Misleading CEO Pay-for-Performance Numbers Target of SECDave Michaels
With its stock price depressed and shareholders objecting to how much its top officers were paid, Weatherford International Ltd. worked to show that its chief executive officer was sharing the pain.
Bernard Duroc-Danner was earning less than every one of his peer CEOs, the energy-services firm declared in its April report to investors before the annual shareholders’ meeting. He received $9.8 million over three years, a period when the firm’s shares declined 15 percent, according to the filing.
That was on Page 9 of the report, where Weatherford explained how Duroc-Danner’s pay related to the firm’s performance. Investors who read deeper found a different calculation of his three-year pay on Page 37, in a box required by regulators: $37.8 million, higher than half his peers.
The inconsistent measures that companies use to disclose CEO pay is the newest battleground in executive compensation. As the Securities and Exchange Commission works on a rule to require pay-for-performance reports, it also plans to end the wide latitude enjoyed by firms when they compute the numbers.
“The way different companies calculate it is all over the map,” said Carol Bowie, head of Americas research for proxy adviser Institutional Shareholder Services Inc. Firms fiddle with different definitions “to promote the notion that they have good alignment between pay and performance,” she added.
The SEC’s rule-making is mandated by the 2010 Dodd-Frank Act. It is one of at least five rules under the law intended to make executive compensation more transparent and aligned with company performance. One rule, nicknamed “say on pay,” requires companies to hold non-binding shareholder votes to approve or reject the pay of top executives. Another, proposed in September, requires corporations to report the ratio of the CEO’s pay to the median compensation of all other employees.
Depending on which method the SEC proposes for computing pay used in performance comparisons, a decision expected to come in 2014, some companies will look better than others, and the rule could prompt changes in how top executives are paid.
Congress complicated the SEC’s pay-for-performance task by writing into the law that firms must show compensation as it is “actually paid.” What that term means has set off a debate among companies, compensation consultants and institutional investors, all of which have lobbied the SEC to adopt their interpretation.
In deciding what to include in actual pay, the SEC has to contend with changes in how companies award compensation. Firms generally have been increasing the incentive portion of compensation for their top officials. Among companies in the Standard & Poor’s 1500 Index, 54 percent of all CEO pay in 2012 was awarded as long-term stock or options, up from 51 percent in 2008, according to Farient Advisors LLC.
Part of the dispute turns on whether to compute CEO compensation as “realized” or “realizable” pay. While the terms sound alike, they treat incentive pay differently and yield very different measurements.
Realized pay counts only what a CEO received over a given period, and is viewed by some as “easily a quantifiable and digestible number,” said Mark Borges, a principal at San Jose, California-based Compensia, a compensation consultant. Realizable pay includes incentive awards, such as shares or options, even if they aren’t accessible until years later.
There are indications the SEC is looking at realized pay as a possible standard. Keith Higgins, the agency’s director of corporation finance, said at a September conference that the language of Dodd-Frank “talks about compensation actually paid, which seems like maybe it’s realized pay.”
Business groups such as The Conference Board, a research group with members including large public companies, generally back realized pay, saying it’s the best way to show the relationship between a CEO’s pay and past performance. Realizable pay is preferred by some companies because it accounts for what is awarded and measures how directors responded to recent performance, said Borges, who favors that standard.
Both of those methods, in turn, are different from an SEC standard known as “total pay,” which firms have had to include in reports to shareholders since 2006. That is the measurement that produced the higher CEO pay figure in the back of Weatherford International’s April proxy letter.
Companies have long complained that total pay is misleading because it includes accounting estimates for incentive pay that may pay out differently and counts changes in the value of a CEO’s pension.
“Looking at the accounting values, which may or may not turn into actual economic gain in the future, really in many instances overstates the amount the executives have actually pocketed,” said Borges, whose firm advises boards on pay design.
Among companies included in the Standard & Poor’s 500 Index, 16 percent included a pay-for-performance disclosure in last year’s proxy report that varied from the SEC’s 2006 method, according to consulting firm Towers Watson & Co.
The lack of consistency hurts the credibility of company-produced figures such as realized pay, said Donna F. Anderson, a global corporate governance analyst at T. Rowe Price Group Inc.
“We really disregard it, honestly,” Anderson said. “I haven’t noted anybody doing a particularly good job of it.”
In the case of Weatherford International, 56 percent of shareholders rejected the board’s executive compensation plan in a 2011 say-on-pay vote held after the Geneva-based company awarded discretionary bonuses to five top officers despite missing performance targets.
The next two times Weatherford published proxy reports, it included a pay-for-performance chart using a calculation of Duroc-Danner’s realized pay. The firm said this year that his pay was aligned with performance because it was lower than his peers and because he gave back a large stock grant that he could have earned over the next two years.
Weatherford’s version of realized pay, though, didn’t match other definitions. The firm excluded $17.3 million in stock awarded to Duroc-Danner that vested from 2010 through 2012. As a result, Weatherford calculated Duroc-Danner’s realized pay as $9.8 million, or 61 percent lower than what it would have been under the Conference Board’s approach.
The company’s decision to exclude vested shares differs from the approach taken by Exxon-Mobil Corp., which this year included the value of time-restricted shares in its presentation of CEO Rex W. Tillerson’s realized pay. Company shares owned by Tillerson that vested in 2012 were worth $8 million, accounting for more than half of his $15.5 million in realized pay for the year, according to Exxon’s proxy.
In its pay-for-performance section, Weatherford also computed the decline in shares in a way that could improve how investors viewed Duroc-Danner’s management. The firm said shares fell 15 percent in the three years ending Dec. 31, 2012. Data compiled by Bloomberg show shares fell 37 percent over that period. To get a 15 percent decline near that time frame, the change would have to be calculated from Feb. 15, 2010 through Feb. 15, 2012.
“They’re making the magnitude of the decline in shareholder value look smaller than it actually was, while at the same time making compensation look lower than it actually was,” said Jesse Fried, a Harvard law professor specializing in corporate governance and executive pay, after reviewing the Weatherford filing.
“The effect is to boost apparent pay-for-performance,” Fried said.
Weatherford officials declined to comment on the discrepancies.
Even if applied consistently, realized pay and realizable pay each have shortcomings.
Realized pay can appear to overstate CEO compensation during years when the executive exercises large numbers of stock options, pay consultant Farient Advisors LLC wrote in a recent report.
Under a realized method, for example, Starbucks Corp. CEO Howard Schultz earned $117.6 million in 2012, with $103 million coming from options granted to him as long as 11 years ago.
“These numbers would show he’s way overpaid,” said Farient CEO Robin Ferracone. “Well, that’s not true. These were earned over eight years. That’s the problem” with realized pay.
Realizable pay also can yield pay figures that some companies would argue are misleading. In 2011, Simon Property Group Inc. gave a time-restricted stock grant valued at $120 million to CEO David Simon. The CEO is eligible to begin receiving the shares if he remains atop the firm in 2017.
Under realizable pay, Simon’s grant was valued at $158 million at the end of 2012, boosting his three-year realizable pay to $234 million, according to data from Equilar, the Redwood City, California-based provider of compensation data. In its own presentation of pay-for-performance, Simon excluded the grant and measured its CEO’s compensation as $30 million from 2010 to 2012.
“The risk with realizable is that when your stock is doing really well, that number is going to be really high,” Borges said. “That is the biggest problem in this area. No solution comes without its baggage.”