A Sample Tally Sheet – And Analysis of How to Use It

Richard Wagner is President Strategic Compensation Research Associates (SCRA) and Author/ Editor of the "Executive Compensation 2004 Guide"

Below is a sample tally sheet that compensation committees can use to help keep track of what payments are due to be paid to the CEO under various circumstances. My assumptions and thoughts are at the bottom:

Components

My estimates above reflect the following assumptions and thoughts/considerations:

Assumptions:

1. CEO appointed at age 47, 5 years ago, will work next 7-10 years

2. CEO has averaged bonuses at mid-point and deferred ½ of bonus and all of LTI

3. Investors expect about 12% per annum stock price gain, hence their target for 5 years hence is $ 50, and for 10 years is $80 per share

4. CEO receives 5% salary increases, achieves bonus & LTI mid-points, defers ½ of bonus and all of LTI over 10 years

Commentary:

Using the facts in the assumptions above as an example, any of the supposedly "arcane" components of the total package can be illustrated.  If an investor buys the company’s shares expecting an increase from $30, to $50, or to $80 because he/she expects P-E multiples to double in 3-7 years, even if management just holds its own or loses revenue or earnings, then the package may be excessive.  On the other hand, if the investors expect management to outperform the market in revenue or earnings, with declining multiples, then perhaps the cash portion is not rich enough and the equity component is less important.

Pension, SERPs, and other deferred compensation are the most telling aspects of the package.  Deferring ½ of annual bonus, plus the proceeds of the LTI will create a liability of $1.2 million at the end of the third year.  At 5% per year for 5 years, that would be a $1.6 million accrued liability.  However if the stock price appreciation is followed, the liability could grow to over $3 million or more.  By retirement or termination 7-10 years hence, the deferred compensation payout could be over $5 million.

Early cash-outs from deferred compensation accounts are under close scrutiny in the Treasury Department, and the Congress.  It was the most unsettling of pre-bankruptcy abuses at Enron and Worldcom.

A general rule of thumb on lump sum valuation of SERPs is that at age 65 the lump sum is 10 times the annuity.  At age 57, that could be 15 or 20 times, especially with low market interest rates.  In the example above, the final average pay (salary and bonus) would be about $1 million.  A 50% SERP at age 57, could have a lump sum value of over $10 million or more.

Using this type of example can also be used to "tally" the change of control protections and Rabbi Trust implications of a total pay package.  With 5-10 years of accrued liabilities, and of stock/stock option grants, the numbers become clear.  Adding the acceleration effect of the prior 5 years of unvested options to that amount is easily understood with a spreadsheet.  At any point in time, our typical CEO has 150,000 options, priced over the past 5 years, which are not yet vested.  The "in-the-money" value at $50 to $80 per share could range from $780,000 to over $5 million (if the stock shot up to $80 at the end of the period).

Change of control severance levels of 2-3 times pay, PLUS the acceleration of 3 years LTI, PLUS the acceleration of stock or stock options not yet vested, PLUS the cash out of prior deferrals, PLUS the lump sum payout of a SERP, are all understandable - but extraordinarily large nonetheless.

The biggest disaster of the NYSE/Grasso fiasco is that the "prior deferrals" argument fell on deaf media ears.  It was NOT the fault of the SERP or of the deferred compensation - but the fault of the huge run-up of bonuses combined with the favorable "Best 3-of-the-last 7" year formula, as well as the "retire while still employed" attempted gamesmanship.  Now, it should be clear that every component of each CEOs total final package should be scrutinized, not just the equity-driven option and restricted share gains.

At a NASPP conference, I have said, "How about a Proxy Statement designed to COMMUNICATE WITH SHAREHOLDERS?  Wouldn’t that be a novel concept?"  Well, we’ve all brought this negative attention on ourselves with decades of attempted obfuscation.  Now’s the time to produce real disclosure.