The Numbers Game

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Expert Perspective by Grahall’s OmniMedia Editorial Board

expert perspective telescopeBrandon Clay is right when he suggests in his August 19, 2009 article for Seeking Alpha (“CEO Compensation: Most Overpaid?”) that to inquire about how much one makes is “… one of those taboo questions that usually goes unasked …[but] CEOs don’t always enjoy such luxuries.” He then shares the list from CNNMoney of the “Top 10 Executive Earners in Corporate America”.  Clay ends his piece with the provocative statement: “I’ll let you decide if these guys were overcompensated for their company’s performance.”

According to the CNNMoney list, Stephen Schwartzman’s “compensation” from Blackstone exceeds $700 million for 2008.  Based on this list topping amount, one might almost feel a tad sorry for Michael Jeffries at Abercrombie, who made a mere $71 million.  But few of us “average Americans” feel sorry for any of these guys. We’re more likely to feel outrage over these amounts – particularly where their companies are losing money.

But it’s more complicated than that. What, other than the enormity of these sums, do we really understand about these numbers?  Do we know that only recently have companies been required to report the value of exercised stock options as compensation?  That requirement is like having the value of your career-long matching 401(k) contributions considered compensation at the time you retire.  Sure it’s wealth, but it’s not compensation.  How much of these enormous amounts represent the value of exercised stock options versus other forms of pay (base, bonus and the like)? And if we are lucky enough to be able to break out all the components of pay, how do we then determine if the CEO is paid appropriately?

I asked one of our Grahall experts how to go about determining the right pay for a CEO.  Just a portion of his response is included below:

First create a database sufficient to be an appropriate sample size so that you can be sure it is representative of the total population of publically traded companies. Next identify 12-15 factors that are proxies for the size and complexity of the organizations. The factors should be multidimensional and preferably have low intercorrleation or multicolinearity. Create a multiple regression analysis using these size/complexity factors as the independent variables and CEO total direct compensation as the dependent variable.  Remember to standardize and translate your independent variables so that they are linear in their relationship with the dependent variable. Complete the regression analysis to determine the intercept and beta values or “beta weights” for each independent variable. Feed these back into the resulting equation to determine the predicted total direct compensation. This is the compensation for the CEO if the market paid only for size. Next….” 

Ok, HOLD ON!

Dear Reader, Do you understand that?   No?  Well, neither do I.  And if we admit that we don’t understand how to best determine how much to pay a CEO then we must also admit that we can’t “decide if these guys are overcompensated for their company’s performance.”  

And that should also make us all painfully aware that we can’t legitimately assess levels of CEO pay as could be permitted with the proposed “say on pay” regulations.  As we know, “say on pay” would give shareholders an annual, non-binding vote on executive compensation. If the bill becomes law, institutional and individual shareholders could vote on executive compensation, perhaps based solely on the relative or perceived size of the pay figure rather than any understanding of the figure’s components or how those component amounts were determined.

”Say on pay” regulations will, of course require that executive pay be disclosed. Some say that these disclosures would be “too much information” and compromise executives’ privacy (in addition to being a “taboo subject” for most Americans).  We would argue that the greater threat of such disclosures is that they will result in meaningless votes based on too little data and too little understanding of the intricate calculations. 

To get more information on appropriate regression analyses used to determine pay for a CEO contact Grahall, or contact Grahall’s Editorial Board at edie.kingston@grahall.com.

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