The real story: public companies and boards that have redesigned or are redesigning incentive programs should be asking: "how is 'performance' defined, and how does it to pertain to the company and its executives?"--particularly so due to the risk of a negative "say-on-pay" vote.

• Author: Reda, James F.
• Position: COMPENSATION

Many public companies are redesigning or have redesigned their incentive programs to ensure a link between performance achievement for the company and executive and performance achievement for shareholders. A disconnect stemming from faulty incentive design could expose an executive and the board of directors to unwelcome scrutiny from shareholders and the public, in addition to the risk of a negative say-on-pay recommendation and vote.

That raises a critical question: "What is 'performance' and how does it apply to executives and the company?"

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It has been more than a year since the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law. While Dodd-Frank includes several provisions that im pact executive compensation, only "say on pay" and "say when on pay" have been implemented. The U.S.Securities and Exchange Commission has yet toissue proposed rules for the other executive compensation sections, such as the pay-forperformance analysis and CEO pay relative to the median of annual total compensation of all other employees.

These new rules are in addition to the SEC rules regarding disclosure of performance measures and target levels, and the impact of risk on executive compensation plans and programs that became requirements in the previous few years.

In 2011, the inaugural year for say on pay and say when on pay, just 42 companies as of October 2011 had failed to receive majority shareholder support. For almost all of these companies, the primary reason was a perceived disconnect between pay and performance (initially by Institutional Shareholder Services (ISS) and ratified by shareholders' vote).

With say on pay a reality, improving disclosure of measures used, the values associated with those measures and how they can be expected to drive performance should be a priority for all public companies. The SEC requires that in their annual proxies, companies disclose the specifics of their executive compensation policies in clear language for investors.

This requirement developed from the assertion by the SEC that if executive compensation performance targets are central to a company's decision-making process, these targets must be disclosed to investors.

Once companies get beyond the difficulties of designing executive programs that adequately balance pay versus performance, they then have the added pressure of clearly explaining their pay-for-performance formula to investors.

There are four broad issues for publicly traded companies relating to performance-based compensation:

* Selection of short- and long-term performance measures that have been approved by shareholders (i.e., contained in incentive and equity plans);

* Adequate disclosure of performance goals (measures and levels) in the proxy filing;

* Review of the risk associated...