Changes Reporting Rule on Bosses’ Pay
By Floyd Norris
New York Times
Wednesday, December 27, 2006
The Securities and Exchange Commission, in a move announced
late on the last business day before Christmas, reversed a
decision it had made in July and adopted a rule that would
allow many companies to report significantly lower total
compensation for top executives.
The change in the way grants of stock options are to be
explained to investors is a victory for corporations that
had opposed the rule when it was issued in July, and a
defeat for institutional investors that had backed the SEC’s
“It was a holiday present to corporate America,” Ann Yerger,
the executive director of the Council of Institutional
Investors, said yesterday. “It will certainly make the
numbers look smaller in 2007 than they would otherwise have
Christopher Cox, the commission chairman, said yesterday
that he viewed the decision as “a relative technicality”
that improved the rule. When the rule was adopted in July,
Mr. Cox said it was aimed at providing information that
would allow shareholders to “make better decisions about the
appropriate amount to pay the men and women entrusted with
running their companies.”
In announcing the new rule on Friday, he said “the new
disclosure requirements will be easier for companies to
prepare and for investors to understand.”
As controversy has grown over rising executive pay, it has
been hard to even get agreement on the total value of
compensation for top executives. The rules passed last
summer required companies to disclose more information and
to compile it in a summary compensation table that is
expected to become the standard by which corporate pay is
The new rule changes the way grants of stock options will be
measured in that summary table.
Under the old rule, if a company awarded an options grant
valued at $15 million to an executive this year, the full
amount of $15 million would show up in the summary
Under the new rule, which takes effect immediately, the
amount reflected in the table would be much smaller, with
the remaining part of the $15 million included in later
years, as the executive qualifies to exercise the options.
Under some circumstances, the options grant might not be
reported at all in the first year, even if the executive
would otherwise have been the company’s highest paid
executive had the full value of the option grant been
The new rule is intended to make the disclosures identical
to the way companies report options expenses in their
financial statements, under accounting standard 123R, as
approved by the Financial Accounting Standards Board.
In an interview yesterday, Mr. Cox said the change reflected
what the commission had intended to do when it adopted the
original rule in July. “My understanding all along was that
we were going to follow the 123R model,” he said. “It came
out differently from that when we adopted it.”
The fact it came out differently was disclosed by the SEC at
the time. The commission pointed out that some companies
had wanted to time the disclosures in accordance with the
accounting rule, but said the other approach “is more
consistent with the purpose of executive compensation
But on Friday, the SEC said it now believed that the change
would provide “a fuller and more useful picture of executive
compensation than our recently adopted rules.”
While practices vary, stock options often vest — meaning
they may be exercised — over a period of three to five years
after they are granted. The options can be canceled if the
employee leaves the company before they vest.
For most executives, the accounting rule says the expense
should be spread over the period from the grant to full
vesting. So if options vest over five years, the expense
would be reported over that period.
In the $15 million example, if the options vested over a
five-year period, the summary compensation table would
reflect a cost of $3 million per year. In the first year,
the cost might be lower if the options were issued
relatively late in the year, and could be almost nothing if
they were issued just before the end of the company’s fiscal
But the new rule could create confusion because it would
treat options issued to some executives — those eligible for
retirement — differently.
If an executive were eligible to retire when the option was
granted, and could keep the option if he or she did retire,
then the entire option grant would be expensed immediately
and listed in the summary table in the year it was granted.
But if the executive is not eligible for retirement, then
the expense is spread out over the several years it takes
for the options to vest.
That makes it possible that two executives with identical
pay packages would have very different disclosures, making
the one eligible for retirement seem to be much better
compensated. “This will muddy the waters,” Ms. Yerger said.
Asked about that, Mr. Cox conceded it was an anomaly. But
he said there were anomalies under the other rule as well.
John White, the director of the commission’s division of
corporation finance, pointed to the fact that the rule
adopted in July could lead to reporting of compensation that
would never be received.
“The anomaly that the commission was most concerned with was
that if an executive leaves the company before the options
vest, the full amount of the option still was reported in
compensation disclosure when, in fact, nothing was
received,” said Mr. White, who became director of the
division in March, after the previous rules were proposed
but before they were adopted.
He said that some companies issued options that had
so-called cliff-vesting, in which all options vested after
five years, and were forfeited if the executive left before
that time. Under the new rule, expenses would still be
reported for the first years, but then a negative amount
would be reported in the year the executive left, reversing
the earlier reported figures. There was no such reversal in
the July rules.
The commission adopted the new rule in an unusual way,
making it take effect immediately even though the commission
had not announced that it was considering a change and had
not sought public comment.
An SEC spokesman pointed to two other rules adopted that
way in recent years. Both were intended to comply with new
federal laws that were about to take effect.
One, in 2000, stated that e-mail messages from mutual funds
could satisfy rules requiring that information be given to
customers in writing. The other, in 2001, established rules
for complying with the Gramm-Leach-Bliley Act allowing
mergers of financial companies.
Mr. Cox said there was no time to seek comment if the change
announced Friday was to take effect in time to affect
proxies issued in coming months. He said it would be
confusing if companies reported one way in 2007 and then
changed in 2008.
The rules adopted in July were intended to deal with
widespread complaints that it was difficult to discover all
elements of pay packages for top executives. Besides
providing the summary table, the disclosures will provide
new information in a number of areas, including retirement
The disclosures will be made for a company’s chief
executive, chief financial officer and the three other
highest paid executives, as indicated by the summary table.
For those on the list, all option grants will be disclosed,
so even if the summary table leaves out much of the value of
options granted to a chief executive, investors could see
the terms of the grant and consider it in assessing how well
the executive was paid.
Under the July rule, a large options grant to an executive
could propel him or her onto the disclosure list. But under
the rule adopted Friday, such a grant might not put the
executive in that group, meaning there would be no
disclosure of that executive’s pay that year.
Over time, of course, most executives whose pay is being
disclosed would have the same total reported under either
rule. Under the new rule, options that were granted in
prior years, but vested in 2006, will show up in next
The reduction in reported pay is likely to be the largest at
companies that accelerated the vesting of options in 2005 to
avoid reporting them as an expense at all when the new
accounting rule went into effect. Executives at those
companies will not have as many old options vesting as they
normally would have, and thus will be able to report lower
The commission said it would take public comments on the
latest change for 30 days, but it added that the new rules
were now final.
When the commission considered the issue earlier this year,
David C. Chavern, a vice president of the United States
Chamber of Commerce, urged it to take the step it rejected
in July and adopted on Friday, saying that to do otherwise
would overstate compensation, since options would not have
been earned when they were reported, and might later be
Whenever the value of the options shows up in the summary
table, the value shown will be the estimated value of the
option at the time it was granted. Years later, when the
options vest, the stock price could be much higher or lower
than it was when the option was issued, making the options
much more valuable — or all but worthless — by the time they
show up in the summary compensation table at the old value.