Should Shareholders Re-approve Performance Goals at the Upcoming Annual Meeting?

As publicly held companies prepare for their annual meetings, consideration should be given to whether or not performance goals within certain incentive compensation arrangements should be re-approved by their shareholders.  This is a worthwhile endeavor because failure to comply with Section 162(m) of the Internal Revenue Code of 1986, as amended, could result in a loss of deduction associated with certain executive officer pay.

As background, Section 162(m) generally provides that compensation paid by a public company to a covered employee is not deductible to the extent it exceeds $1,000,000 ("$1mm"); however, an exemption to the $1mm limit applies for performance-based compensation that satisfies certain conditions (the "Exemption").  One such condition is that the material terms of the performance goals must be disclosed and approved by the company's shareholders before the underlying compensation is paid.

However, if the compensation committee has the authority to change the targets under a performance goal after shareholders approved the goals (which is often the case), then ". . . the material terms of the performance goal must be disclosed to and reapproved by shareholders no later than the first shareholder meeting that occurs in the fifth year following the year in which shareholders previously approved the performance goal."  See Treas. Reg. 1.162-27(e)(4)(vi).  In other words, approximately every five years the shareholders would have to re-approve the performance goals in order for the Exemption to apply (i.e., to protect the deductibility of compensation paid to covered employees that exceeds $1mm).  

Shareholder approved performance goals are typically contained within equity incentive plans, long-term incentive plans (LTIPs), annual bonus programs/plans, and in rare instances, employment agreements.  So don't forget to at least consider the issue!