by John Hughes
One of the more prominent new disclosures coming to Canadian financial statements on adopting IFRS is the summarized information on compensation paid to key management personnel, required by IAS 24 Related Party Disclosures as follows:
An entity shall disclose key management personnel compensation in total and for each of the following categories:
(a) short-term employee benefits;
(b) post-employment benefits;
(c) other long-term benefits;
(d) termination benefits; and
(e) share-based payment.
It defines key management personnel as “those persons having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including any director (whether executive or otherwise) of the entity.”
The IASB says this is important, among other reasons, because “the structure and amount of compensation are major drivers in the implementation of the business strategy.” Now there’s a hot button issue…but I don’t think the IAS 24 disclosure requirement does much to address it, nor to address anything at all really.
The disclosure gives you some numbers, but there’s no requirement to disclose how many people the numbers cover. It wouldn’t tell you if 90% of the share-based payments went to one person and 90% of the cash to someone else. It doesn’t tell you whether the share-based payments represent easy money or whether there’s some genuine, rigorous incentive there. It doesn’t address deferral mechanisms, clawbacks, and so forth. There’s no clarity anyway on how you’d necessarily measure some of the items (is the share-based payment amount just the accounting expense for the year, or a grant date measure, or something in between?)
Given these limitations, no one could meaningfully compare the data provided by two competitor entities, or reach any informed conclusions from it on how compensation might drive the business strategy. In any event, as I wrote in my earlier post on MD&A, aren’t there a myriad of other things that are equally major drivers in implementing the business strategy, but which financial statements make no attempt to address?
Now of course, these numbers won’t be reported in a vacuum. We already have proxy circular disclosures for executive compensation, which have recently been upgraded in Canada – and these do attempt to address some of the factors I mentioned (although on the most sensitive matters, like disclosing specific performance targets and triggers, the quality of compliance hasn’t been particularly impressive). But our proxy disclosure requirements – who’s covered, what’s reported – don’t align at all with the categories laid out in IAS 24.
Canadian entities seem to have two main choices then in how they apply this aspect of IAS 24. They could do something that seems basically compliant (and satisfies the auditors) and just throw it out there for people to scratch their heads over. Or they could actually provide information that makes sense, reconciles to the proxy circular, and does provide some clarity over how compensation supports the business strategy.
That should be a priority now though, not in 2011. Despite the CSA’s efforts, it’s still not hard to find cases where the proxy circular and the MD&A don’t seem to align – for example, the strategy emphasized in the latter doesn’t seem to be driving what’s emphasized for compensation purposes, and you can’t tell why. The amounts paid to the top five individuals are much clearer than they used to be, but the narrative explanation is still often limited and legalistic. But it’s one of the more likely areas of disclosure to be scrutinized. OSFI is focusing now on compensation practices of the entities it regulates; compensation is the number one priority for the Canadian Coalition for Good Governance; it’s obviously an area of heightened interest for the media and of relatively greater potential for generating bad publicity. I think it’s crazy not to examine one’s compensation practices and related risks and commit to the clearest, most coherent disclosure possible. I just don’t think a fragmented financial statement requirement will do much to get you there.
(By the way, the Canadian Accounting Standards Board bizarrely proposed to import this same disclosure requirement into its new Canadian GAAP for private enterprises, which has just been finalized. The idea went down like a lead balloon, attracting widespread opposition, and is now being dropped).
The opinions expressed are solely those of the author.