Are CEOs Paid For Performance? Evaluating The Effectiveness Of Equity Incentives by MSCI
Ric Marshall, Linda-Eling Lee
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Has CEO pay reflected long-term stock performance? In a word, “no.”
Companies that awarded their Chief Executive Officers (CEOs) higher equity incentives had below-median returns based on a sample of 429 large-cap U.S. companies observed from 2006 to 2015. On a 10-year cumulative basis, total shareholder returns of those companies whose total summary pay (the level that must be disclosed in the summary tables of proxy statements) was below their sector median outperformed those companies where pay exceeded the sector median by as much as 39%.
For long-term institutional investors, this potential misalignment of interests between CEOs and shareholders may undermine the adoption of equity-based incentive pay that has dominated executive pay practices in the U.S. for the past three decades. During the observed period, long-term incentive pay was the largest element of CEO pay, accounting for more than 70% of compensation for both summary pay and realized pay (which incorporates stocks gains realized during the course of the year), according to our calculations.
A large part of the issue is that disclosure rules mandated by the U.S. Securities and Exchange Commission (SEC) focus on annual instead of long-term reporting. Inclusion of certain long-term data, such as a comparison of total summary incentive pay over the CEO’s entire tenure to company stock performance, could help better align the interests of CEOs and long-term investors. In addition, improved disclosure of one-time benefits such as signing bonuses and severance agreements in cumulative totals would likely increase the focus on these often significant pay provisions.
In general, companies very rarely include the sort of cumulative figures in presentations of CEO pay that long-term investors would find most helpful. We derived such long-term measures from multiple filings but we believe the general lack of such integrated disclosure results in an excessive focus on short-term share price gains, at the expense of long-term returns. We suggest several ideas for improvement, such as the reporting of cumulative pay and performance data over the CEO’s full tenure, to reduce the focus on the short term that prevails currently.
Are CEOs Paid For Performance? Evaluating The Effectiveness Of Equity Incentives – Introduction
Few other areas of corporate governance are more hotly or widely debated than CEO pay. According to a recent study published by the Rock Center for Corporate Governance at Stanford University, a majority of Americans believe that most CEOs are “vastly overpaid,” while a majority of corporate directors think just the opposite.
This perceptual disconnect is a persistent challenge. News stories detailing the purported excesses of CEO pay have been featured in the business and general media, particularly when the companies cited were performing poorly.
Despite the negative press, investors have approved the vast majority of U.S. corporate pay plans, often votes ranging from 90% to 95%, since “Say on Pay” voting was mandated the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.
Has CEO pay reflected the companies’ stock performance? The seeds of this debate were first planted over 30 years ago, when shareholders and others embraced the idea that CEOs and other senior executives should be rewarded primarily in some form of company equity. In theory, such rewards were intended to convert these corporate agents into corporate principals, and thus ensure the alignment of their personal interests with those of the company’s shareholders. In combination with accounting treatment that favored stock option grants, this notion almost certainly helped fuel the internet-based high tech revolution and subsequent hi-tech bubble of the late 1990s. Even today, long after such favorable accounting treatment has been eliminated, equity awards continue to account for 70% or more of the CEO’s total pay package, based on our calculations.
What do we even mean by “CEO pay”? The total pay figures reported in standard summary compensation tables mandated by the SEC include a combination of prior year base salary benefits and bonuses, plus any forward-looking equity incentive awards made that year. Should we really include such awards, which may or may not be realized, in our assessment of current pay?
These are not the only figures to consider. In reality, CEOs almost never realized the exact amount reported in the summary table, based on our sample period. Moreover, the value of these awards as reported is based on the share price of the company’s stock as of the date the grant was made, usually referred to as “grant date value,” in keeping with SEC requirements. Thus, the reported value of last year’s stock awards may be higher or lower than the previous year’s awards, even if the number of shares granted is exactly the same. Our research indicates that many individuals for whom other executive pay research firms have reported a decline in 2016 reported summary pay actually experienced a net increase in year-over-year total realized pay — that is, how much the CEO actually took home when equity gains are considered.
When it comes to CEO pay, directors see a detailed and transparent process at work — an efficient, well-oiled machine. In contrast, the public — and many investors — often see a complex array of figures and terminology that vary considerably company by company. Is it any surprise that the public cannot help but wonder if this particular machine wasn’t designed by a modern day Rube Goldberg?
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