Focus on Incentive Pay Practices: A Message from the Regulators

Incentive pay is an important part of compensation packages.  It allows employers to reward those employees who perform well (and show those employees who do not that under-performing will have negative consequences).  It is a well known fact that incentive pay drives behavior.  But what the 2008 financial meltdown may have shown is that poorly calibrated incentives may generate counter-productive, if not dangerous, behaviors.  Therefore, all employers should carefully design and document their incentive pay programs to make sure their interests are well protected, and incentive pay is awarded only when appropriate. This is very clearly the opinion of six agencies that oversee financial institutions, and that have come to the conclusion that the 2008 crisis was caused, at least in part, by dangerous pay practices.  The Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), the Federal Housing Finance Agency (FHFA), the National Credit Union Association (NCUA), the Board of Directors of the Federal Reserve System (the Federal Reserve) and the Securities and Exchange Commission (SEC) recently released proposed regulations that set forth detailed requirements applicable to incentive compensation programs adopted and maintained by financial institutions. While these requirements would only apply to covered financial institutions, we believe that they should at least be taken into account by all employers (particularly, publicly held companies), as this new set of rules and principles may very well become “best practices” beyond the financial services industry.  Here are some key aspects of the proposed regulations that may give employers some guidance in the design and implementation on their incentive pay programs. Identifying Risk-Takers While the proposed...

FASB Improves Employee Share-Based Payment Accounting

As part of an ongoing Simplification Initiative, the Financial Accounting Standards Board (the “Board”) recently issued an Update to Accounting Standards Codification (ASC) Topic 718, which deals with stock-based compensation.  The update is meant to reduce cost and complexity while maintaining or improving the usefulness of the information provided in financial statements.  The areas for simplification include the income tax consequences of stock compensation, the classification of stock-based awards as either equity or liability, and the classification on the statement of cash flow.  The changes are summarized below. 1.    Accounting for Income Taxes Generally, for any stock-based award, a positive or negative difference between a tax deduction and the compensation cost that is recognized for financial reporting purposes results in an excess tax benefit or a tax deficiency, respectively.  Currently, excess tax benefits are recognized as paid-in capital when the tax deduction reduces the taxes that are payable, while tax deficiencies either are used as an offset to accumulated excess tax benefits or are recognized in the income statement.  The Board decided that all excess tax benefits and tax deficiencies should be recognized as income tax benefit or expense in the income statement, and should be treated as discrete items in the reporting period in which they occur.  The recognition of a tax benefit is no longer delayed until the benefit is actually realized through a reduction to taxes payable. This change certainly simplifies the accounting rules as it effectively eliminates the need to account for additional paid-in capital (APIC) pools, but some expressed concern that this may increase volatility in reported income tax expenses and effective tax rates. ...