Rob Swystun, Pristine Advisers
We start this week’s post with a sad and confusing tale.
This is the tale of Weatherford International Ltd. CEO Bernard Duroc-Danner and his woefully small salary.
Y’see, Weatherford stock prices had been slipping and, in fact, had dropped by 15% over a three year period, according to the company. Its shareholders were understandably perturbed at what they saw as undeservedly high pay for the company’s top executives.
But, as Weatherford pointed out in report to investors in April last year, just before its annual meeting with them, Duroc-Danner was actually earning less than any of his peer CEOs in the energy-services sector, taking home a mere $9.8 million over a three-year period.
That information about the pittance he was scraping by on was located on page 9 of the report, where it was explained that Duroc-Danner’s pay was related to the company’s performance.
All the way back on page 37 of that same report was a different calculation of his pay over that same three-year period. That calculation, included in a box required by the Securities and Exchange Commission, was slightly higher, putting Duroc-Danner’s actual pay at $37.8 million, which was higher than half of his peer CEOs.
So, was this company trying to dupe its own shareholders, then? Not exactly (more on that later, though).
The discrepancy, as reported on by Bloomberg’s Dave Michaels, was due to how the company interpreted the SEC’s currently-unclear rules on how to calculate executive pay.
“The way different companies calculate [executive pay] is all over the map,” says Carol Bowie, head of Americas research for proxy adviser Institutional Shareholder Services Inc. She added that companies interpret things differently in an attempt “to promote the notion that they have good alignment between pay and performance.”
Right now — as mandated by the 2010 Dodd-Frank Act — the SEC has enacted the say-on-pay rule, where shareholders get to have a non-binding vote to either accept or reject proposed pay for top executives. Another rule, proposed this past September, requires firms to report the ratio of the CEO’s pay to the median compensation of all the other employees in that company.
A decision on which method the SEC will require for calculating pay in performance comparisons is expected in 2014. Regardless of which way the SEC goes, it will likely affect how top executives are paid.
And, just because politicians hate it when things are too clear, Congress went ahead and complicated things by making it a law that corporations have to show executive compensation as it is “actually paid.” They were kind enough to not make it clear what exactly “actually paid” actually means, setting off a debate among companies, compensation consultants and institutional investors on how to interpret that.
The SEC hasn’t yet decided what to include in actual pay. That may be because corporations are changing the way they compensate their executives, leaning more toward incentive pay for top executives. Fifty-four percent of companies in the Standard & Poor’s 1500 Index in 2012 awarded CEO pay as long-term stock options. That’s up from 51% in 2008, according to Farient Advisors LLC.
Realized, realizable & total
Part of the aforementioned debate is whether CEO pay should be calculated as “realized” or “realizable” pay.
Realized pay – This counts only what a CEO received over a given period. The people who advocate for this type of calculation say that it is an easily quantifiable and digestible number and it’s the best way to show the relationship between a CEO’s pay and past performance.
Realizable pay – This, on the other hand, adds incentive awards like shares or options onto what has been received, even if these incentive awards aren’t accessible until years later. People who back this type of pay reporting do so because they say it accounts for what is awarded and measures how directors have responded to recent performance.
However, both of these methods are different from the SEC standard of “total pay,” a number that companies have had to include in shareholder reports since 2006. This is the number that appeared on page 37 of Weatherford’s report in our opening tale.
Many companies have complained that total pay is misleading due to the fact that it includes accounting estimates for incentive pay that may pay out differently from those estimates. It also counts changes in the value of a CEO’s pension.
“Looking at the accounting values, which may or may not turn into actual economic gain in the future, really in many instances overstates the amount the executives have actually pocketed,” says Mark Borges, a compensation consultant at San Jose, California-based Compensia.
Among companies included in the Standard & Poor’s 500 Index, 16% included a pay-for-performance disclosure in 2012’s proxy report that varied from the SEC’s 2006 method, according to consulting firm Towers Watson & Co. This lack of consistency hurts the credibility of company-produced figures such as realized pay.
“We really disregard it, honestly,” says Donna F. Anderson, a global corporate governance analyst at T. Rowe Price Group Inc. “I haven’t noted anybody doing a particularly good job of it.”
In the case of Weatherford International, 56% of shareholders rejected the board’s executive compensation plan in a 2011 say-on-pay vote held after the Geneva-based company awarded discretionary bonuses to five top officers despite missing performance targets.
And the next two times Weatherford published proxy reports, the company included a pay-for-performance chart using a calculation of Duroc-Danner’s realized pay. But the firm said in 2013 that his pay was aligned with performance because it was lower than his peers and because he gave back a large stock grant that he could have earned over the next two years.
However, Weatherford’s interpretation of realized pay didn’t match other definitions. The firm didn’t include $17.3 million in stock awarded to Duroc-Danner that vested from 2010 through 2012. And because it didn’t include this, the company calculated Duroc-Danner’s realized pay as $9.8 million.
Other companies, like Exxon-Mobil Corp., do include the value of time-restricted shares in realized pay. These types of shares accounted for over half of Exxon CEO Rex Tillerson’s reported $15.5 million in realized pay for 2012, according to Exxon’s proxy.
Tricks of the trade
There are reporting tricks to use to make a CEO’s compensation look fairer.
In its pay-for-performance section, Weatherford said shares fell 15% in the three years ending Dec. 31, 2012. But, data compiled by Bloomberg show shares fell 37% over that period. To get the 15% number that Weatherford used, the change would have to be calculated from Feb. 15, 2010 through Feb. 15, 2012.
“They’re making the magnitude of the decline in shareholder value look smaller than it actually was, while at the same time making compensation look lower than it actually was,” says Jesse Fried, a Harvard law professor specializing in corporate governance and executive pay, after reviewing the Weatherford filing. “The effect is to boost apparent pay-for-performance.”
So, which way is the SEC leaning for pay calculation? There are indications it is leaning toward realized pay as the standard. The SEC’s director of corporation finance, Keith Higgins, said at a conference last September that the language of Dodd-Frank “talks about compensation actually paid, which seems like maybe it’s realized pay.”
But realized pay, along with its cousin realizable pay, both have shortcomings, even if applied consistently.
During years when an executive exercises a large number of stock options, realized pay can appear to overstate CEO compensation.
For example, under a realized method, Starbucks Corp. CEO Howard Schultz earned $117.6 million in 2012. But $103 million of that came from options granted to him as long as 11 years ago.
“These numbers would show he’s way overpaid,” says Farient CEO Robin Ferracone. “Well, that’s not true. These were earned over eight years. That’s the problem” [with realized pay].
Realizable pay can also yield figures that companies argue are misleading. For example, in 2011, Simon Property Group Inc. gave a time-restricted stock grant valued at $120 million to CEO David Simon, who is eligible to begin receiving the shares if he remains atop the firm in 2017.
Under realizable pay, that grant was valued at $158 million at the end of 2012, boosting his three-year realizable pay to $234 million. In its own presentation of pay-for-performance, Simon Property excluded the grant and measured its CEO’s compensation as $30 million from 2010 to 2012.
“The risk with realizable is that when your stock is doing really well, that number is going to be really high,” Borges says. “That is the biggest problem in this area. No solution comes without its baggage.”
If there’s one thing that is likely to stay consistent regardless of which way the SEC goes on executive pay reporting, it’s that companies will probably still look for loopholes and reporting tricks to make their CEO’s compensation look fair.