More Risky Business - Why the Compensation Risk Assessment Is Still Important

This year, for the first time, public companies have been required to include a disclosure in their proxy statement to the extent that “. . . risks arising from the registrant’s compensation policies and practices for its employees are reasonably likely to have a material adverse effect on the registrant.” In a blog post today on compensationstandards.com (subscription site), Andy Mandel and Larry Schumer of Buck Consultants described a study they completed about the voluntary risk disclosures (or lack thereof) in the proxy statements of 200 large public companies.

They report some interesting findings:

• Predictably, no companies reported that they found a reasonable likelihood that the compensation risk will have a material adverse effect. However, a majority of companies (67%) did include some voluntary risk assessment disclosure. Of these companies, a majority (63%) made an affirmative statement that there were no risks that created a material adverse effect.
• Few companies described the process they used in their risk assessment. Instead, most of the disclosures focused on factors in their compensation programs that mitigate risk. The study lists the risk mitigation factors cited, including 58% of companies mentioning the balance of short-term and long-term incentives.
• The SEC has started issuing comment letters asking for more detail on the assessment process. The authors reported that the SEC has issued such comments, not only to companies whose proxy statements were silent, but also to companies that stated their conclusion but did not include a discussion of the process.

Why is the risk assessment discussion an important consideration for the upcoming proxy season, when most companies will be dealing with the issue for the second time? Because this time, compensation disclosures will be the subject of a Say-on-Pay vote, and the risk assessment is an important factor that will be considered by many shareholders in casting their vote. At the recent Proxy Disclosure Conference sponsored by thecorporatecounsel.net, Patrick McGurn of ISS reported that risk mitigation is the third greatest compensation-related concern reported by investors (behind pay for performance and problematic pay practices). Investors want a robust explanation of what the risk assessment examined, and how the company ensures that pay practices don’t incentivize the wrong behavior. At the same conference, Mark Borges of Compensia suggested that the summary section of Compensation Discussion and Analysis highlight the risk discussion and refer to the place where it is discussed more fully.

For more information on risk assessments, see this previous post for a description of how a compensation committee might select which non-executive pay programs to include in its evaluation. And, for a comprehensive description of risk elements examined by one company, see the 2010 proxy statement of Brown-Furman Corporation under “Compensation Risk Assessment” starting on page 36.