Are CEOs Worth the Big Bucks?

Are they worth it?

That’s the question asked each year by shareholders, regulators, politicians and the public when publicly traded companies reveal how much they pay their CEOs.

Different methods have emerged to try to answer the question of “Are they worth it?” with no general agreement, but one way to more accurately calculate a CEO’s compensation is called “realizable pay.” Realizable pay has gained popularity among investors and some companies. Hawaiian Electric Industries Inc. reported realizable pay for the first time this year in its proxy statement covering 2012 compensation to CEO Constance Lau – Hawaii’s highest paid CEO in 2012 and 2011. HEI was the only one of Hawaii’s 10 largest publicly traded companies to specifically report realizable pay.

Under HEI’s summary compensation table formula, Lau’s 2012 compensation was reported at $5.82 million. That’s the traditional way of reporting executive compensation and a method required by the federal Securities and Exchange Commission. However, HEI’s realizable pay calculations reported her compensation at $4.1 million – $1.71 million less.

Realizable pay values equity awards based on the value at the end of the three-year measurement period, rather than on the fair value on the grant date, which is the method used in summary compensation tables. Realizable pay also excludes amounts from the change in pension value and nonqualified deferred compensation earnings column as calculated in the summary compensation table.

Those two changes can make a big difference. And, when you have a totally different figure for CEO compensation, you must also reconsider how a CEO’s overall compensation compares to his or her contribution to the company’s bottom line. In other words, realizable pay can radically change the answer to the big question about CEO pay: “Are they worth it?”

Hot Topic

Each year, when companies release their proxy statements, many people turn first to the summary compensation tables to find out how much was paid to CEOs and other senior executives. The tables list base and bonus pay, cash incentives, and the fair value of equity at the time it was granted.

The compensation of CEOs has always been a big issue, but it has become a bigger issue in recent years as average CEO compensation has soared. In April 2013, a Bloomberg News analysis of S&P 500 companies found that the average CEO made 204 times the average wage of their rank-and-file workers, up 20 percent since 2009. The increase follows a historical trend, Bloomberg reported, citing estimates by academics and trade-union groups that put the number at 20-to-1 in the 1950s, rising gradually to 120-to-1 by 2000.

Today, publicly traded companies must deal with the issue of “Say on Pay,” which grants shareholders the right to vote on a company’s executive compensation program at the annual shareholders meeting. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 requires companies to hold a nonbinding vote on executive compensation at least once every three years. “Say on Pay” has aimed the spotlight on the link between executive pay and company performance, helping spur the pursuit of the perfect way to measure a CEO’s value to the company.

Sadly, there is no perfect pay-for-performance measurement at the moment, and compensation experts seem to agree on only one thing: Measuring pay for performance is an art, not a science.

“There are many ways to measure (pay for performance), but it’s more than using simple ratios such as compensation to market capitalization or compensation to revenue,” says David Larcker, senior faculty member at Stanford University’s Rock Center for Corporate Governance. “The traditional method has been to compare CEO compensation to the mean or median total compensation for CEOs in their peer group. But many other factors like change in market cap during the CEO’s term, leverage and total shareholder return also need to be considered.”

Larcker says he would also consider a company’s size, performance, risk, type of industry, strategy, competition, quality of the CEO and whether the CEO is a founder. Many of these are intangible factors requiring expert analysis and can’t simply be plugged into a spreadsheet.

But the hot topic these days among executive compensation experts is how to most accurately calculate compensation, according to Jack Marsteller, a partner at Pay Governance, a New York-based executive compensation firm. And all eyes are on a calculation called realizable pay.

Pay Governance specializes in helping companies calculate realizable pay for their executives. Marsteller asserts it is the best measure and a truer representation for assessing pay-for-performance alignment than what we’ve seen in the past, as it reflects the actual compensation most likely attainable by a CEO over three to five years.

Analyzing several years data of realizable pay to total shareholder return (TSR) allows for peer group comparisons to determine the degree of pay for performance alignment.

Pay Governance advocates the value of realizable pay as it connects to pay for performance and helped persuade HEI to report realizable pay for Lau. The calculation of Lau’s compensation showed that her realizable compensation pay for performance was somewhat aligned with her peer group – that is, CEOs of similarly sized U.S. utilities (see chart “Pay for Performance”).

Chet Richardson, HEI’s executive VP, general counsel and chief administrative officer, says HEI has been aware of realizable pay for several years. He says he has become convinced that realizable pay gives a more accurate depiction of the compensation actually being paid as opposed to any other calculation method.

Others agree. Beginning Feb. 1, 2013, Institutional Shareholder Services began using realizable pay in its analysis of S&P 500 CEOs if the companies’ compensation policies fall into the high-concern or medium-concern categories. Richardson says the ISS endorsement was a major reason HEI jumped on the realizable-pay bandwagon.“We watch the trends and try to keep up to date with best practices in terms of executive compensation and disclosure,” says Richardson. “Even though not many of our shareholders follow ISS on a rigid basis, most of our institutional shareholders read the ISS reports, so we wanted to be speaking the same language.”

Pay Governance calculated Lau’s compensation using realizable pay and assessed it for performance alignment. Marsteller, who does not work directly with HEI and did not personally do the calculations, says it is typically done by developing a peer group in similar size and industry, looking at the TSR over three to five years, then calculating the CEO’s realizable pay for the same period. CEO rankings are done for both TSR and realizable pay that allows companies and investors to compare where CEOs rank within their peer group.

HEI took this type of standard approach to reporting realizable pay, according to Dan Walter, president/CEO of Performensation, an independent compensation consulting firm in San Francisco, who reviewed HEI’s realizable pay calculations at the request of Hawaii Business.

“They show data for the past three years and have a combination of realizable pay which is made up of the current value of RSUs (restricted stock units) awarded during the measurement period; estimated value of performance awards granted during the period not yet paid out; and realized pay – the base salary for the past three years, annual incentive payouts, performance-based awards where both the grant date and payout date were in the measurement period,” explains Walter.

Richardson says there was no specific response or feedback by HEI shareholders to the reporting of realizable pay and, although HEI was prepared to handle comments, the company suspected that realizable pay would not be a new concept to its institutional shareholders.

However, shareholder support on “Say on Pay” for Lau’s 2012 compensation package was down to 83 percent. It was 91 percent the previous year.

Richardson says the company is certain this decline of 8 percentage points is not attributable to its use of realizable pay, but due to a partial write-off that HEI took because of a global settlement with the state Public Utilities Commission. This write-down was applied against 2012 numbers and explained in a footnote in the proxy statement, Richardson says, but some shareholders might have taken it at face value and seen only that TSR dipped while executive pay rose, without delving into the reasons. He says “Say on Pay” support had consistently been in the 91 percent range before 2012 and he says he fully expects it to return to that level in 2013.

Companies like HEI that have begun reporting realizable pay appear to be ahead of the game, as Dodd-Frank requires the federal Securities and Exchange Commission to come up with rules for companies to disclose information about “executive compensation actually paid” and how it is linked to corporate performance. The SEC has not yet defined the term “actually paid” and how it should be linked.

“There is no requirement to report realizable pay and, until it’s regulated, it’s unlikely that most companies are going to jump at it because there’s still some dispute as to whether this is the right way or the best way to measure pay for performance,” says Walter. “The investors who think it’s an important metric tend to do the math on their own. The ones that can’t do the math can hire ISS to do it for them. But, in general, most companies are not reporting realizable pay yet.”

That’s the case with Hawaiian Airlines, which continues to report executive compensation through traditional methods as required by the SEC, according to Ann Botticelli, senior VP of communications. Hawaiian Air’s Mark Dunkerley is the third-highest paid CEO in Hawaii, at $2.5 million, using the traditional summary compensation table calculation method. “The reported compensation under the (summary compensation) formula often turns out to be inflated – sometimes highly inflated,” Botticelli explains. “Nonetheless, there are no plans to change the way we report compensation at this time.”

Bank of Hawaii also continues to report executive pay including that of Peter Ho, the second-highest paid Hawaii CEO at $3.97 million, in the customary way. Bank of Hawaii had no comment as to why it has not adopted realizable pay.

Along with the fact that it is not a required disclosure, companies may hesitate to report realizable pay because, once that path is taken, there may be no turning back.

“If you report it one year and don’t report it the next, then you have to explain why you now aren’t reporting it,” says Walter. “So now you’re explaining why you didn’t report something that was never required to be reported in the first place. But for companies that have nonvolatile stock, realizable pay also becomes not so volatile. So you can pretty much guess where you’re going to be at in any given year.”

That appears to be the case with HEI.

“My expectation would be that we will continue with realizable pay,” says Richardson. “We’ll continue to look at what the best practices are, and will continue to use realizable pay as our normal process because I think it makes sense.”

Walter says the biggest flaw with realizable pay is that it is still a hypothetical number. He says it is usually a more accurate number, but the reality is that it’s still a guess as to what people could get paid and not actually what they got paid since it is calculated at a specific point in time. For instance, a CEO’s realizable pay might be reported at $10 million, but it could have been calculated at a time when he couldn’t trade his stock because of a blackout. When he finally gets paid out, stock prices may have dropped and his compensation may only be $2 million. CEOs are not required to report how much they actually made on their stock options, except on their income tax forms.

“The old ways, the historic ways of measuring pay for performance were not necessarily wrong, they were incomplete. It was only when people tried to defend them as complete that they looked flawed. If you looked at them for what they were, you were OK,” says Walter. “The same will be done for realizable play. If people use realizable pay as an overall tool to measure executive compensation and in conjunction with the other tools available, it’s much more likely to be right. But it’s never going to be an exact science, because we don’t know how the stock market is going to do or how companies will perform over the long run.”

Hawaii’s Best Paid CEOs

Last year, Hawaii Business published a list of Hawaii’s best-paid CEOs. This year, the Honolulu Star-Advertiser ran a similar, comprehensive list in April. (You can read the list by using this online shortcut,, though you will hit the Star-Advertiser paywall if you don’t have an account.) Rather than compiling a “me too” list, we focused in depth on one newer way some companies use to calculate their CEOs’ compensation.


Pay for Performance


This graph compares the alignment between Hawaiian Electric Industries CEO Constance Lau’s realizable pay and HEI’s total shareholder return (TSR) relative to HEI’s compensation peer group over the 2009-to-2011 period. The peer group mostly includes similarly sized utilities in the U.S. Companies that fall within the shaded range in the following graph are generally viewed as having pay and performance alignment; the darker the shading, the closer the alignment. Over the 2009-to-2011 period, Lau’s realizable pay ranked in about the 24th percentile, while HEI’s total shareholder return was about in the 19th percentile.

Sources: HEI, Pay Governance LLC


What’s Included in Realizable Pay?

Realizable pay includes the value of full value awards, such as restricted stock and restricted stock units. These types of awards are different from traditional stock options since the shares continue to carry the full value of the stock at the time it is granted, despite future drops in stock prices. The company retains the stock until it vests under certain pre-determined conditions such as employee tenure or employee performance. It is transferred to the employee once it is vested. Since realizable pay includes these elements with direct cash value, it better reflects the pay delivered and more tightly links to corporate performance and total shareholder return.

Realizable pay consists of:

  1. Average base salary earned over three years;
  2. Average performance-based cash payments earned over three years;
  3. performance-based equity awards earned over three years, based on actual payouts for completed periods and proxy statement estimated performance for periods not completed as of Dec. 31 of the third year, valued using the third year’s year-end closing price; and
  4. time-based equity awards granted over the three years, valued using the third year year-end closing price.
  5. Perquisites and many other pay, or pay-related elements are not included in Realizable Pay. Realizable Pay is focused on cash or its convertible equivalents. Other pay elements have little or no direct cash value and accounted for in other areas of compensation disclosure.

Compensation based on the summary compensation table is included in all publicly traded companies’ annual reports. It consists of these items:

  1. base salary;
  2. annual incentive payouts;
  3. restricted stock units awarded based on grant date fair value;
  4. performance-based equity award opportunities based on grant date fair value;
  5. change in pension value and change in value of executive death benefits; and
  6. any perquisites.
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