The Advisors' Blog

– Fred Whittlesey, Hay Group

I think most of us see at least one media story per week (or per day) about executive pay which so severely misinterprets the data that we cringe. I have ranted a couple of times on this blog and others on this topic.

A few years ago, I was speaking at the NASPP Silicon Valley Chapter annual conference when a media story that morning had concluded that (1) a certain Valley CEO had received a 90% pay cut from the previous year and (2) this was a clear indicator that CEOs across Silicon Valley would be taking massive pay cuts. It was a bit awkward to cite that story in the introduction to my presentation knowing that another writer from that publication was in the audience, but it was a great and timely example of my topic that day.

Since then, the changes in proxy disclosure rules led some media organizations to rethink their executive pay interpretation and reporting policies and practices in the interest of responsible reporting. There, I thought, was hope.

But a couple of weeks ago, it was déjà vu all over again. The story reported that a Silicon Valley technology company “cut” its CEO’s compensation “by about half.” Well, that’s a story that I’m not only going to read, but am going to research for myself. In the ongoing crisis-fueled executive pay frenzy, this is critical because next week I’ll be in some boardroom and some director will ask me about those big pay cuts that CEOs are receiving and the CEO in the corner will be waiting eagerly for my response.

True, “pay” as measured by this media organization was in fact lower this past year in comparison to the previous year. But the truth of the article ends there. All three facets of executive pay interpretation – collection, valuation, and reporting – were seriously flawed.

The collection issue was easy to discern. The CEO had been promoted in January 2008 in a company with a fiscal year ending on July 31. That gets ugly right away. So base salary went up, as reported in the Summary Compensation Table, but that was a full-year CEO salary compared to a half-year CEO salary the year before, and his salary amounts received were not increased by the 5% reported; it was not increased at all last year after the 33% base salary increase as a result of the promotion in January 2008.

Annual incentive earned and paid for the year did indeed go down “by about half” but the CEO had received a substantial additional discretionary bonus the year before, almost doubling the amount versus his target, by discretion of the Compensation Committee. Was this related to his promotion? Difficult to discern, but his 2009 bonus was only about 14% below target. Whether he’s feeling that year-to-year change was a “pay cut” is questionable.

But here’s the kicker. The proxy disclosure clearly states that the individual received an additional equity grant relating to his promotion last year with a grant date fair value of $6.2 million. How should such promotion grants be treated in pay analysis? Did he get a “pay cut” because he was promoted to CEO last year and didn’t get a promotion this year? Where would he go from here? (One thing that did not complicate this analysis was that the Company’s stock price on the grant dates in the two years was virtually the same, so we don’t get into that debate.)

Another pay action that didn’t fit into the pay tables, and could be deemed a pay “increase” that year was the Compensation Committee’s decision to make changes to the performance goals for the performance RSUs . This is the performance share equivalent of an option repricing. The goals were missed, so the goals were lowered. Where do we put that? It’s shown as the “new” grant for the second year. This highlights both the collection and the valuation issue. Would that have been captured in a survey or proxy database? Doubtful. Given that this is a repriced grant from the prior year and no other equity grants were made in the past year, it could be deemed a 100% pay cut in equity.

Finally, two grants of RSUs were missed in the calculation. Oops. A little $4.1 million data collection oversight there.

This media organization did avoid what they said they wouldn’t do, which is to simplistically report the SCT numbers. But where they ended up may have been worse. Collection, valuation, reporting. Reporting a pay cut resulting from a comparison year of a promotion (or new hire), and then missing a significant portion of LTI awards, is an interpretation problem. If you accept their general approach, the CEO really received a 70% pay cut, not “about half.” But nothing was cut.

A friend of mine often cites the line used by construction contractors: “You can have it good, fast, or cheap. Pick any two.” But in executive compensation, we can’t opt out of the collection, valuation, reporting troika – getting two out of three right won’t do. People often have gripes about an experience with a contractor, and executive compensation professionals are quickly headed to that same status if we don’t get better and force the media and pay critics to do the same.

These issues are rooted in the continued practice of reporting year-over-year changes in executive pay as if executive pay were an orderly annual event, which it is not. More on that in the next posting.