The Advisors' Blog

– Broc Romanek

Here’s a note from Pearl Meyer’s Dave Swinford in response to this blog:

A recent Wall Street Journal article proclaimed, “Best-Paid CEOs Lag in Results, Study Says.” The article was based on an MSCI study titled “Are CEOs Paid for Performance? Evaluating the Effectiveness of Equity Incentives.” The article essentially, said two things: 1) the summary compensation table (SCT) in proxy disclosures does not predict what executives will actually receive; and 2) three years is not a long enough frame to measure the relationship between pay and shareholder returns.

This is not news.

Everyone in this business knows that the SCT measures accounting cost, not compensation actually paid or received. Three years is simply not long enough to get a good read on management’s long-term performance. The MSCI report makes these points, but then goes on to provide the headlines that excite the press.

MSCI argues that we should measure and report realized pay—something that a number of companies already do in their proxies. However, the authors of the study did not examine that, probably because the analysis would be extraordinarily time-consuming and complex.

There are other more important and relevant points we should glean from the MSCI study:

1. The SCT was not designed as a pay-for- performance (PFP) analysis tool. It started out as a measure of compensation expense when the SEC took an accounting approach to the compensation disclosure issue. However at that time, PFP was not the focus that it is today.

2. Corporate governance professionals and Congress (through Dodd Frank) are asking the proxy statement to provide information that current disclosure rules were not designed to provide, so we need something different, like realized pay.

The headlines make it sound as if executive pay is flawed, but the study says that the reporting of executive pay is flawed for the purpose of analyzing the relationship of pay- to- performance. That’s a big difference. Until we move away from SCT definitions of pay, and extend the time frame of evaluation to a minimum of five years, we will not be able to properly assess pay vs. performance.

A good analysis of PFP requires looking at financial performance beyond Total Shareholder Return (TSR) because TSR is impacted by many outside pressures over three- to- five-year time frames. Earnings growth and return on capital measures are far more indicative of management’s recent performance than TSR. They indicate fundamental company health, and both are more substantially within management’s control.

This is why the alternative measure reporting in the proposed SEC rules on pay versus performance is so important—TSR is not the answer for the time periods that we have been measuring. Until we sort out the basis for making pay versus performance comparisons, we will continue to debate CEO pay without the benefit of relevant or accurate facts.

Also see this rebuttal to the MSCI study from Pay Governance…