How Will SEC’s Newest Pay Disclosure Rule Shape Board Views of Executive and Company Performance?

On Aug. 24, 2022, the US Securities and Exchange Commission (SEC) voted 3 to 2 to pass a long-pending rule on “pay vs. performance.” While the rule’s title may seem like old news, the new requirements in the rule could cause boards and CEOs themselves to see performance in new ways.

Paying for Performance Is Not New 

In some respects, the new rule, which was first proposed in 2015 in the aftermath of Dodd-Frank, is old hat. Public company directors today already understand that they should pay CEOs and senior executives based on their performance. In fact, this has been the case for at least 30 years, ever since the 1992 rule (published in 1993) requiring public companies to report their CEO’s compensation for the most recent fiscal year, as well as the “relationship between executive compensation and the registrant’s performance.”

Directors also know full well the importance of explaining the pay-for-performance link to investors. Consider the 2006 rule that required a compensation discussion and analysis and compensation tables in the proxy statement, and the 2011 rule that required companies to obtain shareholder approval of executive pay plans in a precatory (nonbinding) shareholder vote called “say on pay.”

What Is New in the Rule?

With all these pay-for-performance disclosure rules already in place, what is new here? A comprehensive explanation is beyond the scope of this brief blog, but here are two important changes:

First, whereas in the past, companies had some discretion in defining performance, now they are given an absolute requirement to disclose comparative data on cumulative total shareholder return (TSR).*

Second, and arguably most valuably, the new rule will cause companies to clarify their own definitions of performance. During the original comment period in 2015 and the renewed comment period in 2022, a number of commenters, including NACD, objected to emphasis on TSR as the most important measure of performance. (NACD’s comments sent in 2015 and 2022 are cited 18 times in the rule.) Accordingly, the final rule states the following (p. 77): “To address commenters’ concerns with respect to the proposal to use TSR and peer group TSR as the sole measures of performance (such as causing companies to adjust their compensation programs to more heavily rely on TSR), we are also requiring registrants to include net income and a Company-Selected Measure as performance measures in the tabular disclosure, and also permitting companies to voluntarily include additional measures of their choosing in the table, as suggested by some commenters.” (Emphasis added.) 

In the end, the final rule has combined the originally proposed TSR disclosures plus others that critics suggested. As explained in the SEC press release of August 25, companies must now provide a table showing “specified executive compensation and financial performance measures” for the most recent five years for the company, showing total shareholder return (TSR), the TSR of peers, company net income, and a financial performance measure chosen by the company. The rule defines financial performance measures as “measures that are determined and presented in accordance with the accounting principles used in preparing the issuer’s financial statements, any measures that are derived wholly or in part from such measures, and stock price and total shareholder return.” (p. 86, footnote 336).  

Importantly, companies will also “list of at least three, and up to seven, financial performance measures,” which “represent the most important financial performance measures” the company uses to pay its  executive officers (p. 224). This requirement, reflecting views of NACD and others, shows that the SEC is willing to take a flexible approach to performance. The release even says that companies are permitted to “include nonfinancial performance measures in that list” (p. 88)—something NACD had advocated.

The new rule will obviously add to the disclosure burdens of public companies, but this burden is something they have always born with the help of expert staff and advisors. The real risk the rule proposes is the possibility that boards will judge CEO and senior executive performance based on TSR alone rather than based on the drivers of TSR as captured in other metrics. Boards should use the new rule as a tool for broadening, not narrowing, their appreciation of executive and company performance. With a possible new rule on executive clawbacks around the corner (thanks to a reopened comment periods), renewed attention to performance measures has become all the more important.

Alexandra R. Lajoux is the chief knowledge officer emeritus at NACD.

*Note: Cumulative TSR is defined in the original 2015 proposed rule release, which states that “cumulative total shareholder return is calculated by ‘dividing the (i) sum of (A) the cumulative amount of dividends for the measurement period, assuming dividend reinvestment, and (B) the difference between the registrant’s share price at the end and the beginning of the measurement period; by (ii) the share price at the beginning of the measurement period,’” per p. 45, footnote 85 of the proposed rule, citing The Code of Federal Regulations.

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NACD Rings Nasdaq Closing Bell to Celebrate 1,000 Certified Directors

The NACD Directorship Certification® program reached the milestone of 1,000 certified directors this summer. To commemorate the occasion, NACD leaders and certified directors rang the Nasdaq Stock Market closing bell on Aug. 25, 2022.

President and CEO Peter Gleason was joined by Sue Cole, chair of the NACD board; Graeme Roustan, NACD Corporate Directors Institute board member; the NACD senior leadership team; and nearly 60 NACD Certified Directors as they rang the Nasdaq closing bell.

“Ringing the closing bell at Nasdaq is the perfect way to celebrate the strides NACD has taken to continue to educate and prepare corporate directors,” said Gleason. “The ceremony is a great way to commemorate the accomplishment of the first 1,000 NACD Certified Directors. We are honored to be joined by certified directors to ring the bell in celebration of their accomplishments and look forward to the continued growth of the program.”

NACD recognizes the 1,000 and growing certified directors across the United States and around the world that have committed to ensuring the highest standards of leadership in the boardroom. Launched in 2020, NACD Directorship Certification® is the nation’s first-of-its-kind certification for corporate directors and it sets a new standard for director education, positions directors to meet boardroom challenges, and is a way for directors to highlight their commitment to staying current on the latest information necessary to contribute effectively in the boardroom. It allows certified directors to demonstrate that they have a baseline understanding of the requisite knowledge and skills required of a board member, helps bolster investor trust and public confidence in boards with certified directors, and enhances the talent pool for public boards by recognizing individuals who have committed to continuous learning.

NACD members that have achieved certification are directors of Fortune 500 companies, private businesses, and nonprofit organizations. These NACD Certified Directors represent leading boards such as those of Advanced Micro Devices, Cigna, Foot Locker, Morgan Stanley, and Nasdaq and nonprofits such as the American Heart Association, the American Cancer Society, and AARP. The official 1,000th certified director is Philip D. Amoa, managing partner in the Philadelphia office at McCarter & English, board member of the NACD Philadelphia Chapter, and a former board member at the Board of Pensions of the Presbyterian Church, which was a winner of the 2020 NACD NXT Awards.

“NACD is thrilled to celebrate this first group of 1,000 leaders who have taken action to better prepare themselves for board director roles, and we look forward to seeing the certification program continue to elevate both experienced and newer directors,” said Gleason. “NACD has defined the standard for director education in response to the convergence of a fast-moving, dynamic business environment with changing expectations for the board’s role. As the scope and pace of change in demands continue to grow, it is more important than ever that directors are prepared and continually educating themselves on issues and trends. The certification program is all about enabling directors to lead with the highest standards of governance.”

The NACD Directorship Certification® program begins with director education courses and events, followed by an exam to test potential certified directors’ knowledge. Then, certified directors must engage in continuing education and ongoing learning through NACD and NACD Education Network events and offerings to earn a certain number of education credits every two years.

“All corporate directors need continuing education to provide effective board leadership. NACD’s Directorship Certification is the benchmark for corporate governance and a great tool for director development. Certification has helped me increase my value in the boardroom, including through strengthening investor trust and keeping me updated on the emerging issues and trends impacting the companies I serve,” said Amoa.

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How Resilient Is Your Business to Nature Loss?

The consequences of environmental degradation on businesses are wide-ranging. Not only does extreme biodiversity loss, widespread pollution, and the overconsumption of natural resources present direct challenges for key industries, but they also exacerbate critical challenges associated with climate change, societal health, supply chain reliability, and food security that are experienced across economies and societies. Boards of directors will need to ensure that their organizations have a nature-risk strategy to navigate changing regulations, manage complex interdependencies, and take advantage of emerging opportunities from new technologies and more efficient business processes. The imperative is to increase resilience to nature risks and help to reverse nature loss.

Nature loss is not a recent issue, and decades of regulation and technological advancements have led to some changes but have not reversed the global trend of deteriorating ecosystems.

In particular, the complex interactions between environmental degradation and climate change threaten to edge us closer to dangerous tipping points, with unpredictable, irreversible, and catastrophic ramifications. Many of the ecosystem services that humanity relies on are under pressure from climate change, while efforts to avoid even more dangerous levels of global warming rely heavily on functioning ecosystems to absorb carbon.   

Risk experts and leaders in business, government, and civil society surveyed by the World Economic Forum for the latest edition of the Global Risks Report 2022 identified “biodiversity loss and ecosystem collapse,” “human-made environmental damage,” and “climate action failure” among the top ten risks the world will face in the coming decade.

For businesses, these global issues translate into direct and indirect risks, with impacts on business models, value chains, investment portfolios, market strategies, and stakeholder relations.

Businesses should get ahead of the curve by taking a hard look at their risks and strategic responses. This will include reviewing the “double materiality” of risks—understanding how a business’s assets and operations impact nature and how in turn a business depends on nature. 

A growing number of global agreements, policies, and legislative steps are underway, and we can expect countries to eventually establish biodiversity and ecosystem targets on which to measure public policy and economic activities. The most recent example is the new “National Strategy to Reflect Natural Assets on America’s Balance Sheet,” announced by the White House in August.

However, nature loss is a complex area, and well-meaning policies and corporate initiatives can have unintended consequences. Greenwashing is a growing challenge, particularly in the absence of clear standards as to what reversing nature loss entails. In the near term, all of this will make for considerable policy and regulatory unpredictability as conflicting stakeholder pressures resolve into a coherent approach and new solutions emerge. 

Boards of directors need to show leadership by ensuring that their organizations are alert to these regulatory changes and that necessary steps are taken to embrace nature loss as a business risk and to reverse it as an opportunity. Below are four related steps boards can take:

Embed Nature in Internal Governance Processes

Organizations should embed nature-related risks into a dynamic resilience culture and ensure that current governance processes bring together all business functions relevant to nature risks, from operations to product design, risk management, and employee engagement. Boards of directors need to ensure that businesses consider nature as a key component of their companies’ wider environmental, social, and governance (ESG) and environmental resources management strategies.

Assess, Disclose, and Act on Risks and Opportunities

Businesses need to take advantage of better data and improved analytics to increase resilience and capitalize on new growth opportunities. Building on the adage that what gets measured gets managed, various methodologies and tools are being developed to assess and help reduce environmental degradation. One key development is the launch of the Taskforce on Nature-related Financial Disclosures (TNFD). Established in 2021, TNFD aims to redirect financial flows to nature-positive outcomes by developing a cross-industry framework for organizations to assess, report, and act on nature-related risks and opportunities. TNFD is rapidly emerging as the standard for nature disclosures. Early engagement gives businesses a chance to learn and shape the emerging framework.

Embrace Market Opportunities

A shift to nature-positive outcomes requires significant investments and changes in the flow of capital. Markets were for a long time “blissfully ignorant” but are now increasingly seen as part of the solution, with a range of innovative approaches being piloted by corporations, investors, and the public sector. One example is the world’s first sovereign blue bond issued by the Republic of Seychelles to support sustainable marine and fisheries projects in the country. Another example is a green water bond set up by DC Water to secure funding for the delivery of green infrastructure to improve water quality in Washington DC. In particular the market for carbon credits has seen significant growth, with landowners starting to trade ecosystem services such as carbon offsets through their forests. However, while an increase in natural carbon sinks such as forests or peatlands is essential to fighting climate change, this should be considered complementary but not an alternative to radical reductions in fossil fuel emissions.

New financial instruments are being tested, aimed at regenerating coral reefs and mangroves for coastal storm protection. Financial stakeholders are already involved in nature-related initiatives such as Finance for Biodiversity and more capital will move into new ventures aimed at transforming business models to be actively nature-positive. Nature has emerged as a new focus for investors actively looking to demonstrate the mutually beneficial social, economic, and environmental possibilities of their investments. It is an imperative for senior leaders and those developing nature-positive strategies to understand the requirements, risks, and dynamics of these markets and to evaluate how this can provide capital for their own nature-positive transition.

Seek Wider Partnership and Engagement

Boards need to ensure that companies are engaging across stakeholders to build trust. There is a growing expectation from employees, customers, business partners, regulators, and policy makers that businesses adapt their strategies to help reduce nature loss. Businesses can use these relationships to help challenge themselves about blind spots and shortcomings and avoid the danger of greenwashing. They will likely find that nature-risk resilience efforts align well with other agendas, such as ESG ambitions and operational resilience.

Reversing nature-loss is imperative from a corporate resilience and risk management perspective and, if done early and smartly, can translate into significant new business opportunities. Accelerating environmental degradation makes this shift more urgent, but organizations will have to navigate complexities and uncertainties. The interdependencies between nature and business are dynamic and wide-ranging and it is hard to predict the speed of transition, persistence of political will, fluctuations of consumer sentiments, and regulatory effectiveness.

Boards of directors across sectors and geographies should embrace this new business imperative and all the complexities and challenges that come with it and put it firmly on the corporate agenda.

Swenja Surminski is the managing director of climate and sustainability for the Marsh McLennan Advantage Insights team.

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Landing the Deal: The Human Factor

Realizing the value of a merger or acquisition is an exercise in complexity. In the past, dealmakers have rightfully focused on value drivers such as retention of important customers and suppliers and integration of critical operations, but one element that today’s boards of directors may neglect is the human side of a deal. It’s an aspect that can sink a deal if mishandled, especially with the unprecedented dynamics of today’s workforce.

Many companies are feeling the pinch from the current talent gap, resulting from new, pandemic-era employee expectations and a glut of openings in the job market, and boards understand how the situation is affecting the hiring and retention of top leaders. Now, that gap has moved organization-wide.

Going forward, boards who want to ensure that their deals will succeed long-term should elevate both pre-deal and post-deal activities that aim to optimize the human elements of a combined organization.

Here are five actions to ensure that your next deal doesn’t miss the human side of mergers and acquisitions (M&A).

Do Your Human Capital Due Diligence

The key to a successful transaction in today’s environment is to conduct due diligence on the people and cultures of both companies with as much rigor as you would on finance or operations.

There must be a heavier focus on people across the organizations. While holding on to top leadership is vital post-deal, many people in technical roles throughout the companies are also flight risks during the transition. Research from the MIT Sloan School of Management found that 33 percent of acquired employees left after one year.

To mitigate risk, dealmakers must consider the real cost of employee turnover in the target company. Who are the critical people at all levels that could head for the door? What are the replacement and onboarding costs to get back to full staff? Just as the cost of turnover will vary across job families and leadership levels, so, too, should the board oversight of plans to mitigate key people risks.

In addition, certain circumstances may create an inherent liability. Acquiring entrepreneur-led companies, for instance, can create a serious challenge for retention. Remove the entrepreneur from the company and, in some cases, you’re removing one of the strongest retention levers. Without the founder, many people will leave to find another start-up or growth company.

The key here is honestly appraising the human value-drivers and risks for the deal. It is the board’s responsibility to ensure its executive team is applying the proper scrutiny.

Remove Acquirer’s Bias in the Deal

Acquirer’s bias often has been a default of the subconscious integration mindset in the past. It assumes that processes, roles, and corporate culture of the acquiring company will subsume the new entity.

This may still be true for some of the more system, process, or technical aspects of integration. But if you apply this thinking across the board to the human beings involved, you have a decent chance of all layers of integration failing. Boards should be pressure-testing this bias by asking: How will assimilation to our culture erode the competitive advantages we’re paying for? Are there elements of the target’s culture we should be assimilating, too? Are there leaders at the target who are better positioned to take the combined entity to the next level?

Here’s a simplified scenario where bias hinders integration: Imagine that a large company with strict vacation rules acquires a Silicon Valley darling with unlimited vacation time policies. If the acquiring company imposes its vacation policies on the acquired company, where do you think the new talent will go once the deal is done? The cost of maintaining or extending the target’s approach to vacation time could be a win-win for everyone with little incremental cost.

Know the Difference Between Acquirer and Target Employee Deals

Each company has its own established employee deal—a stated or unwritten agreement between the organization and its talent. These employee expectations usually involve the company’s brand attractiveness, culture, professional development structures, decision-making authority, promotion navigation rules, leadership access and alignment, and total rewards to the employees.

Leaders should evaluate each area of employee deals from both companies and identify the areas with the largest cultural gaps to design the optimal future state of the new company.

Too often, boards and executive teams fall prey to the “deal honeymoon,” inflating commonalities or synergies while downplaying or ignoring potential risks. The excitement of a deal can easily “rose-color” critical differences in leadership style, decision-making approach, pace of career development, or overarching company culture.

Ultimately, the best approach is to optimize a combined, future-state employee deal, accompanied by an appropriate plan to communicate the vision at launch and beyond. Six months in, if employees are wondering “What’s in it for me?” then your company will be facing retention risk at all levels.

Remember That It’s Never Too Early—or Too Late—to Start Your People Due Diligence

It’s never too early to design what you want the business to be before you get hooked on the lure of the deal. Dealmakers often get overly excited about acquiring the shiny new company and forget the culture and people aspects. Leaders must become self-aware of the impact and complexity of merging cultures.

That said, it’s never too late to address the human side of the transaction. Already well into deal-planning or integration? Don’t despair. Even late in the game, the board can influence critical changes to human elements that will improve change leadership, reduce turnover, and ultimately better support the objectives of the merger or acquisition. And this pivot doesn’t have to dramatically impact timelines.

For example, we worked with a board to implement a short pause in integration planning to execute a sprint evaluation of critical people and culture value-drivers. Just two weeks later, the integration management team was back at work, with critical changes in place to address people risks.

Stay in the Game for All Four Quarters

Most leaders are focused on the first 100 days, but talent is the long game. Boards should maintain adequate oversight of organization and people workstreams beyond the initial months following a change in control, and sometimes for up to two years after the deal closes.

Communication is critical during this timeframe. Leaders should focus on expectation-setting across key people topics. Employees want to know that there are plans for professional development, as well as for promotions and rewards, and they want to know when to expect those events to happen in their careers. Boards play an important role in coaching executive teams to stay the course, carefully tracking to established retention milestones at the 6-month, 12-month, and 24-month timeframes.

Yes, It Is About the People

With today’s real talent gap, the value of most deals won’t originate solely from a bundle of processes and assets. In addition to traditional focus areas, the human aspect of a deal can drive, or put at risk, a considerable portion of expected value. Failing to focus on people and culture during M&A activity can drive loss of top talent and slow value capture.

To avoid this, boards must remind their deal teams that it is all about the people and provide the right oversight to address the human-side of the deal to ensure long-term success.

Matt Campbell is a managing director with Alvarez & Marsal’s Corporate Performance Improvement practice in New York and serves as leader of the group’s Talent, Organization, and People practice. 

Colin Harvey is a managing director with Alvarez & Marsal’s Corporate Performance Improvement practice in Austin and the national solution leader for the group’s Corporate M&A Services.

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SEC Cyber-Risk Governance and Its Boardroom Business Resilience Implications

Earlier this year the US Securities and Exchange Commission (SEC) released proposed cybersecurity disclosure rules to advance risk management and governance regarding cyber risk. To quote the SEC, “The Securities and Exchange Commission… is proposing rules to enhance and standardize disclosures regarding cybersecurity risk management, strategy, governance, and cybersecurity incident reporting by public companies that are subject to the reporting requirements of the Securities Exchange Act of 1934. Specifically, we are proposing amendments to require current reporting about material cybersecurity incidents. We are also proposing to require periodic disclosures about a registrant’s policies and procedures to identify and manage cybersecurity risks, management’s role in implementing cybersecurity policies and procedures, and the board of directors’ cybersecurity expertise, if any, and its oversight of cybersecurity risk.”

These recent developments heighten attention to the management and disclosure of cyber risks and incidents by public companies. They also underscore the importance of advancing risk management and governance efforts across the boardroom community that ensure resources and investments are applied to those cyber risks that have the most material financial, business, and operational impact. 

Below, recent SEC developments and what they mean for board directors, ways companies can prepare while they wait for the specifics of the expected SEC cybersecurity rule, and how companies can contextualize cyber risks and incidents with business, financial, and operational impact are discussed.

Focus on Resilience and Financially Aligned Cyber-Risk Investments

As cyber threats advance, companies worldwide are bolstering their cybersecurity budgets. Meanwhile the regulatory community, including the SEC, is advancing new requirements for companies to effectively manage and govern cyber risk. For companies, this requires significant investments to reduce cyber risk while maintaining a compliant cybersecurity program. Given the rate of cyber losses, it is more critical than ever that clear and effective strategies are established to counterattack the impacts of cyber risk. Clarifying cyber-risk engagement in the boardroom is the first step.

Effective communication is a cornerstone of positive outcomes in business. Developing a common language for discussing the complex issues of cyber risk is essential to achieving business resilience. This requires simplifying confusing, technical discussions loaded with nuanced security terms into precise economic analysis that shows how cyberattacks endanger organizations financially in the short and long term.

Building resiliency in an organization requires proper oversight from the boardroom based on a clear plan built on business and economic analysis. Industries such as insurance are basing cyber-risk evaluations in their underwriting standards on established and understandable financial exposure analyses. In doing so, insurance industry players are shifting the cyber conversation from a highly technical and ambiguous security one to one where businesses can understand and effectively manage their financial exposure in relatable business terms. If financial exposures from cyber threats are clear, boards will find it easier to align cybersecurity strategies with economic cyber-risk metrics.

Developing the organization’s cyber-risk appetite levels in financial terms, based on its unique risk profile, and defining effective remediation and mitigation steps to reduce financial exposure are important initial steps when planning for cyber resiliency. Boards should keep certain items on the cyber resiliency agenda in their discussions with management. On an ongoing basis, the board should keep abreast of how management uses return-on-investment analysis to align the cybersecurity budget to financial exposure reduction. So, too, should boards oversee the steps that are taken to practically implement the cybersecurity strategy.

When formulating their companies’ cyber resiliency plans, boards would do well to ask management questions such as the following:

What is our financial exposure to cyber threats?What cyber threats are most likely to have a major financial impact on our business?How much financial exposure are we willing to accept across our enterprise and digital supplier ecosystem?How can we align our budget, implement controls, and optimize risk transfers to address our cyber-risk exposure?Are our digital initiatives being developed in a cyber-resilient way?

Board Level Governance and Risk Management Disclosure

As per the proposed SEC cyber rules, companies are now required to disclose the substance and nature of board oversight of a registrant’s cyber risk, the inclusion and exclusion of management from the oversight of cyber risks, and how the implementation of related policies, procedures, and strategies impacts an investor’s ability to understand how a registrant prepares for, prevents, or responds to cybersecurity incidents. Moreover, companies are required to disclose their cybersecurity governance capabilities, including the board’s oversight of cyber risk, a description of management’s role in assessing and managing cyber risks, the relevant expertise of such management, and management’s role in implementing the registrant’s cybersecurity policies, procedures, and strategies. Specifically, where pertinent to board oversight, registrants are required to disclose:

whether the entire board, a specific board member, or a board committee is responsible for the oversight of cyber risks,the processes by which the board is informed about cyber risks, and the frequency of its discussions on this topic, andwhether and how the board or specified board committee considers cyber risks as part of its business strategy, risk management, and financial oversight.

Formulating and implementing cyber resiliency plans, focusing on aligning these plans with financial exposures, and understanding how the board and management effectively oversee cyber risk and can improve will help any board prepare for SEC rules likely to come.

Chris Hetner served as the senior cybersecurity advisor to SEC chairs White and Clayton and currently is a senior advisor at The Chertoff Group, a special advisor for cyber risk at NACD, and a member of the NASDAQ Center for Board Excellence Insights Council.

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