies stumble, lay off employees or renege on billions of dollars in pension obligations for workers’ retirement. The chasm between executives’ salaries and the pay of rank-and-file employees continues to widen.
In the SEC’s 72-year history, no other issue has stirred as much interest, with more than 20,000 letters filed during the public comment period that followed the proposal being floated in January, according to agency officials.
The SEC removed from its original proposal, though, a requirement for companies to disclose the pay details of as many as three non-executive employees whose individual compensation exceeds that of any of their top five executives. Dubbed the “Katie Couric clause” by critics, it brought a flurry of opposition during the comment period from Hollywood and big media companies.
As an alternative, the SEC decided to propose a narrower requirement for disclosure of the pay of non-executive employees who help set corporate policy and strategy at big companies — excluding most professional athletes, and TV and film personalities.
On Capitol Hill, Rep. Barney Frank, D-Mass., who will take over in January as chairman of the House Financial Services Committee, has proposed legislation that would require shareholder approval of executive compensation plans.