Almost overnight, a new phrase — realizable pay — has emerged as companies seek a better way of explaining to shareholders what executives can potentially gain from their stock grants.
Confusion often arises from the summary compensation table in proxies, where companies are required to list the grant-date value of options — not what the executive ultimately earns.
“The proxies only report the value of what's been granted,” which can create the appearance of high pay compared with what the executive ends up earning, based on the actual performance of the company, said Andrew Goldstein, a practice leader for executive compensation in the Chicago office of New York-based Towers Watson.
Christine Oberholzer Skizas, a partner in the Chicago office of New York-based executive compensation consulting firm Pay Governance LLC, agrees.
“If equity is never earned, then that amount in the summary compensation table could turn into zero for some people,” she said. “So companies are presenting information in their proxies [based] on what the realized pay is vs. what the pay opportunity is.”
Each organization or executive compensation research or advisory firm uses a different formula. But essentially the common denominator is that they typically replace the grant-date value of the equity with some calculation of the real value held by executives from recent equity grants.
For example, executive compensation research firm Equilar Inc., based in Redwood Shores, Calif., adds base salary, cash bonus payouts, all other compensation and the intrinsic value of all equity grants given in the previous three years — rather than the grant-date value of that equity — when it calculates a number for total compensation that incorporates realizable pay.
Similarly, Pay Governance calculates the total by adding actual cash compensation earned, current value of restricted shares, actual payout from performance shares of cash, aggregate value of in-the-money stock options and the estimated value of outstanding performance-share or performance-contingent cash.
“We are seeing companies try to communicate the actual value — not just the target value that is in the summary compensation table — because the stock price at the time the grant is exercised is what [determines] the value of the equity that a person is holding,” said Aaron Boyd, research director for Equilar.
Towers Watson's Goldstein agrees that there needs to be a high correlation between pay and performance.
“We all agree with the realizable pay concept,” he said, “but the debate is how we will measure that pay that's been earned and whether there is going to be a standard.”
That will be “the next significant battleground,” said James Reda, managing director of compensation consulting firm James F. Reda & Associates LLC in New York.
“Do you look at opportunity pay, realizable pay, or the actual pay that ultimately is earned? When you look at what was actually earned or realizable pay, there is a very high correlation between pay and stock price,” he said.
Methods of calculating realizable pay include: measuring stock options based on gains made in the year they are exercised, averaging gains over the period of time they could have been exercised, calculating gains based on what they might have been had they been exercised annually, calculating them in the first year they could have been exercised, or calculating them each year as if all the grants in a three-year long-term incentive plan had been exercised that year.
“While not perfect,” said Pay Governance, “we think that a direct comparison of realizable pay to company performance during set periods has the capacity to measure performance on a relative basis and allows for a direct test” of whether a compensation plan is properly tied to performance.