Aligning CEO pay with shareowner value is key for many. A new tool (at least new to me), the Compensation and Wealth Calculator, from the Stanford Graduate School of Business, Corporate Governance Research Program, allows users to see how the compensation of CEOs and other NEOs, which they have already received over the years in the form of stock and stock options, aligns with share price.
The tool plots changes in an executive’s wealth against changes in the company share price ranging from +100% to -100%. The 0 percentage point on the x-axis is based on CEO wealth at prevailing market prices and the -100 percentage point is where the value of equity goes to zero.
A manager who is rewarded predominantly in restricted stock or holds only stock will see a change in wealth that is based on a ratio of one-to-one. If they hold out-of-the-money stock options the payoff curve can become quite steep. “Steep payoff structures provide strong financial incentive to perform but might encourage unintentional or excessive risk taking.” Such structures can also incentivize cooking the books and other illegal or shady behavior.
According to the accompanying paper, Sensitivity of CEO Wealth to Stock Price: A New Tool for Assessing Pay for Performance, by David Larcker and Brian Tayan:
Based on a sample of 4,000 publicly traded U.S. companies, the average (median) CEO stands to gain roughly $58,000 in wealth for every 1 percent increase in stock price. Among the largest 100 companies, this figure approaches $640,000.
The Percentage Return to Shareholders vs. Percentage Return to Executive tool helps you compare the payoff functions of up to 5 executives (looks like the NEOs), among one or multiple firms. I often couldn’t find the CEOs using the tool… perhaps because they are relatively new. For my own little experiment, I compared:
- Forest Labs (FRX), Howard Solomon
- Eli Lilly (LLY), John Lechleiter
- GlaxoSmithKline (GSK), Andrew Witty
- Pfizer (PFE), Ian Reed
The way I’m reading the resulting graph, Andrew Witty’s return was the highest of the group in comparison with shareowner’s at 270. When shareowners experienced a 100% increase in share price, Witty received a 270% return. Howard Solomon was next at 140, Ian Reed was at 137 and John Lechleiter came in at 108.
A couple of possible improvements to this nifty tool would be highlight the CEO when returning search results of company NEOs. Another would be to build in dividend payments, since stock price does not reflect total returns.
Although it is interesting to play with, I’m not sure how valuable the tool actually is. In fact, it could be viewed as supporting ”performance-based” compensation tied directly to stock price. Just because corporations may pay executives more when their stock prices rise does not mean that executive compensation in any way contributed to the stock prices rising.
Unfortunately, most any conclusions that might be drawn from the tool would be predicated on an assumption that executive compensation contributes to stock price performance. As I have noted elsewhere, that assumption is often false. See, for example, yesterday’s post, The Problem with Pay for Performance
To contact James McRitchie directly, please email jm@corpgov.net
