Just Realize It’s Simply One More Tool in Your Toolbox


Print | No Comments | Share/Save

Can you hear them? Scratching away, or these days more likely pecking away at keyboards. The auditors are at it, it’s coming up on proxy time! They are working furiously, not exactly 24/7 but close to it to balance the books for some 10,000 publicly traded companies in the US. Unfortunately, not even Grahall can do this in its sleep! Journalists, activist investors, and regulators are poised to dissect the proxy statements that will start to be released in just a few weeks.

Today’s proxy bears little resemblance to that of 5 or 10 years ago, as there have been lots of changes in the way executives are compensated and the way that compensation is reported. As Grahall’s Garry Rogers says: “Nearly every aspect of compensation, with the exception of Code Section 162(m), has been revisited in the past several years. Stock options have been marginalized as a primary compensation tool because of changes in expensing and concerns about risk. In their place, the prevalence of restricted stock and performance shares is on the rise.” Companies must concern themselves with burn rates, risk assessments, ownership guidelines and post termination remedies, such as clawbacks.

You can see in this post-Enron, post-bailout, post-great recession world how important compensation information has become. It was errors in risk, pay, qualifications, structures, oversight, and conflict of interest that heralded a decade of corporate malfeasance in the early 2000’s. Not something any person should be nostalgic about.

Pay for Performance has been the mantra of regulators, investors, consultants and watchdogs seeking to level the playing field between executives and shareholders, but it has proven to be an elusive goal, in part due to inherent difficulties in normalizing pay data across appropriate time and performance periods. For example, the current proxy table mixes the annual values of base salary and short term bonus with the full long term value of stock awards and the theoretic value of stock options and performance awards. As each of the stock, option and performance awards may not be realized in the 12-month window that is the proxy’s life cycle, the values disclosed in the table may be highly misleading.

So can you tell from the summary compensation tables if executives are being paid for performance? It depends. The numbers presented in the tables as required by the SEC might make the compensation appear inappropriately high. And, since target bonuses, for example, are not required to be reported, there really isn’t a way to determine if the executive received more or less than the target without reading the Compensation Discussion and Analysis (CD&A).

There is a growing trend among companies to bring more clarity to the numbers reported for executive pay.

According to a Wall Street Journal article “Proxy Firm Will Use Realizable Pay After Feb. 1” by Emily Chasan, published on January 15, 2013, “A growing number of companies have published their own measures of realizable pay over the past two years to persuade investors voting in their company’s annual say-on-pay vote that compensation figures are not as high as those required by the government. The two figures generally differ due to changes in the value of equity grants or the value of pensions.”  No doubt, these differences can be dramatic.

“Realizable pay” approach is being embraced by one of the country’s leading proxy advisory firms, Institutional Shareholder Services (ISS).

So what is realizable pay? It’s an attempt to measure what is actually realized as opposed to what the executive had the opportunity to earn. It includes the value of full value awards (such as Restricted Stock/RSUs, “in the money” stock options and earned performance shares). Since this measurement uses real values, it is believed by some to better reflect the pay delivered and theoretically links that pay to corporate performance and shareholder return.

But caveat emptor! Realized pay is not a perfect measurement tool, but rather another tool in the box. And we hope that companies, regulators, investors, and watchdogs will use it as such rather than as the “be all end all”, ultimate measurement device. As a tool to help investors decide how to view executive pay and vote their “say on pay”, the jury is out on whether it will have much of an impact, and how to measure that impact.

But that leads to the question, how much pay is too much and do proxy disclosures help us to figure that out? From our perspective, any compensation not tied to driving behaviors that sustain and grow the corporation is maybe not “too much” but rather, it’s just wrong. As Michael Graham said in his forthcoming book A Principled Approach to CEO Contract and Compensation, “The way to approach CEO [and other executive] contracts and compensation is unambiguous: the contract should be reasonable given the circumstances and the reward structure must guarantee that your [executives are] rewarded for the things that will help the company not only survive, but thrive in any economic situation. And further, that the rewards do not encourage activities that are in any way detrimental to the company and its stakeholders.”

Executive pay practices might be analogous to football -you need to be on the field, but you need the play the whole thing. Don’t leave out the end zones or you will never make a touchdown. Here is an example. One of Grahall’s clients is a company in its industry known for extraordinary innovation and “pushing the envelope” to bring value. For that company, we helped to design a somewhat atypical compensation program that was, in fact, questioned by a large institutional shareholder. The compensation program was controversial but it was also justifiable and as we discussed the approach with the shareholder they came to understand the effectiveness of our recommendations. In the end they endorsed the approach.

It is certainly necessary that compensation packages need to “fit” the organization and support its goals and strategies, but still be within the boundaries of reasonability.

For more information on how you can structure executive pay in a principled fashion, contact us.

For more information on how you can structure executive pay in a principled fashion, contact us.

Post a Comment