An opinion piece in this week's Wall Street Journal by SEC Commissioner Robert Jackson and former Fidelity Investments President Robert Pozen demanded that compensation committees use "the same scorecard as ordinary shareholders" when determining incentive pay - or explain the reasons behind any adjustments. The opinion cited 2017 research by Pozen (who is now a senior lecturer at MIT Sloan School of Business), along with professors S.P. Kothari and Cornell's Nicholas Guest showing that CEOs of S&P 500 firms in the top quartile of companies with the largest non-GAAP adjustments announced earnings that were, on average, 23% higher than GAAP and that higher non-GAAP earnings predicted higher CEO pay despite lower performance.
The op-ed comes amid heightened focus by the SEC on enforcement of guidelines governing the use of non-GAAP financial information in public disclosures, especially disclosure of non-GAAP measures in a way that is "more prominent" than GAAP measures or failing to provide comparable GAAP measures in earnings releases. However, the Jackson op-ed calls for the SEC to require companies to disclose an explanation of the use of non-GAAP performance metrics and reconciliation back to GAAP within the CD&A itself, which is not currently mandated. At a recent conference, Ken Bertsch, the Executive Director of the Council of Institutional investors indicated that CII was considering petitioning the SEC to require such a disclosure.
Given the increasing prevalence of non-GAAP financial metrics as well as the important value and insight provided by adjusted disclosures, which is recognized in the Pozen paper, it is unlikely that companies will restrict the use of non-GAAP measures entirely. The Center has developed a white paper providing an in-depth assessment of the use of adjustments to GAAP incentive metrics and suggestions for transparent disclosures, available here.