Tallying Top Executives’ Total Compensation

Fred Cook, Chair, Frederic W. Cook & Co.

We in the executive compensation community are used to tallying a top executive’s total compensation as the sum of base salary, annual incentive bonuses and the present value of long-term incentives, including stock options, granted or earned for a particular year.  Even this sometimes weighty number, however, overlooks the value or cost of employee benefits, perquisites and retirement benefits accrued for the year.  These are important numbers because they represent what the Board’s Compensation Committee can manage and influence going forward.  But they overlook another important number that the Compensation Committee and the Board should be aware of – the sum total that the company would owe the executive upon a termination of employment.

Critics of American business and executive compensation practices seemed shocked that the Board of the New York Stock Exchange did not realize that it owed Mr. Richard Grasso $139.5 million when he renewed his contract, and might owe him an additional $48 million when he terminated employment.  It was not surprising to me, however, and I suspect to others in the compensation community, that these numbers were not known to the Board or its Compensation Committee.  They are not disclosed anywhere and are often not even tabulated until the event occurs that triggers their payment.

The lesson is obvious.  The Chair of the Compensation Committee should ask the company to prepare a special report every year or every other year enumerating the amount of termination benefits that would be owned to the CEO and other senior executives upon a termination of employment.  These numbers should be tabulated under five termination scenarios:

1. A voluntary quit – In addition to the total amount owed, the Committee should be shown how much the executive would forfeit as unvested benefits ("golden handcuffs")
2. A normal or early retirement
3. An involuntary termination – This amount includes any contractual severance benefits and any accelerated vesting of unvested benefits
4. An involuntary termination for "cause" – In addition, the Committee should review the company’s "claw back" rights
5. An involuntary or "good reason" termination following a change in control – This amount should include the cost to the company of any golden parachute excise tax and gross-up owed

Once reviewed by the Compensation Committee, the report should be shared with the Board in executive session.

The first time around, it may take the staff some considerable effort to prepare the report.  But once the assumptions and format are worked through and accepted, it should be fairly easy to maintain.