The Advisors' Blog

– Ira Kay and Steve Seelig, Watson Wyatt Worldwide

We read with interest Broc’s post about the “debate” on whether CEO pay went up or down during 2008, and the have a very short answer to that debate: Our research finds that CEO pay levels have declined no matter how you measure it.

Oh, were there not apples and oranges. We’ve blogged here before on how we think equity values should be measured. Not based on the grant date value for accounting purposes used by the Associated Press in their reporting (and soon to be required by the SEC per Mary Schapiro’s most recent comments) and most certainly not based on the number the SEC currently requires to be shown on the Summary Compensation Table (the value recorded for the year on the financial statement). Either of these measures is just the opportunity being granted to the executive for the year. We think the real equity value earned for the year is what the executive gained or lost based on how the stock price changed for the year on outstanding grants and those vested for the year, something we call “realizable pay.” We’ve written about this concept in a recent Watson Wyatt Insider article and intend to ask the SEC to consider using this approach on the Summary Compensation Table as it revisits the disclosure rules.

Any study that measures CEO pay levels based on grant date values from the start of the year, but then measures whether they match the value delivered to shareholders as of year-end must be viewed with some skepticism. Stock values need to be measured on an apples to apples basis. This is not to say there’s no room for criticism if there are higher pay opportunities granted for the 2009 fiscal year or when 2008 year-end discretionary bonuses are paid when the company performed poorly.

So what does the data say about 2008 realizable pay and 2009 pay opportunities?

1. 2008 Realizable Pay: In a soon to be released study, we looked at pay levels of 80 CEOs and found the typical CEO saw a decline of $39 million or 53 percent in value for pay realizable in 2008, with a drop in annual bonuses alone of 24 percent. These declines in pay opportunity and realizable pay are proportionate to the companies’ stock price declines. The analysis also found that despite a moderate stock market rebound in recent months, the typical CEO lost an additional 21 percent in equity value for existing holdings in the first three months of 2009.

2. 2009 Pay Opportunity: Based on a review of Form 4 filings during the first quarter of 2009, we found the long-term incentives granted to CEOs for 2009 declined 17 percent in dollar value from values granted in 2008, even though there was an 25 percent increase in the number of shares granted to account for stock price declines. This reflects that companies did not stick with a pure economic value approach to equity grants and recognized a need to cut back on grants to recognize poor performance during 2008 and to mitigate potential gains should the market rebound.

In a separate survey of corporate directors just released, more than a third (34 percent) of directors said their companies had already reduced salary, target bonus and/or long-term incentive award levels. Six percent plan to make those changes in the next six months and another 48 percent are considering making them.

Our research reflects that the so-called “ratchet effect” for CEO pay, whereby pay levels only increase as companies chase the illusive ever-rising median, does not exist in our current down market. If and when the stock market recovers over the next few years, we think we will see an uptick in pay opportunity and realizable pay.