Executive Pay Through the Lens of Actual Pay

The SEC recently announced rules implementing the pay-versus-performance disclosure requirements of the Dodd-Frank Act [§953(a)] which mandate disclosure of the relationship between “executive compensation actually paid” and financial performance and stock price.  The SEC’s final pay-versus-performance rule requires a complex calculation to determine a version of realizable pay, termed compensation actually paid (CAP), representing the latest effort to provide shareholders with a standardized approach to assessing pay for performance.

While many investors may see this as an improvement over the use of the Summary Compensation Table as the basis of pay for analyzing pay for performance, a recently published academic study from the University of Connecticut School of Business, Information in CEO Take-Home Pay, provides an analysis of LTI awards based on financial objectives that were granted by S&P 500 companies over the period 1996 to 2011 (2,262 such awards). The report concludes that actual payouts received from long-term incentive plans provide investors with valuable insights as to the performance of executives and avoid the potential for “biased conclusions” based on estimated values of long-term incentives.  

With the increased portion of CEO and NEO pay represented by long-term incentives, and the growing “gap between reported compensation, and actual take-home pay,” the authors content that actual payouts earned under such awards reflect the extent to which executives are meeting the expectations of the board and achieving established performance objectives. The authors note that “[t]he findings suggest that the current practice of extrapolating executives’ payout-for-performance relation from the reported expected values (of LTI awards) could be misleading.”  

However, a potential shortcoming of the study is the limited focus on the correlation of pay and accounting-based measures of performance, rather than including relative TSR, the most prevalent metric in LTI awards, although the study finds that when accounting-based LTI awards pay out at or above target “the stock market reacts positively.”

Recognizing there is no one best way to assess pay for performance, the results of this study provide an alternative, and potentially helpful, lens through which investors can evaluate the relationship between CEO pay and performance.