The Effects of SEC Comment Letters on Compensation Contract Efficiency

The SEC issues comment letters about executive compensation disclosure deficiencies. Although it is not the SEC’s goal, we posit these comment letters indirectly influence compensation practices via improved disclosure. We show these letters increase pay-for-performance and relative performance evaluation in compensation contracts. Consistent with better disclosure increasing stakeholder discipline, we show the enhancement to contracting efficiency is most pronounced when (i) firms anticipate more negative public attention from receiving a comment letter and (ii) the comment letter is likely to spur changes to disclosure. Using grant-level details of plan-based compensation, we also document that comment letters lead to an increase in the use of performance objectives and the selection of performance peers that are more similar to the firm. As a consequence of the enhanced efficiency, comment letters are associated with increased future investment efficiency and profitability. Overall, we document that comment letters improve compensation contracting efficiency via improved disclosure