MGTcompensation-7.pdf

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