The board, the proxy, and executive pay.

• Author: Lederer, Jack L.
• Position: Executive compensation

The new SEC rules provide an opportunity for the board to communicate its philosophy and objectives. But care must be taken in exercising this freedom.

Executive compensation now is a communications issue. When the Securities and Exchange Commission adopted new regulations on disclosure of executive compensation, pay moved into a new arena. For corporate boards of directors, of course, executive pay remains a key motivational tool. However, it now has become a vehicle for communicating a board's philosophy and objectives.

By now, most members of corporate compensation committees have read the SEC's new rules requiring addition of a variety of information to proxy statements. However, the rules give compensation committees numerous options. The wrong choice easily could give shareholders the wrong impression about a board.

For example, the SEC says a company now has some latitude in selecting which employees are listed as the five highest paid. Of course, the chief executive officer must be listed. However, expatriate pay earned by a non-CEO officer need not be included in calculations to determine the other four.

As well, if an officer's pay jumped substantially in the previous three years because of job promotions, it would be wise to add an explanatory footnote. Without the footnote, which is not required, it might appear that a company has approved rather unusual pay hikes.

Another place ripe for communicating incorrect impressions to shareholders is in the new section on options. The SEC provides three alternatives for disclosing the value of options. The wrong choice, particularly if an executive is granted a substantial number of options, can invite unnecessary -- and unfounded -- criticism.

Under one option, a proxy must list the future gain from the option grant assuming exercise on the expiration date and compound annual stock price growth rates of 5% and 10% per year (also 0% if the exercise price was below market on the date of the grant). This alternative may greatly overstate the likely value of the options, particularly if the 5% and 10% annual stock price growth rates bear little resemblance to historical or expected future performance.

Most institutional shareholders now believe that calculation of potential realizable value in future value terms is fundamentally misleading. In addition, these sophisticated shareholders also recognize that most options are exercised prior to the expiration date.

Another choice for this...