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There's a lot more to executive pay than meets the eye.
David McCann, CFO.com | US
July 15, 2011
Down in the weeds of executive compensation, things can be pretty hard to fathom. Not just for ignorant folk, but for experts, too. "Even for people like me who are in it every day, it's still hard to understand sometimes," confesses Aaron Boyd, head of research for Equilar, a compensation-research firm. Indeed, others who make their living analyzing compensation data or consulting on the topic have said much the same.
On July 2, The New York Times published an article declaring the median total compensation for CEOs at the 200 largest public companies that filed their proxies by June 23 leaped by 23% in 2010. The attention-grabbing headline was, "We Knew They Got Raises. But This?"
That prompted a call to CFO by Gary Pokrassa, finance chief for a $100 million public company called Lakeland Industries, which makes protective clothing. Both he and, he says, Lakeland's directors were incensed by the article. In fact, they've been incensed since late 2009, when the Securities and Exchange Commission required companies to report in their annual proxy statements the maximum possible grant-date fair value of top executives' equity-based compensation awards.
Many such awards vest over multiple years, yet the new rules — effective for proxies filed after February 28, 2010 — also require proxies to assign the entire amount to the year of grant, which can drastically increase total reported compensation for that year. The move was intended to give investors another data point on compensation to consider. Previously, companies reported in proxies the amount actually expensed for each specific year, just as in their financial statements (which continue to display the expensed amounts).
The eventual worth of all equity awards is subject to the stock's future performance, but Pokrassa points out that in any particular case the stock might never even be issued, because such awards are often subject to the executive's meeting earnings-per-share or other performance targets. "The Times article was based on a false premise and fallacious logic," he charges. "But it was inevitable that an article would come out proclaiming how much executive compensation has increased."
But there are few airtight arguments when it comes to executive compensation.
First, let's further flesh out Prokrassa's view. As an example, he points to Howard Schultz, CEO of Starbucks. The company is too small to be among the 200 in the Times's data set, but the paper identified Schultz as making more money last year than the median CEO in that group.
Starbucks files its proxy annually in January, so this was the first year it had to comply with the new rule. The document shows Schultz as having total 2010 compensation of $21.73 million, a 45% jump from $14.97 million in 2009. But he was given restricted stock, to vest over three years, valued at $10.5 million. If that column included only the expensed amount shown in the company's financial statements, his total pay would have been virtually the same as the previous year.
Pokrassa points to letters about the article that the Times later published as underscoring why he and his board are so irritated. While Pokrassa himself sent in a letter that was not published, the writer of the lead published letter admitted that he knew "little about the business world other than what I read in the newspaper" before questioning how CEOs could be worth their pay. Another letter called for raising the top individual tax rate to 75%–80% as a way to rein in executive compensation. (Such a move might also rein in the number of qualified people who would choose such a stressful job.)
Both Boyd of Equilar, which provided the data used in the article, and Pradnya Joshi, its author, acknowledge that an executive's total pay as shown on a proxy statement under the new SEC rules could be misleading in cases like Schultz's. "People can definitely have a gripe about the numbers," allows Boyd. "They are not perfect. You can't accurately capture what an executive is going to walk away with in the future after just one year of a multiyear cycle."
But here is the other side of the argument. The presence of such cases does not refute the central fact of the article: that median CEO total compensation for the group of 200 large companies shot up 23% last year. Because the measurement reflected the median (middle number) rather than the mean (arithmetical average number), for the result to have been influenced by the new SEC rule, more than half of the companies would have had to have given their CEO new multiyear grants in 2010 while not having done so in 2009.
While 2009 was a miserable year for corporate profits, there was still a healthy flow of equity-based awards, notes Boyd. "There was not a huge number of CEOs receiving multiyear grants in 2010 who didn't get anything in 2009," he says. "But the value of their stock was way up, with the recovery of the market." And, he adds, the single-biggest factor in the compensation spike was that cash bonuses reaped by the 200 CEOs were up 38% last year.
In addition, the methodology of the Equilar data analysis has not changed in recent years, Boyd and Joshi say. Equilar, believing that grant-date fair value is a better measurement of an award's worth than the amount expensed in a given year, was already using the former in its research even before the SEC proxy rules were changed.