A Better Approach to CEO Pay Analysis

Below is the next installment in our series on pay versus performance data now available in corporate proxy statements. Calcbench has been working with Stephen O'Byrne, a renowned expert on executive compensation, to demonstrate how this information can help to assess whether CEOs are earning their keep and whether companies are aligning pay with performance. See his previous post for an introduction to the value of “PvP” disclosures.

By Stephen F. O’Byrne

Pay versus performance (PvP) disclosures give investors the ability to measure key pay dimensions for public companies and the executives leading those businesses. Investors can do this first by calculating relative cumulative pay and relative cumulative Total Shareholder Return (TSR); and then by calculating the regression trendline relating the natural log of relative pay to the natural log of relative TSR.

Such a regression analysis provides insight into four “dimensions” of executive pay. 

• The slope of the trendline provides a measure of incentive strength, what I call “pay leverage.” Pay leverage is the percentage change in relative pay associated with a 1 percent change in relative shareholder wealth. 

• The correlation between the two 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 (that is, the slope divided by the correlation) provides a measure of relative pay risk.

All that might sound a bit complicated. Let’s consider an example. First is the pay leverage trendline for Pfizer CEO Albert Bourla, in Figure 1, below. 

Figure 1: Bourla at Pfizer 

Next is the same for Verizon CEO Hans Vestberg (Figure 2, below). 

Figure 2: Vestberg at Verizon

The peer group used to compute relative TSR for Pfizer is the NYSE ARCA Pharmaceutical Index. The peer group used to compute relative TSR for Verizon is the S&P 500 Telecommunications Services Index. 

In both examples, 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 show how the company differs from a hypothetical “Perfect Correlation Pay Plan” where relative pay always equals relative performance.

What the Numbers Tell Us

When we perform a regression analysis of log relative pay on log relative performance, that gives us a window into the company’s success in achieving the three objectives of executive pay: (a) providing strong incentives to increase shareholder value, (b) retaining key talent; and (c) limiting shareholder cost. 

For example, the slope of the trendline for Bourla at Pfizer is 1.45. This means that a 1 percent increase in relative shareholder wealth increases the CEO’s relative cumulative pay by 1.45 percent. This provides a very strong incentive to increase shareholder value. 

In contrast, the slope of the trendline for Vestberg at Verizon is only 0.23. This means that a 1 percent increase in shareholder wealth increases the CEO’s pay by only 0.23 percent. Comparing the two graphs shows that Bourla’s incentive to increase shareholder wealth is roughly six times greater than the incentive for Vestbert.

The intercept is the pay premium at peer group average performance. It provides a negative measure of retention risk, and a positive measure of shareholder cost. The pay premium for Pfizer is 0.70. It’s stated in natural logarithms. We can convert it to a percentage premium by taking the anti-log. The percentage premium is 101 percent (= exp(0.70) – 1). 

This tells us that Pfizer pays 101 percent above market at average performance. This pay premium limits retention risk because Pfizer pays above average for average performance; so the CEO would have more reason to stick around. It also raises shareholder cost for the same reason. The pay premium shows that Pfizer strikes the balance between limiting retention risk and limiting shareholder cost heavily in favor of limiting retention risk. 

The natural log pay premium for Verizon is -0.30. The percentage pay “premium” is -26 percent. This pay premium shows that Verizon strikes the balance between limiting retention risk and limiting shareholder cost modestly in favor of limiting shareholder cost.

Which approach is right? That isn’t for us to say, but perhaps we should note that Verizon ousted Vestberg on Monday.

Doing the Analysis

Doing this analysis requires some work by investors. Market pay is not reported in the PvP disclosure, but is needed to calculate relative pay. Investors can figure out market pay using industry regression trendlines relating the natural log of the CEO Summary Compensation Table (SCT) pay to the natural log of company revenue. 

Investors also need to calculate the expected accretion in market pay. Market pay is a present-value number while Compensation Actually Paid (CAP) is a future-value number, so market pay needs to be adjusted upward to reflect the expected difference between future value and present value. 

My analysis of the 2024 PvP disclosures shows an expected difference of 5 percent annually. Investors also need to adjust Compensation Actually Paid to take out the pay attributable to unvested grants made prior to the five-year performance period. This ensures that performance is compared to the pay granted in the same period; and gives more accurate estimates of pay leverage, pay alignment, and the pay premium at peer group average performance. 

I make this adjustment using two tables from the proxy (Outstanding Equity Awards and Grants of Plan-Based Awards) and the reconciliation of CAP to SCT pay in the PvP disclosures — in particular, the change in value of awards granted in prior years. This adjustment highlights the importance of the reconciliation included in the PvP disclosure.

Analysis like this might seem challenging, but when you have the data (which Calcbench now provides), it can provide an invaluable window into how much the CEO is or isn’t motivated to increase shareholder value. 

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 sobyrne@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!