say-on-pay rule: study shows shareholder votes may not matter

How does your company’s executive compensation plan measure up? A recent study found that CEO compensation at large public companies has continued to increase despite the “say-on-pay” rule that went into effect in 2011. Here’s more information on this rule and key findings from the 2018 Equilar CEO Pay Trends report.

Soliciting feedback

Following the financial crisis of 2008, the Dodd-Frank Act required public companies to provide investors a “say on pay.” In January 2011, the SEC published Release No. 33-9178, Shareholder Approval of Executive Compensation and Golden Parachute Compensation. This rule, which went into effect in 2011, aims to curb excessive executive compensation by allowing shareholders to vote on executive compensation at least once every three years.

The votes aren’t binding, but they let boards know what shareholders think of executive compensation arrangements. Furthermore, the year following a say-on-pay vote, companies must disclose in proxy statements how they’ve responded to the most recent say-on-pay vote.

Analyzing the effects

Corporate research firm Equilar analyzed filings of the 500 largest companies in terms of revenue to determine the effect that the say-on-pay rule has had on CEO compensation. The study, which was published in February 2019, found that compensation has continued to rise during the eight years the rule has been in effect.

“Intuitively, it seems possible that CEO pay should decrease since it is under the scrutiny of a large number of shareholders. However, the data reveals a different story,” said Equilar.

Specifically, the study revealed that median CEO compensation after the rule went into effect was $9.5 million, while the median pay before Dodd-Frank was signed into law in 2010 was $6.6 million. The compensation research firm attributed the 43.9% increase in pay to the economic growth after the financial crisis.

However, the study also showed that, when a company fails its say-on-pay vote multiple times, it usually tries to align CEO compensation with industry standards. In fact, average CEO total compensation at companies that failed say-on-pay votes decreased 44.9% from 2011 to 2017.

The study highlights Bed, Bath & Beyond Inc. as an example of the “moderating effect” multiple say-on-pay failures can have over time. In 2014, Bed, Bath & Beyond failed its annual say-on-pay vote, but it increased the option and stock awards granted to its CEO for 2015. Not surprisingly, the company failed its say-on-pay vote again in 2015. In response to recurring shareholder disapproval, the company then decreased CEO compensation by 20.9% from 2014 to 2017.

“This shows that the [Bed, Bath & Beyond] made a concerted effort to gain approval in the eyes of its shareholders,” Equilar said.

Lessons learned

Equilar’s study concludes that the say-on-pay rule initially didn’t have a major influence on the pay amounts, but now that public companies have settled into the routine of receiving shareholder feedback on executive compensation arrangements, the rule is having a noticeable effect.

“Over time, compensation professionals realize the power of [say-on-pay votes] and take appropriate actions,” concludes the study. While say-on-pay votes may not have a direct influence, “the continuity of attention by shareholders and proxy advisors over the executive pay issue is an increasingly significant feature of the corporate governance and executive compensation landscape, and will likely continue to be so.”

©2019 THOMSON REUTERS

exploring segment reporting alternatives

In February, the Financial Accounting Standards Board (FASB) discussed its ongoing project to improve how companies provide information around business segments. It doesn’t appear that a proposal will be issued anytime soon. Instead, the FASB plans to reach out to more investors on what segment data they’d like to see disclosed.

Segment reporting guidance

The FASB has spent months on outreach related to potential tweaks to FASB Accounting Standards Codification (ASC) Topic 280, Segment Reporting. In general, the FASB wants to improve the detail businesses provide about their segments.

The existing standard advises businesses to connect the information for reporting segments based on the person or group of people described by the disclosure requirements and implementation guidance as the chief operating decision maker (CODM). Businesses are required to disclose certain information about their segments if the information is regularly reviewed by the CODM. This is more commonly known as the so-called “management approach” to segment reporting.

Under the existing rules, segment totals must be reconciled to the consolidated amounts if the segment totals are “significant.” In general, a business must report information about an operating segment if:

• Its revenue — including sales to external customers and intersegment sales or transfers — is 10% or more of the combined internal and external revenue of all operating segments, or
• Its profit or loss is 10% or more of the greater of either the combined reported profit of all operating segments that didn’t report a loss or the combined reported loss of all operating segments that did report a loss.

A segment that includes assets that are 10% or more of the combined assets of all operating segments also must appear in the financial statements.

Need for change

Investors often complain that the financial reporting that conforms to Topic 280 leaves them with too little information. They say large multinationals often report one or two business segments when other evidence indicates they should report more.

Investors say the problem can be traced to the leeway companies are given to determine when they should aggregate information from several business lines. In addition, the existing disclosure requirements are somewhat limited. Yet businesses are wary about offering too much information that could give competitors information about trade secrets.

Ongoing research

In June 2018, FASB staff began surveying issuers on ways to improve segment reporting. They explored three options for changing the current approach for determining which segment information needs to be reported. The management approach “requires an entity to report segment information in the way that management internally organizes its segments to make operating decisions and assess performance.”

Of the three alternatives, FASB staff didn’t recommend pursuing two of them. Under the remaining alternative, staff will study how to clarify the meaning of “regularly reviewed information,” with a particular focus on technology changes and information that’s reviewed by the CODM only on an irregular basis.

FASB members want more investors to be consulted as part of the ongoing study. In particular, FASB member Gary Buesser advocated focusing on two groups during the research study: 1) companies who report, and 2) investors who consume financial information.

Stay tuned

No formal decisions about segment reporting have been made yet. However, if your company is interested in participating in the FASB’s ongoing research study, contact your CPA as soon as possible.  

©2019 THOMSON REUTERS

CLOSE-UP ON MATERIALALITY

The Auditing Standards Board (ASB) of the American Institute of Certified Public Accountants (AICPA) has been discussing options to amend its definition of the term “materiality.” In May, the ASB plans to vote on issuing an exposure draft of the updated guidance. Here’s what’s currently on the table.

Existing auditing standards

Under current U.S. Generally Accepted Auditing Standards (GAAS), misstatements and omissions are considered material if they, individually or in the aggregate, could “reasonably be expected to influence the economic decisions of users made on the basis of the financial statements.”

In January, the ASB approved a narrow project to revise the definition of materiality. The effort aims to reduce inconsistencies in how this term is defined in the United States. Currently, there are subtle differences between the definition used by the AICPA, the U.S. Supreme Court, the Securities and Exchange Commission (SEC), the Financial Accounting Standards Board (FASB) and the Public Company Accounting Oversight Board (PCAOB).

FASB definition

The ASB’s materiality project comes as the FASB has decided to return to its original definition of materiality, which was in effect from 1980 until 2010. Effective in August 2018, the FASB’s amended definition of materiality is: “The omission or misstatement of an item in a financial report is material if, in light of surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item.”

The FASB’s updated definition no longer syncs with the International Accounting Standards Board’s definition — or the GAAS definition.

If GAAS is changed using the FASB’s language, it would read: “Misstatements, including omissions, are considered to be material if, in light of surrounding circumstances, it is probable [emphasis added] that the judgment of a reasonable person relying on the financial statements would be influenced or changed by the misstatements, individually or in the aggregate.”

PCAOB definition

On the other hand, PCAOB Auditing Standard (AS) 2105, Consideration of Materiality in Planning and Performing an Audit, doesn’t define materiality. Instead, it describes materiality by quoting a Supreme Court decision in TSC Industries v. Northway, Inc. That opinion concludes, “In interpreting the federal securities laws, the Supreme Court of the United States has held that a fact is material if there is ‘a substantial likelihood that the . . . fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.’”

AS 2105 states that “the auditor should evaluate whether, in light of the surrounding circumstances, there are particular accounts or disclosures for which there is a substantial likelihood that misstatements of lesser amounts than the materiality level established for the financial statements as a whole would influence the judgment of a reasonable investor. If so, the auditor should establish separate materiality levels for those accounts for disclosures.”

If the AICPA changes its definition using PCAOB wording, the proposed GAAS definition would be: “Misstatements, including omissions, are considered to be material if there is substantial likelihood [emphasis added] that, individually or in the aggregate, they would influence the judgment of a reasonable user made on the basis of the financial statements.”

Among other things, the ASB must decide whether the definition of materiality under GAAS should use the language from the FASB’s definition or from the PCAOB’s definition. The task force working on the materiality project has recommended the PCAOB’s language because it comes closest to the Supreme Court wording. Moreover, it will eliminate differences between audits of public and private companies.

Setting the audit materiality threshold

Materiality is one of the gray areas in financial reporting. No matter how it’s defined in the auditing standards, there are no bright line rules. Instead, auditors must rely on their professional judgment to determine what’s material for each company, based on its size, industry, internal controls, financial performance and other factors. Contact us to discuss the appropriate materiality threshold for your next audit.  

©2019 THOMSON REUTERS

state income tax for businesses and individuals

Attendees will learn about state income tax issues relevant to Nebraska based businesses and their owners. This presentation, led by Russ Smith, includes a discussion of business income tax topics such as nexus, apportionment, composite filings, and nonresident withholding. Individual income tax topics include resident vs non-resident filings, the Nebraska Capital Gains Exclusion, and Nebraska’s treatment of income earned by S Corporations and LLC’s.