Management compensation-both companies
Overview: Select two companies. They should have DEF14A or a similar filing on the SEC’s
website: sec.gov
For both companies that you selected, evaluate the extent to which accounting influence
management compensation of your companies.
For example, DESTINATION XL GROUP, INC, states that “The performance targets [for
the CEO] included Corporate targets (Sales and Adjusted EBITDA)…”
So, Sales is clearly is an accounting figure directly from the Income Statement. The other
figure is EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and it is
“Adjusted” for events that the compensation committee believes do not relate to management
performance. These amounts, Earnings, Interest, Taxes, Depreciation, and Amortization are
clearly accounting figures from the Income Statement. The committee excludes Interest,
Taxes, Depreciation, and Amortization from the Earnings when they decide how well the CEO
has performed. As an aside, it seems to me that the CEO can influence these amounts. The
CEO might well be able to raise capital through debt increasing interest and encourage
aggressive tax positions, but these decisions to increase interest or be aggressive with taxes
are not part of the CEO’s performance metric.
Background: The point of this project is to develop some knowledge about financial reporting and its
role in how compensation committees pay top management. This includes knowing what factors the
committee uses in deciding whether the management did a good job or not and what forms the pay
comes in (cash salary, cash bonus, options, restricted stock, other). Please inspect the report of the
compensation committee in the proxy statement for your company. The proxy may be available on
the website of the company. Alternatively, if you are looking at the SEC’s website, the form is titled,
“DEF14A, Other Definitive Proxy Material.”
The “Report of the compensation committee” will usually describe what they look at when deciding
how to reward management. This section might also be titled, “How executive pay levels are
determined.” Please read the report of the compensation committee carefully. There are two parts to
the project. The first is to describe all the data items that the committee uses to determine how to
compensate the executives. The second is to find out how much the CEO makes and what forms the
compensation takes.
When you find out what the compensation committee looks at to decide whether management did a
good job or not, describe whether (1) each data item is drawn from the financial statements, (2) is not
drawn from the financial statements, or (3) is an adjusted figure or hybrid based on financial
statement information but not the same as the reported information.
If the data item is drawn from financial statements, state which statement(s) is (are) involved. For
example, Net Income and Earnings Per Share are drawn from the Income Statement. If the
compensation committee using EPS to evaluate management, then state that, and note that the figure
is drawn from the Income Statement. If the data item does not come from a financial statement
provide a guess about where the information comes from. Include a breakdown of the components of
pay. For example, an executive that makes $1 million in salary, and a bonus of $4 million, and is
granted stock options valued at $5 million, makes a total of $10 million. The factors used to
determine bonuses, for example, would vary widely. Here are three examples of factors used:
Return on assets. This is usually some form of Income divided by Assets. This is drawn from
the accounting reports. The Income is taken from the Income Statement, and Assets is found on
The two companies are Carrier Global and Burger King
the Statement of Financial Position (the balance sheet). If the compensation committee adjusts
income, be certain to describe the adjustments. Typical adjustment would include the effect of
mergers, restructuring costs, restatements, or unusual items. Describe the probable effect of the
adjustments on income and the bonus.
For example, Pfizer uses a figure they call Adjusted Income. I would describe that amount as a
hybrid figure, with the accounting part being drawn from the income statement. They start with Net
Income, but they add to and subtract items from Net Income to arrive at the figure the
compensation committee uses
Increases in stock price. Financial statements do not record the increase in market price of
a company’s stock. This is not part of the basic financial statements, so it is not an
accounting item. Instead it is drawn from observing the market price on a traded exchange.
Required: The rubric describes the requirements that are due for each company. This is a
written project. I imagine that it can be completed in about three pages per company.
Last question is do the CEO/President of each company receive bonuses based on financial performances.
The exact rubric is
Rubric
Management Compensation Report for each company
Criteria Pts
State the name of the CEO 1 pts
State which accounting firm audits the financial statements.
There are four large accounting firms: PriceWaterhouseCoopers, Deliotte, KPMG, and Ernst and
Young. They audit most publicly traded companies, but not all.
1 pts
State the accounting firm’s opinion about the financial statements.
A clean opinion would be when the accounting firm states that the financial statements “fairly
present” the results in accordance to Generally Accepted Accounting Standards. Some companies
might use International Financial Reporting Standards
1 pts
State which standards the company uses to evaluate internal control over financial reporting
processes.
The most common would be the Internal Control–Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (2013 framework).
2 pts
State whether the management believes that the internal control has been effective. Sometimes
management will state that internal control had some deficiencies. 2 pts
State how the components of the CEO pay is divided.
(for example, salary, bonus, and long-term) 2 pts
State the reasons (the objective) the compensation committee gives for dividing the compensation in
the way they divide it.
Here's an example: [The compensation plan] balances short- and long-term objectives to focus our
executives on actions that create value today, while building for sustainable future success.
Approximately 90% of our pay is performance-based, directly tying a significant portion of executive
compensation to Company performance and shareholder returns. Our compensation program is
market-based (to ensure our ability to attract and retain talented executives) and produces
compensation outcomes that are performance-based (to incent the achievement of profitable growth
that increases shareholder value).
5 pts
State whether the compensation committee is composed of independent directors 2 pts
Did the compensation committee use an outside consultant to help set the compensation?
Typical consultants might be Meridian Compensation Partners, Pearl Meyer & Partners, Aon plc
(Radford), Longnecker & Associates, and Compensia, Inc
2 pts
Management Compensation Report for each company
Criteria Pts
For any salary component, state how the compensation committee determines the salary.
Examples: "approximately the median for comparable companies," "competitive with other
comparable executive officer salaries", "to attract high quality executive talent," "market
competitiveness, and the specific roles and responsibilities, experience, expertise and individual
performance throughout their tenure."
3 pts
For any performance component, state how the compensation committee determines the performance
component.
A company might have a short term incentive plan (a bonus) and a long term incentive plan.
3 pts
For any non-performance component, state how the compensation committee determines the
component.
The compensation committee may make equity awards to management that are not specifically tied to
performance. When the report states "make equity awards" they mean shares of stock. The awards
might be made with the intention of having management's personal wealth go up and down the same
way the investors' wealth goes up and down, helping them to identify with the shareholders.
2 pts
State whether accounting is used in any of the components to determine compensation.
Examples might include
Income Before Interest Taxes Depreciation and Amortization, IBITDA
Return on Assets
Adjusted Earnings Per Share
In these examples, the raw figures from the financial statements are used in an adjusted way. For
example, in IBITDA, the net income is a starting point, but a variety of expenses are deleted before
evaluating the CEO. Adjusted Earnings Per Share might start with EPS, but if a subsidiary was
acquired or sold off (or shares of stock issued or repurchased), the EPS might be reconstructed to be
in line with the target EPS that the company had set out as a goal for the CEO.
Examples that are not based on accounting include measures like Total Return. Total Return might be
defined as the increase in the market price of the Company’s Common Shares plus dividends declared
thereon and assuming such dividends are reinvested into the Company’s Common Shares. A measure
like that is based on what happens in the market and not on the financial accounting reports.
5 pts
State which financial statement(s) the performance measure comes from, if it comes from a financial
statement 3 pts
State whether the company limits CEO compensation to the amount that is deductible under the tax
law. If not, how does the company justify paying more than is deductible.
The company might state: The Compensation Committee believes that our interests and those of our
stockholders are best served by providing competitive levels of compensation, even if not
fully deductible, so some of the compensation that we have provided to our Named Executive Officers
in the past, and that we provide to our executive officers in the future, may not be deductible under
Code Section 162(m)
3 pts
Management Compensation Report for each company
Criteria Pts
State whether the company has a provision for recovering bonus pay in the event of an error or
irregularity in the award computation. They probably call it a clawback provision.
Merck states this: Return of Incentive Compensation (“Clawback Policy”) Under our incentive
compensation recoupment policy, the Board will seek reimbursement for the annual cash incentive
and/or LTI awards paid to the executive, where the Board determines (a) the executive engaged in
misconduct that resulted in a material violation relating to (i) the research, development,
manufacturing, sales or marketing of the Company’s products or (ii) the overall goodwill or reputation
of the Company (the latter of which was added and approved by the C&MD Committee in November
2021), or (b) a significant restatement of financial results has occurred. In the event of a financial
restatement, the portion of the annual cash incentive and/or PSUs paid to the executive, in excess of
the amount that would have been paid if the financial results were reported accurately, will be
recouped.
0 pts
No
Mark
s
3 pts
Total Points: 40
