Everything That Glitters May Now Be Gold

In the 1990's and into the 2000's, employee stock options glittered.  When the glitter faded due to market downturns and increasing volatility, new forms of equity compensation emerged to restore the sheen - option exchanges and repricing and restricted stock units.  This past week's market volatility, economic uncertainty, and the contributing factors took away a bit of the remaining glitter.  

With widespread concern about equity investments, what has been the newest shining light?  Gold.  But we can, and in many cases must, compensate employees with equity and we can't do that with gold...can we?

Beyond the surging price of gold in response to global economic, financial, debt, and currency issues, there are some trends underway not gaining the attention of mainstream media that point to a growing influence of gold as a currency.  Does this open an opportunity for considering gold as a form of employee compensation? 

While this may appear to be a “fringe” idea, such a view would place the world’s most prominent countries, most sophisticated investors, and a dozen US states on this fringe.

This, of course, is all intended to stimulate discussion.

• My accounting and valuation colleagues will point out the technical issues (with pay linked to a commodity)
  
•  My tax colleagues will poke holes in the court cases and cite the Code
  
•  My legal colleagues will undoubtedly identify all of the reasons that this is a poor idea and the possible liabilities resulting
  
• My equity plan administration colleagues will curse me for recommending a non-equity form of compensation (can the software platform handle a ”restricted gold” award?)
  
•  My survey and proxy data colleagues will wonder where gold would be categorized on a data input questionnaire and in the database.  A full value award?  Bonus? Other LTI?
  
• And of course, my corporate governance colleagues will cite the horrendous outcome of decoupling compensation from shareholder value. 

Not unlike issues we’ve faced with other “new” pay vehicles, like cash long-term incentive awards.

I’m providing a few links below that set the stage for what I believe will be a discussion over the next year that will move from what may appear to be a humorous alternative, perhaps even satirical, view to a central discussion point in employee compensation planning – designing, delivering, and measuring pay value if and when the bottom falls out of both the global economy and the US currency. 

Some of these links are on sites that are clearly pro-gold, anti-US currency, and even a bit anti-government, but some are a bit more credible.   All are factually true.  Sources of these excerpts are available at the links.

Winning the Tax Case in 2007…

The essence of the argument is that under the Constitution Congress is obligated by law to mint and circulate such coins as demand requires, and must establish the value of coins as they are used as legal tender, but the coins' market value, arising as valuable personal "property," is a distinct, separate attribute of such coins, and is of no legal consequence if the coins are used as legal tender.

In other words, if a worker is paid with such coins, his taxable "income" (if any) can only be the face value indicated upon the coin money paid -- i.e., $1.00 for a circulating silver dollar or $50 for a circulating gold U.S. coin. Not surprisingly, the IRS has never issued any public guidance regarding this significant issue.

But Losing the Tax Case in 2009…

(Defendant) faces up to 296 years in prison and fines of up to $14 million, Brower said. (Co-defendant) faces up to 71 years in prison and fines of up to $2.75 million.

Note:  The above cases were not just about the use of gold coins as compensation but had a number of counts of fraud and conspiracy related to hiding assets and other tax-avoidance actions.

The Technical Tax and Legal Points

The government called three accountants to testify. The defense asked each one, “What is the proper way to calculate income for purposes of the Internal Revenue Code if you are paid in a gold coin that has a $50 face value on it?” All three of them responded, “I do not know; I’ll have to research that.”  One of them had a masters degree in taxation.

No Federal Court of Appeals has ever ruled that the gold coins in question must be reported to the IRS based on FRN (Federal Reserve Note) market value.

Utah Legalizes Gold, Silver Coins as Current (22-May-2011)

Utah became the first state in the country this month to legalize gold and silver coins as currency. The law also will exempt the sale of the coins from state capital gains taxes.

Earlier this month, Minnesota took a step closer to joining Utah in making gold and silver legal tender. A Republican lawmaker there introduced a bill that sets up a special committee to explore the option. North Carolina, Idaho and at least nine other states also have similar bills drafted.

What Would Have Happened If…?

20-20 hindsight being what it is, I still find it interesting to do a what-if analysis.  For example, what if the typical Nasdaq company 12 months ago had granted gold instead of restricted stock units (RSUs) with a one year cliff vesting date? (based on Tuesday, 16-August-2011 closing prices) – with RSUs represented by the Nasdaq Composite Index and gold represented by the SPDR Gold Trust ETF (click on links to see price charts):

S&P 500 vs, Gold, 1-year

Nasdaq:  +15.66%
Gold:  +45.26%

What about a 5-year view?

S&P 500 vs. Gold, 5-year

Nasdaq:  +22.63%

Gold:  +177.341%

Hmmm.  7.8x. (The 10-year comparison is around 10x).

So What?

Will companies start using gold to pay employees?  Probably not.  Will some company somewhere do it?  Probably so.  We cannot discount the effects of political views of boards of directors, CEOs, and private company owners in the employee compensation decision process. And some people just love a new idea and being the first to try it.

Maybe a company will grant gold (or a gold derivative) as a confidence-builder when inflation returns and employees realize that meager salary increases, like current interest rates,  are really a negative number.

Or as an element of an employee choice program – bonus, stock options, or gold coins?

Or when the stock market crashes again, options go underwater, RSUs represent a fraction of their grant value, and yet another option exchange program loses its luster.

Or maybe a gold coin will replace the holiday bonus, with employers grossing-up for taxes.  Better that than a turkey, which is what the US dollar may turn out to be.

Zoellick Says China Currency To Be Global Player (14-August-2011)

World Bank president Robert Zoellick a gathering of the Asian Society in Sydney on Sunday that the renminbi and other Asian currencies may form a basket of currencies in the future that play the role as the international reserve and trade currency instead of the current US dollar-based global finance and trade system.

Just looking ahead.

A New Generation of Performance Plans?

Over the past few years we have seen performance share units and other varieties of performance-based awards grow in prevalence in response to a series of corporate governance concerns.  What concerns? Stock options, time-vested awards, executive ownership levels, and most importantly the link between pay and performance.

In this first round of say-on-pay in the US this spring, we saw these issues raised as key points in investors’ and proxy advisers’ voting policies and actions.  The new say-on-pay environment has turned the dialogue on these plans from anecdotal comments to a chorus of complaints about the manner in which these plans have been designed and operated over the past few years and the resulting impact on corporate governance.

While performance plans have been adopted to resolve some governance issues, they are creating new governance challenges which are not always apparent or easy to identify and measure.  We have identified TWENTY unique governance issues specific to performance plans and how companies can address these issues before next year’s say on pay votes.  Resolving these issues will result in the next generation of performance plans.

Equity compensation, long one of the list of items considered by investors, has become a central corporate governance issue and equity compensation professionals need to understand and be able to respond.

Here are some resources for learning more about this issue:

Performance Problems?  Addressing Emerging Issues with Performance Plans

 

Solium Transcentive Synergy Conference

12-14 September 2011, Scottsdale, AZ

Panel discussion with Fred Whittlesey, Elizabeth Dodge (Stock & Option Solutions), and Takis Makridis (Equity Methods)

This session will be videotaped for those unable to attend the Conference

The Next Generation of Performance Plans?  Fixing Governance Ups and Downs

 

Global Equity Organization - National Equity Compensation Forum

14-16 September, Scottsdale, AZ

Panel discussion with Fred Whittlesey, Elizabeth Dodge (Stock & Option Solutions), and Takis Makridis (Equity Methods)

The Governance Ups and Downs of Performance Plans (book chapter)

by Fred Whittlesey

Performance Awards

GPS:  Guidance - Procedures - Systems

Performance Awards

Fred Whittlesey, contributing author

Perfecting Perception: The Behavioral Economics Approach to Equity

At the NASPP's Silicon Valley Chapter Annual Conference last week I participated on a panel titled Perfecting Perception:  Understanding Perceived Value; What It Means for Your Stock Program.  The discussion, moderated by Emily Cervino of the CEP Institute with Keith Pearce of Intel and Jason LeBovidge of Fidelity, covered several approaches to the issue.


And what is the issue?  It's that a significant proportion of equity compensation program participants - maybe half or more - don't understand what they've been granted, don't consider the equity as part of their "compensation" for their job, and then not surprisingly don't work any harder or any smarter because of the grants.


If that is true, we have a serious problem, because companies spend millions and billions of dollars in expense and dilution on these programs and should expect a positive return on investment (ROI).  How do we fix this?


A lot of the discussion is around communication but I think there is a serious plan design component to this as well.  My portion of the panel drew primarily on the research and analysis I did for my book chapter in Global Equity Organization's GEOnomics 2009, "Behavioral Economics and Equity Compensation" (with co-author Kiran Sahota).


I'll be doing a two-part webcast on this topic for GEO in September and October that will take the discussion further.  Stay tuned.

New Book: If I'd Only Known That

I contributed to the National Center for Employee Ownership's new book "If I'd Only Known That" and what an interesting experience it was remembering all of the equity plan horror stories I've encountered over the years.

Unfortunately, we continue to see horror stories in the making with the proliferation of performance plans.

At the NASPP's Silicon Valley Chapter Annual Conference last week I moderated a panel titled "Performance Problems: The Governance Ups and Downs of Performance Plans" which detailed 20 different problems we're seeing with the design and operation of these performance award programs.  My portion of the presentation was based on the book chapter I authored in GEOnomics 2011.


I'll be participating on similar panels at both the Global Equity Organization's National Equity Compensation Forum and Solium Capital's Synergy conference in September.

Plenty to talk about.

Debt-based executive pay: a not-so-new solution in search of a problem

Re-blogged from the Hay Group site:

http://blog.haygroup.com/?p=470

Blogging Around

It's been quite a while since I added to this blog...since joining Buck Consultants I have a few constraints on what I can write and where. But there are many new pieces of content you'll find of interest:

On the CompensationStandards.com Advisors' Blog:

Rethinking Equity Valuation

Stop Before You Swap

Counterpoint: Or Might Stock Option Use Go UP?

IFRS: Here Before We Knew It

The Global Equity Organization (GEO) Podcast Series:

Keeping Up with Fred Whittlesey

And a couple of articles of interest:

Published by Stock & Option Solutions:

Differentiating Equity Grants: The Dilution Solution

Behavioral Economics and Equity Compensation

A chapter in GEOnomics 2009

You also an access many of my other articles and conference presentations the Buck Surveys site

Executive Pay: What is Not Said

"You have to listen to not only what is being said, but what is not said -- which is often more important than what they say." — Kofi Annan

There may be daily updates on this issue because I am reading, daily, misreporting of executive pay. This time, it's the Washington Post and it's about what was not said.

Capital One Chief Was Paid $17 Million in 2007
Capital One, the McLean credit card issuer, awarded chairman and chief executive Richard D. Fairbank a pay package it said was worth $17 million last year, almost entirely stock options. That compares with a package worth $18 million in 2006, the company said. Fairbank last year exercised stock options at a gain of $54.8 million, the company said. That sounds heroic, a CEO just getting paid from gains received by shareholders.

They got the "awarded" part right. Of course the $17 million number is likely a significant understatement of the value of those options but that has been in this blog before and will be again, but not right now.

The problem here is what was not said. It is true that he had a gain of $54.8 million on options. But as the media continues to miss the significant change in executive equity compensation packages, this reporter missed a little $18.3 million vesting event on restricted shares, understating pay by about 25%.

Now, there is another complexity here. A footnote indicates that:

"Values reported for Stock Awards are related to the vesting of Mr. Fairbank’s performance shares on March 31, 2007, delivery of which are deferred until the end of Mr. Fairbank’s employment with the Company. Therefore, Mr. Fairbank neither acquired any shares nor realized any value from such shares in 2007." Not true. If someone gives me $18 million in stock but I've told them to just hang onto it until I retire, it is difficult for me to argue that I didn't "realize any value" from that. That is a tax technicality.

This further highlights not only the complexity of executive pay but the need to understand both the tabular disclosures and the voluminous footnotes. And the accounting, the tax, and the other technical nuances.

What was not said here is important: When Capital One's stock price was flat for two or three years their interest turned to giving executives free shares of restricted stock. Now that the stock has lost half its value, how attractive those stock options look again so the executives can participate in the rebound. Flat price, guaranteed pay. Low price, guaranteed participation in the rebound. (See previous posts on Washington Mutual for the popularity of this approach.)

That's the real story, Washington Post. With your reputation for investigative journalism, how about spending a little more time on the shenanigans going on in the financial services industry right now. We are seeing various combinations of fraud, failure, and folly and even the least serious of those is an important corporate governance issue. Directors are paid to prevent folly, and not be a part of it.

New Issue of The Compensation Committee Adviser

Beware the Compensation Headlines: Apples and Oranges

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,...

To keep reading, click here: http://compensationcommitteeadviser.blogspot.com/

Those Darn Compensation Consultants

"Mortgage mess CEOs defend pay" - Cnn.com
"Countrywide's Mozilo resisted pay cuts" - WSJ.com
"Wall Street Executives Defend Pay at House Hearing" - Bloomberg.com

In all of the media coverage today, perhaps the most interesting tidbit was not what was said in the hearings but what was learned from some email messages in the course of the investigation. Beyond the left-vs.-right debate, the accusations and justifications, and the election-year posturing, there's this:

"The report says two compensation consultants hired in recent years urged the board to cut back on certain aspects of Mr. Mozilo's compensation. The first...advised Countrywide in 2004 when it was discussing an extension of Mr. Mozilo's contract.

"A second consultant...in 2006 recommended reductions in Mr. Mozilo's compensation, the report says. After the board's compensation committee proposed making those cuts, the report says, Countrywide management hired another consulting firm, Towers Perrin, to review the board's proposal. Though the firm was being paid by Countrywide, Mr. Mozilo regarded the Towers Perrin representative...as his own adviser, emails reviewed by the committee staff suggest.

"'The board made a number of revisions to accommodate Mr. Mozilo and (the consultant)," the report says. Among other things, the board put larger companies into the peer group used to gauge Mr. Mozilo's pay and gave him a $10 million bonus to stay on as CEO longer than planned.
The report cites an email (from the consultant) to Mr. Mozilo expressing disappointment that the board's final proposal "lowers your maximum opportunity significantly."

"According to the report, Mr. Mozilo replied: "At this stage in my life...this process is no longer about money but more about respect and acknowledgement of my accomplishments.... Boards have been placed under enormous pressure by the left wing antibusiness press and the envious leaders of unions...'."

Source: WSJ.com

The consultant expressed "disappointment" at the Board's actions. Wow.

(There was a fourth consulting firm involved as Countrywide's consultant to the Board Committee which is mentioned in their most recent proxy statement.)

"Lawmakers have argued that these consultants are merely getting paid to tell the board and CEO what it wants to hear." - Cnn.com

Apparently the Board was told by two, maybe three, different consultants that Mr. Mozilo's pay was too high. The Company even incurred the additional expense to file an amendment to its proxy statement with nice charts showing how Mr. Mozilo's pay was going to be lower under his new contract than under this old one.

Why does this really matter? Because a few companies with questionable pay practices end up in a Congressional hearing, which then leads to legislation regarding executive pay. That legislation is typically ill-conceived, fails to achieve its objective, and creates additional cost and constraints for all of the other companies. Like Sarbanes-Oxley, a law reacting to a few big companies' missteps penalizes thousands of smaller companies who have done nothing wrong. And that has a negative impact on American businesses, their employees, and our economy. I suppose in an election year I should claim that my position is "patriotic" but it's also one shared by many investors and even some other compensation consultants.

Who ever thought compensation consultants could have such an impact?

Disclosure: I am a shareholder of both Washington Mutual and Countrywide Financial but do not believe my financial interest in those companies influences the opinions expressed here. I do believe, however, that executive compensation practices directly impact shareholder value. I suppose I also should disclose that I once worked for Towers Perrin but never worked for the three other firms cited in the news today.

A Week Late but Never a Dollar Short, in Fact...

A Week Late but Never a Dollar Short, in Fact...
Fred Whittlesey
Compensation Venture Group, Inc.


The U.S. House of Representatives Committee on Oversight and Government Reform will hold a hearing titled, “Executive Compensation II: CEO Pay and the Mortgage Crisis” on Friday, March 7, at 10:00 a.m.

I hope it's on CSpan, even though I have never watched CSpan. But if I wanted to start watching a Congressional hearing at 7:00am Pacific Time, which I probably wouldn't, I'd know that my government is providing such access. These things are always archived on the web for later viewing anyway. No doubt YouTube will have it although I am concerned that explicit discussion of executive compensation could violate their obscenity standards.

The list of those testifying can be viewed here and a little background on the topic here. In the hearings will be CEOs and Chairs of Compensation Committees from Merrill Lynch, Citigroup, and Countrywide. I would add one more to the list but couldn't find a link allowing such suggestions other than the "contact us" link on the Committee's website and who knows who actually reads those.

Because it seems that while they're on the topic of the mortgage crisis they wouldn't want to exclude Washington Mutual, here in Seattle our local poster child for the mortgage crisis, destruction of shareholder value, and continued delivery of lucrative compensation to those responsible for the crisis and destruction. While other banks fired their CEOs, triggering big payouts, WaMu doesn't require them to be fired in order to continue receiving high levels of compensation unrelated to performance. Read on.

The furor had barely died down over the last SEC filing disclosing WaMu's equity compensation grants to executives - hidden beneath the misleading headline suggesting that the CEO had given up his bonus for the year. This, by the way, raised the question of why he should have been getting a bonus in such a disastrous year. The answer: That's how the plan operated - we did the calculations and despite the clear disaster, the plan didn't seem to think it was a total disaster.

Which leads right into the latest controversy with Monday's filing: The 2008 bonus plan pays the executives a bonus if certain parts of the income statement are positive, even if the company loses money. Worse, the plan will allow the Compensation Committee to subjectively override any formulaic outcomes. And, those overrides could be up or down.

And, that subjective discretion costs WaMu shareholders because that renders the plan - which is not a plan but just a fancy discretionary bonus - nondeductible for tax purposes. At the target amounts disclosed that could cost WaMu shareholders about $3 million in lost tax benefits. But I suppose that's not "material" for a company, and management team, that destroyed about $25 billion dollars in shareholder value last year.

And, I could tell you a lot more about the corporate governance issues reflected in these plan designs but I won't. Let's just say that on our firm's Compensation Integrity scoring system that has a scale of 1 to 100, we're exploring how to accommodate negative numbers because we wouldn't want to exclude any companies due to system limitations.

Look Who's Coming to Dinner..or maybe a late continental breakfast

Look Who's Coming to Dinner..or maybe a late continental breakfast
Fred Whittlesey
Compensation Venture Group, Inc.

After the last entry "Change is Possible" - check this out:

Committee to Hold Hearing on CEO Pay and the Mortgage Crisis

The Committee on Oversight and Government Reform will hold a hearing titled, “Executive Compensation II: CEO Pay and the Mortgage Crisis” on Thursday morning, February 28, 2008, in 2154 Rayburn House Office Building.

The hearing will examine the compensation and retirement packages granted to the CEOs of three corporations deeply involved in the current mortgage crisis. This will be the Committee’s second hearing on executive compensation practices. On December 5, 2007, the Committee examined the role of compensation consultants in determining CEO pay.

Note that one of those "three corporations" happens to be Countrywide Financial.

I am no fan of government intervention (and not much of a fan of government in general) but this is very interesting and should make for some great executive pay drama on C-Span. Like the cast of "Guess Who's Coming to Dinner" the list of "witnesses" is an all-star cast. (Boy, doesn't "witnesses" make it sound like a criminal trial? - Yes, your honor, I DID SEE him exercise those stock options.) The who's who of highly-paid executives, people who approve the pay for highly-paid executives, and people who don't really like highly-paid executives should make for an interesting broadcast which likely is the real objective of the Committee. In an election year. Pardon my cynicism.

I hope they're serving some nice coffee and pastries at this hearing because these executives are accustomed to quite a nice set of perks, which won't be detailed here because I'm not interested in inflaming the issue. But it is fun to read last year's proxy statements and see the details of their perks. Before they got fired.

Not to diminish the quote of Neil Armstrong, but this hearing is yet another small step for executive pay awareness but probably no giant leap for executive pay reform. Because the latter will require some big changes in how Compensation Committees, compensation consultants, and management teams interact. And so far those changes are about as far along as civil rights were in 1967, the year "Guess Who's Coming to Dinner" won an Academy Award. Yes, we already had the Civil Rights Act of 1964. But we know all about the time lag between ceremony and legislation and real change.

As Tillie said, "Civil rights is one thing. This here is somethin' else." Yes, high pay for executives is one thing, but what we'll hear about is this hearing is indeed somethin' else.

Change is Possible

Change is Possible
Fred Whittlesey
Compensation Venture Group, Inc.


Just a quick update. I've included the links so that you can view the original story.

13 January 2008
Los Angeles Times
For CEOs, Failure Can Be Lucrative

"This is another clear example of pay for failure," said Fred Whittlesey, principal consultant with Compensation Venture Group in Seattle. "How many more examples of this will we have to see before this gets fixed?"

"Every year, there's more talk about boards getting tough," said Whittlesey, who is a Countrywide shareholder. "But every year, they keep saying yes to these contracts."

14 days later...

27 January 2008
AP
Countrywide CEO Mozilo Will Give Up $37.5 Million in Severance Benefits

"Countrywide Financial Corp. CEO Angelo Mozilo, under fire over the size of his potential payout from the proposed sale of his troubled mortgage company, says he is forfeiting some $37.5 million in severance pay, fees and perks he was scheduled to receive upon his retirement. 'I believe this decision is the right thing to do as Countrywide works toward the successful completion of the merger with Bank of America,' Mozilo said in the prepared statement."

And then there's this one...

23 January 2008
Seattle Times
Wamu Leaders to Profit Even if Stock Stays Low

"That rationale was condemned as "outrageous" by Fred Whittlesey of Compensation Venture Group, a Seattle-based executive-compensation consulting firm. All shareholders should hit the roof when they see what they've done here," said Whittlesey, himself a WaMu stockholder. They've created another layer of poor compensation policy on top of the existing poor compensation policy. Rather than setting the options' strike price at Tuesday's closing price of $14.77, Whittlesey said, WaMu's board should have set it at $40 — the stock's approximate price before last year's swoon. One of the things you don't do with stock options is give them to people who drove the shares down so they can profit by bringing them back up," he said.

Let's watch the headlines.

Bwaa-hah-hah-hah! Truly Scary Compensation Stories

Bwaa-hah-hah-hah! Truly Scary Compensation Stories
Fred Whittlesey
Compensation Venture Group, Inc.

Yes, Halloween is a favorite holiday of mine and what a gift to have a couple of frightening stories appear in the media in the last few days.

Now, I think it’s important that compensation experts continually explore data, testing relationships between executive pay and shareholder value. I also think it’s important that so-called experts have some modicum of ability to interpret data and, more importantly, not be inclined to reverse-engineer their analysis to support a predetermined point. But unfortunately what I think about that and what continues to happen are quite different. (Costume idea: Pollyanna)

The first story: “Companies using compensation consultants pay CEOs more with no shareholder benefit, says study.” Oh, the horror, the horror. This “study” is filled with so many flaws, non sequiturs, and misinterpretations that I don’t know where to begin. It scares me that such flawed research, conducted by The Corporate Library (whose well-known axe grinding about executive pay is notoriously one-sided despite their claim of being the "independent and objective") can make the headlines in a fine publication like Financial Week. I have not seen the study itself, however, (because I wouldn’t pay good money for something like that) so perhaps it is the writer’s interpretation of the data that is the problem. That’s scary in its own right as few will read the study but many will repeat the headline they read. (Costume idea: parrot)

The study’s key conclusion according to Financial Week: That companies using compensation consultants did not have any better shareholder returns than companies not using (or at least not disclosing the use of) compensation consultants. I didn’t know, as a compensation consultant, that I was personally responsible for shareholder return but if it turns out that I am, boy will my hourly rate go up tomorrow. Either that or I ask for a percentage of the increase in shareholder value. Kind of like those private equity firms that get 20% of the gains, and 1% regardless of gains. To think I've been charging by the hour all these years. (Costume idea: Private equity guy with bulging pockets and cigar)

The scary comment directly from the source of the study: “Consultants do not increase the effectiveness of incentive plans.” “We did see some patterns” said Alexandra Higgins of the Corporate Library. I see some patterns, too, Alexandra. Bizarre patterns of thinking that link “incentive plan effectiveness” with “shareholder returns” and “the use of compensation consultants.” (Costume idea: Picasso painting)

Here’s one thought: what if the use of compensation consultants is normally distributed across companies based on their shareholder returns? Then, on average, companies with consultants and companies without consultants should have the same return. Apparently the problem is that as soon as the consultant enters the picture, we are so brilliant in designing executive compensation programs that shareholder return should immediately improve. And if a company underperforms then they’re not entitled to professional assistance with the complex topic of executive pay. (insert scream soundtrack here) Let’s not give any consideration to past returns, industry sector, market cap, or any other relevant factors because that might ruin the predetermined conclusions that the only thing worse than executives who get paid are consultants who work for them. (Costume idea: Larry, Curly, and/or Moe)

Four days later, Financial Week published the headline “Comp consultant: CEO pay gains among Dow 30 in line with stocks’ performance.” Ah, much better. Now we know that executive pay is really OK. Except that upon further scrutiny this consultant’s analysis apparently shows that CEO pay in those 30 companies grew 15.1% annually for the past 10 years while compounded shareholder return grew by 12.1% during that time. His opinion is that CEO pay “only modestly” outpaced returns. A little arithmetic highlights the result that CEO pay went up 4x while shareholder value went up 3x during that time. That’s a “modest” difference? Those private equity fees are starting to look more reasonable. (Costume idea: Gordon Gecko)

But I really loved this compensation consultant’s point that this was an important analysis because the Dow 30 companies are “where the trends typically come from and a lot of the (other companies) follow suit.” Yeah, right. Those gigantic mature no-growth firms certainly set the pace for the several thousand entrepreneurial growth companies in America. (Costume idea: Arnold Schwarzenegger and Danny Devito as Twins)

I don’t know whether to be scared that someone like this actually gets media coverage, or to just burst out laughing. No, I’m scared that someone either really believes that or, worse, has some bizarre motive for saying it anyway. Yet some CEO somewhere will think he or she is underpaid because they don’t have a pay formula that gives them pay increases of at least 133% of the rate of total shareholder return. Ah, to work for Google with a deal like that. (Costume idea: Nerd executive in Lamborghini)

I wish that such frightful lapses in analytical ability, common sense, and objectivity were limited to the Halloween season but unfortunately we’ll likely continue to see them for months and years to come. And that gives the real experts plenty to write about and plenty to fix. And yes, I make a living doing both but still only get paid by the hour. (Costume idea: Superhero in business casual, with eyeglasses)

The other scary story this week was the “say on pay” debate but that’s too frightening to even consider discussing in the same Halloween blog. Maybe that’s a topic for All Saint’s Day, which is apparently when shareholders expect boards of directors and executives to be honored once we compensation consultants figure out how to guarantee incentive plan effectiveness and above-average shareholder returns. (Costume idea: Barney Frank)

Pay Granted, Earned, and Paid: Bubble, Bubble Toil and Trouble?

by Fred Whittlesey
Compensation Venture Group, Inc.

The actual line from Macbeth was, of course, “Double, double toil and trouble.” Factual documented information often gets twisted into a widespread misunderstanding. And so we have executive pay.

For the past twenty or more years the media have reported executive pay as a “story” worth covering. This has escalated over the past few years as the topic has moved from the business section to the front page. There are a couple of reasons for this. First, the numbers are bigger. Apparently it’s more interesting to read that someone was paid $210 million than it is to read that someone was paid $10 million. Second, the reason for the pay has changed. $210 million for getting fired versus $10 million for running a successful company does indeed have a human interest angle.

But where do these numbers come from and how do we know they are right? The answers to that compound question are “the proxy statement” and “we don’t.” The SEC’s new proxy disclosure rules changed the Summary Compensation Table (SCT) from a report of apples (dollars earned and paid), oranges (dollars contingently paid), and bananas (stock options granted – the number, not the value) into a recipe for vegetable stew (accounting expense) – which would be alright if we were looking for vegetables, but we were really wanting to know about fruit.

Here is the root of the problem:

Most compensation professionals were trained, and continue to believe, that the amount granted in a single year, regardless of contingencies for future vesting or performance, is “pay” for that year. We do need to value those grants. By way of example, Steve Jobs, CEO of Apple was “paid” only $1 (there are no missing zeroes, there, just one dollar) in 2006. He received no bonus, no stock option grants, no stock awards. Just a buck.

The new SCT portrays what the accountants recorded as an accrued (read: estimated or hypothetical) and thus earned expense for the year. Some joke that the SCT now stands for “Summary Cost Table” but it is not that either unless your only view of “cost” is accounting expense and shareholders are move savvy than that. We do need to decide if the accounting numbers are useful in valuing those grants. Under this method, Steve Jobs was paid $1 plus the portion of the $577 million in restricted stock that he “earned” during the 2006 fiscal year. We'll know that number when Apple files their next proxy under the "new rules."

The media, of course, like to report what was paid, even if that represents an accumulated amount based on 10 years of work. Those big numbers sell newspapers. I think we can conclude that these numbers are far removed from any single year’s grants. Under this method, Steve Jobs was paid $577 million in 2006...oops, $577,000,001. We could talk about Mr. Jobs other job, as CEO of Pixar, or his Gulfstream, but we'll leave those for another blog day.

The Jobs/Apple example is extreme enough that it invites more scrutiny. But what about the CEO of one homebuilder whose three numbers for 2006 are $2,015,499 granted, ($2,296,918) earned, and $7,903,997 paid. Negative compensation? That guy must have had a really poor year but fortunately was “paid” almost $8 million in a year in which he “earned” negative $2 million.

This can make one feel like all of this data more witches’ brew than vegetable stew, and impossible to digest. Compensation professionals have never faced such a large amount of such confusing information. I think it is a fair estimate to say that it is at least “double double toil and trouble” to analyze executive pay. Shakespeare saw it coming.

It’s critical that a company and its Compensation Committee take a position on how pay is measured and use that consistently in benchmarking, analysis, and the decision process. An appropriate data collection strategy focused on the most recent data available, combined with attention to details of compensation design, will cut through the confusion and tell the correct story. Data from SEC filings is the most valuable and most accurate data available for executive pay, and it’s worth the toil and trouble.

Next blog: An example of the measurement problem