Why ‘Compensation Actually Paid’ Is Such a Better Metric

 Today Calcbench welcomes a guest post from Stephen F. O’Byrne, president of Shareholder Value Advisors. O’Byrne is a renowned expert on executive compensation, and his article below explores how financial analysts can use the expanded new disclosures about executive compensation that Calcbench first wrote about last week.

New compensation disclosures available in corporate proxy statements (all of them indexed by Calcbench and readily exportable into your financial models) are meant to give investors a better sense of executives’ pay compared to the performance of the companies they lead. This is known as “pay versus performance,” or PvP. 

Today we explore why one new disclosure — compensation actually paid (CAP) — provides far more useful information than the Summary Compensation Table (SCT) disclosures that companies have reported for years. It provides great new insight for financial analysts, corporate governance professionals, and others who are trying to assess the value and effectiveness of executive compensation. 

CAP is more informative because the number reflects changes in the value of an executive’s unvested equity, akin to the mark-to-market disclosures companies report for investments; SCT only reflects the grant date value of the equity award. If we do a regression analysis of relative pay vs. relative total shareholder return (TSR) using both measures, the information gap becomes clear. 

Consider the two figures below as an example. Both are for Pfizer CEO Albert Bourla. Figure 1, on the left, shows relative CAP pay versus relative TSR. Figure 2, on the right, shows relative SCT pay versus relative TSR. (Spoiler: CAP shows that Bourla has a much stronger pay incentive than what traditional SCT tells us.)

In each figure, the solid line is the regression trendline. The dashed line is a line with a slope of 1.0 and an intercept of 0.0; it’s included in the graph to provide perspective and to show how the company differs from a theoretical “Perfect Correlation Pay Plan” that makes relative pay equal to relative performance.

Figure 1                         Figure 2

This relative pay versus relative performance regression provides measures of four pay dimensions. 

The slope of the trendline provides a measure of incentive strength, which can be described as “pay leverage.” Pay leverage is the percentage change in relative pay associated with a 1 percent change in relative shareholder wealth. The correlation provides a measure of alignment. The intercept provides a measure of performance-adjusted cost; that is, the pay premium at peer group average performance. 

The ratio of pay leverage to pay alignment (the slope divided by the correlation) provides a measure of relative pay risk. Relative pay and relative TSR in Figure 1 are cumulative measures, while relative pay in Figure 2 is based on annual SCT pay, not cumulative SCT pay. 

We use annual rather than cumulative SCT pay in Figure 2 because a perfect correlation of relative annual, not cumulative, SCT pay and relative cumulative TSR is needed to provide a perfect correlation of relative cumulative CAP pay and relative cumulative TSR.

When we compare Figure 1 against Figure 2, we see that CAP pay provides much more accurate information for investors. An investor looking at SCT pay for Bourla would conclude that he has a very weak incentive to increase shareholder value, because his pay leverage is only 0.17. But CAP pay shows that Bourla has a very strong incentive, with pay leverage at 1.45 — almost nine times greater than what the investor sees in SCT pay.

The Bigger Picture

Figure 3, below, widens the lens. It compares pay-versus-performance and SCT data for a sample of 1,097 companies, all with the same CEO for the four-year period of 2020-23. 

The PvP disclosures tell investors two things. First, that CEO pay leverage is almost three times greater, 0.60 vs. 0.22, than it appears from SCT pay data; and second, that CEO pay alignment is more than twice as great, 0.66 vs. 0.29, than it appears from SCT pay data. 

Alignment is the correlation of relative pay and relative TSR. Alignment squared is the percentage of the variation in relative pay that is explained by relative TSR. When we look at alignment (r-sq), we can see that the information from the CAP disclosures is dramatically different from the SCT pay information. 

The CAP disclosure shows that relative TSR explains 44 percent (0.66 x 0.66) of the variation in relative pay for the median CEO. Meanwhile, the SCT pay disclosure shows that relative TSR explains only 8 percent (0.29 x 0.29). In other words, the CAP disclosure tells us that alignment (r-sq) is more than five times greater than it appears from the SCT pay disclosure.

Stephen F. O’Byrne is president of Shareholder Value Advisors. He has more than 30 years of experience as a consultant to companies on compensation, performance measurement, and valuation issues. He can be reached at info@valueadvisors.com. 

If you’d like to learn more about proxy statement disclosures or see for yourself how Calcbench can help with your research, view our first post on the new pay-versus-performance disclosures and look for more coverage soon!