The Council of Institutional Investors filed a petition Monday with the Securities and Exchange Commission urging the agency to require public companies to explain in their proxy statements why and how non-standard metrics are used to determine CEO pay.
CII has heard complaints from asset owners and managers about the complexity in executive pay, Executive Director Ken Bertsch said in a call with reporters Monday. Robert Pozen, senior lecturer at the MIT Sloan School of Management and a senior fellow at the Brookings Institution, who was also on the call, said 60% to 80% of companies are not using generally accepted accounting principles in setting executive compensation.
"It used to be case that non-GAAP metrics were the exception in compensation committee reports but now they've become the rule," said Mr. Pozen, who co-authored an op-ed in the Wall Street Journal on the topic earlier this month with SEC Commission Robert Jackson Jr.
Many companies are tying executive pay to "adjusted" earnings that overstate performance as measured by GAAP metrics, without clear definition and explanation of the measures used, CII said in its petition. Firms in the S&P 500 that announced adjusted earnings were, on average, 23% higher than GAAP earnings, according to research co-authored by Mr. Pozen.
While the SEC has strict regulations on the use of non-GAAP metrics and in reconciliation of those measures to GAAP in the earnings releases and most reports that public companies must file with the regulator, the compensation discussion and analysis section of a proxy statement is exempt, Mr. Bertsch noted.
In its petition, CII is asking for the CD&A section exemption to be removed and for companies to be required to explain why they are using any non-GAAP metrics in setting executive compensation and provide a quantitative reconciliation of such metrics to their GAAP financials.
"All we are asking (for) today is clarity on the adjustments, (and) that there be transparency so that the shareholders can easily understand and see the impact of an adjustment," Mr. Bertsch said.
CII is not asking the SEC to ban companies from using non-GAAP financial measures to determine compensation, Mr. Bertsch noted. There can be valid reasons to use adjusted earnings or other measures to assess performance, Mr. Pozen added, including after a merger when there could be significant differences between GAAP and what the company thinks its core operating earnings are.
"Sometimes there are legitimate reasons ... but it's hard to tell unless you have a quantitative reconciliation and a good explanation about what exactly is happening," Mr. Pozen said.