Beware the Compensation Headlines: Apples and Oranges

Beware the Compensation Headlines: Apples and Oranges
by Fred Whittlesey, Principal,
Compensation Venture Group, Inc.

I have often said that when one reads an article about executive compensation in any of the leading business publications – the Wall Street Journal, Business Week, Forbes – one should assume that the pay amounts cited are incorrect. While they are not always incorrect, such an assumption will be valid the vast majority of the time, and saying it’s wrong makes you right most of the time.

With proxy season upon us, we now have many headlines every day reporting executive pay as reported in the proxy statements. The new disclosure rules have resulted in large amounts of additional data, reported in different formats and under different methods. What was granted, earned, paid, and realized are very different numbers and can all be construed as “pay.” The media go further by adding terms of received, valued at, payment, and worth. Not to mention the adjectives they include: excessive, exorbitant, lofty, huge, and so forth.

Despite many companies’ best efforts to go beyond the new requirements and produce additional tabular disclosures and associated narrative explaining their executive pay programs, the technical complexity and sheer volume of the information leads to misinterpretations.

Yesterday, three prominent companies had their CEO’s pay reported in the media. All three were reported incorrectly.

§ The WSJ reported pay for the CEO of Coca-Cola Company that was 13.9% higher than actual, off by $3.9mm. This is because the number used for stock awards was pulled from the Summary Compensation Table rather than the Grants of Plan-Based Awards Table. They reported all apples with one orange.

§ The New York Times did a little better in the treatment of the pay for the CEO of General Electric, getting the numbers generally correct. I say “generally” because they are consistent with the SEC-mandated reporting which requires accounting-based values for long-term incentive awards and which are completely irrelevant for compensation analysis purposes. They reported all apples but then mixed their fruit when it came time to discuss pay that was “earned” – earned pay (again according to accounting rules) was up 9.7% ($1.7 million) not down 6% as reported in the article. Earned and granted are both important measures but who wants to eat an apple and an orange at the same time?

§ Back to the Wall Street Journal, and a piece about the new CEO of E-Trade. This should be easy because it’s a new-hire package, no confusion over what was granted vs. earned vs. paid. But alas, complexity is here too. While it is true that he would receive a severance payment of $5 million if terminated without cause or in connection with a change in control (five times base salary) he also would receive accelerated vesting of the stock awards. Because his agreement entered in 2008 ends in 2009, and given E-Trade’s potential as a takeover target, there’s a good chance he’ll get that $15.4 million in accounting value of his stock and option awards. (That’s about $21 million for a year or so of work and we can put that in the queue for the next batch of Congressional hearings.) More importantly for this discussion, that $15.4 million is a vast understatement of what those awards will be worth in any change in control scenario or even in a business-as-usual scenario. What we know is that his severance likely will be not $5 million but a multiple of $5 million. Those apples and oranges will more likely end up a watermelon, or two.

At a time when CEOs, Chairs of Compensation Committees, and compensation consultants are being summoned to Congressional hearings on the topic, it is critical to interpret market information properly. Journalists show a continued inability to do that and it’s not their fault. The reporting rules were designed by legislators, government agencies and lawyers. The data are prepared by various combinations of lawyers, accountants, actuaries, and consultants. And very few journalists have any of the foregoing backgrounds. Various interest groups, with admittedly less objectivity than journalists are hoped demonstrate and no greater expertise, use the multifaceted data to bolster their views. Experts in the field, like me, disagree with each other on how to properly measure pay so as we point our finger the others are indeed pointing back at us.

Companies must understand that the proxy disclosure requirements are a poor basis for understanding executive pay practices. The data are a starting point for analytical approaches that can provide that understanding, and nothing more. The footnotes and narrative contain critical information that isn’t presented in the structured tables but often are the key to determining the real value of pay.

Compensation Committee members, executive teams, and compensation professionals have a more important responsibility than ever for understanding, analyzing, and basing decisions on correct interpretations of market data. We’ve never had more data, never had better electronic means for getting and analyzing that data quickly, and never had more opportunity to get it wrong. This week’s headlines are proof of that, and each week ahead of us will provide more examples.

Disclosure: My family owns shares of Coca-Cola, does not own shares of GE, and sold our position in E-Trade shares last year. I do not believe that my past or current financial position in these companies has any impact on my opinion of their compensation practices or the reporting thereof.