What's next in corporate pay practices? An enhanced role for compensation committees and a hard look at stock options are in the offing.

Author:Dennis, Anita

EXECUTIVE SUMMARY

* RECENT SCANDALS HAVE CREATED A PUBLIC perception that corporate executives are putting their own interests ahead of shareholders' concerns. While the Sarbanes-Oxley Act of 2002 does not directly mandate changes in compensation methods beyond placing restrictions on personal loans to executives, its emphasis on corporate governance has been a catalyst for public companies to reexamine how they pay their top executives.

* IT'S NOW UP TO COMPANIES TO REVISE THEIR pay methods with CPAs' assistance. On a practical level, greater duties for board compensation committees and a reconsideration of companies' use of stock options will have the greatest impact on how companies compensate their executives.

* FOR COMPENSATION COMMITTEES SEEKING GUIDANCE on how to begin, CPAs can recommend a list of best practices developed late in 2003 by the National Association of Corporate Directors' blue ribbon commission on executive compensation. Executive Compensation and the Role of the Compensation Committee suggests compensation committees maintain their independence, create fair pay packages, focus on long-term shareholder value, link pay to performance and encourage transparency.

* CPAs CAN HELP COMPENSATION COMMITTEES CAREFULLY examine how stock options should fit into the mix. Option grants became less appealing after the market boom ended. They also were perceived as encouraging executives to focus on short-term results that would cause a temporary stock surge and raise the option value just in time for exercise. FASB has introduced mandatory expensing of stock options, which may diminish their appeal for some companies.

In a speech last fall, PCAOB Chairman William McDonough said many members of Congress had asked him whether he could "figure out a way they could pass a law controlling compensation." In expressing his doubts to the National Association of Corporate Directors annual corporate governance conference, McDonough said he didn't believe any one law could fit each company's unique situation, though "that doesn't mean that one won't get passed if the American people stay angry enough."

Regulators and Congress have begun to scrutinize how public companies pay their executives; the subject remains a sore spot for investors as well. "Something has gone wrong with executive compensation in the United States," Sean Harrigan, president of the California Public Employees' Retirement System--the country's largest public pension system and a powerful institutional investor--told Congress last year. Harrigan said it was "shocking" to see top corporate executives insulating themselves from any risk while shareholders are losing value.

This article identifies some of the key concerns on which CPAs--in their capacity as CFOs, human resources professionals, financial managers or consultants--can advise companies as they seek to revise their pay practices. CPAs also can offer important advice on tax, financial reporting and compensation issues. In addition, the information in this article will be helpful to the CPAs who, because of their financial expertise, are increasingly being asked to serve on corporate boards (see "CPAs as Audit Committee Members," JofA, Sep.03, page 32).

THE CPA's ROLE

"CPAs employed by companies can take a proactive role in advising their hoards on compensation practices," says Roselyn Morris, CPA, associate dean of the McCoy School of Business Administration, Texas State University at San Marcos. Depending on the CPA's position, "this may even be part of his or her job." A CFO, for example, could offer advice and opinions when dealing with the board and other executives. CPAs in other areas of the organization not directly involved in compensation can direct governance issues, shareholder advocacy concerns and other questions to the company's ethics hot line.

For CPAs seeking to guide employers or clients through the compensation minefield, Morris says openness will be a key concern. "Today, a company wants to be more transparent rather than less," she says. That may mean going beyond minimum disclosure rules to consider what information an investor might want. For example, from a financial reporting standpoint, "in an audit, if something is not material, you don't have to be transparent." But, Morris notes, "what may not be material to a company may be material to creditors and investors. If you're doubling someone's salary and paying them $1 million in cash and $1 million in stock options, I don't care if it's immaterial to General Motors. If you don't tell investors or creditors about it, they feel you're playing games with them." CPAs can help companies understand the value of exceeding basic requirements to satisfy creditor and investor concerns. "Even if it's possible to avoid disclosure, you may want to do so anyway," she says.

In working with or serving on compensation committees, CPAs are in an excellent position to help the committee understand various pay options. On some committees not all members will be familiar with different pay strategies, so CPAs can help fill the gaps in their knowledge. CPAs also can offer valuable perspective--for example, ERISA laws prohibit companies from offering executives benefits packages that are unavailable to other employees. "Compensation committees need to start asking whether they would be willing to pay all their employees the way they are paying top executives," Morris says. A CPA can provide the answers.

CPAs also can play a role based on their more traditional areas of expertise. They are in the best position to advise human resources executives and the board of directors on the financial reporting and tax implications of new...

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