CEO Compensation Becomes Incomprehensible

The New York Times and The Wall Street Journal each published their list of the compensation packages of the CEOs of the 200 largest companies, although each defined this group differently.  Some of the disparity came from the fiscal years that each list covered. More troubling, other discrepancies had to do with different interpretations of the corporations’ proxy figures. Larry Ellison of Oracle (ORCL) is at the top of The New York Times list with a total compensation of $84.5 million. Oracle’s fiscal year prevented him from making the WSJ list at all.
Compensation for some CEOs who did make both the WSJ and The New York Times was different on the two lists. Some of the differences were minor, less than $1 million in most cases. But in a few others the spread between the Times and the Journal’s number was significant. Mark Hurd of Hewlett-Packard (HPQ) was paid a total of $11 million according to the WSJ. The Times reported that the number was over $24 million.

It is hard to imagine how investors, even professional ones, can accurately calculate chief executive compensation at big companies if the first-rate analysts who work for the media cannot. The difficulty is rarely due to the base cash salaries the CEOs receive or in their bonuses. The almost impossible valuation task is based on stock grants and options that are given to executives. The rules set out by the SEC for management pay disclosure in proxies is byzantine and makes it harder for shareholders to analyze whether the compensation packages of their management teams are fair based on a company’s performance. The entire movement to allow shareholders a larger voice in determining executive pay must be based on the foundation of compensation disclosure. If the numbers are incomprehensible, the ability to decide whether pay is fair will be impossible.

Hurd of HP is a case in point. The computer company’s proxy said he made $1.3 million in base salary in 2009. His bonus was $1.2 million. The problem with accurately evaluating Hurd’s total compensation occurs because the company shows that he made $10.2 million in stock awards, $2.5 million in options and $14.6 million in non-equity incentive plan compensation. HP explains its compensation packages based on a complex model that makes it difficult for shareholders to interpret the difference between what the value of compensation for management is defined by SEC rules compared to the company’s own valuation of the awards. Referring to the work that the proxy’s authors have done for stockholders, the document says, ‘The table below shows the Committee’s view of the compensation that it awarded the NEOs in fiscal 2009 under the policies and programs described under “Compensation Discussion and Analysis” reflecting HP’s strong emphasis on variable compensation and its pay-for-performance culture. Because such a high percentage of HP’s CEO compensation is stock-based, and because applicable SEC rules require stock-based compensation to be reported based on what is expensed for financial statement purposes, this alternative table is provided as a guide to understanding the difference between the Committee’s actions with respect to NEO awards in fiscal 2009 as described under “Compensation Discussion and Analysis” and the amounts required to be reported in the Summary Compensation Table.”

Put another way, HP has told its shareholders that the government regulations for setting value on incentive compensation are useless, so the company has provided its own. Unfortunately, the firm’s analysis is more complex than that of the SEC.

None of the SEC reporting standards gives shareholders enough information to divine what a CEO makes over time, especially from stock options and retirement programs. The rules attempt to get the best “guess” from public companies based on arcane calculations. The results of those calculations are only good insofar as the stock market’s predicted stability is. A CEO could get a 10 million share option grant at a $5 price point. If the company’s stock goes to $1 and stays there for the duration of the grant, the options are probably worthless.

The SEC would do public company investors a favor if it set up rules that forced companies to show the range of what a CEO would make over time if the stock rose during his tenure. This is less arbitrary than setting a fixed value on the shares at the time of the grant, even if the complex calculation is accepted by both the accounting profession and the SEC. An investor, even a sophisticated institution, would rather know what a CEO makes if his company’s shares rise 50% than what an actuary has concluded using an abacus.

Douglas A. McIntyre

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