For years, U.S. publicly traded companies have been required to disclose what their top executives earn, with the rationale that transparency is the best defense against bad practices.
The information comes out in proxy statements filed by companies a few months after their fiscal year ends. Media outlets and think tanks gather the proxy data and report on CEO pay every year.
But not all of us measure executive compensation the same way.
Two methods are typically used to report CEO pay packages — one based on “realized” compensation and the other on “granted” compensation.
The Union-Tribune uses the realized pay method. Like everything surrounding executive pay, it’s complicated. But here’s how it works.
Both the “granted” and “realized” frameworks count salary, cash bonuses and perks the same way. They differ in how they treat stock-based compensation, which can make up 90 percent of a CEO’s pay package at large companies.
The granted pay method measures the value of stock awards on the date they’re granted to executives by the company’s board of directors. Financial models estimate the worth of these shares. That amount is published in the summary compensation table of a company’s proxy statements.
Stock compensation, however, almost always has strings attached. Executives don’t get the shares right away. It usually takes three to four years for them to vest based on retention and performance goals. Sometimes they vest proportionally on a monthly or quarterly basis. Sometimes they vest all at once at a predetermined date or when performance targets are hit.
If performance goals are missed or only partially achieved, then a portion — or all — of performance shares are withheld.
Stock option awards are subject to vesting schedules, too. They can span one to five years. And options are worthless unless the company’s share price increases above the grant-date strike price.
The realized pay method, which the Union-Tribune uses, ignores the estimated grant-date value reported in the summary compensation tables. Instead, the realized pay counts the value of retention and performance shares only upon vesting — that is, when they are released to executives to keep or sell.
The same goes for stock options. Realized pay recognizes value only when options are exercised — in other words, purchased by the CEO.
Options have a 10-year lifespan. The strike price corresponds to the company’s share price on the day the options were granted. So if the company’s stock price increased over time, the CEO can exercise the option and acquire the shares at a discount to current value. He or she can then sell the shares and pocket the difference or hold onto them in expectation of further gains.
But if the company’s stock price falls below the strike price, the options are underwater and considered worthless.
The realized pay method is in sync with the tax code. Executives owe taxes on stock-based compensation when shares vest and options are exercised.
Realized pay isn’t the most popular way to report on what CEOs earn. But it has been gaining traction in the media and with think tanks recently as stock markets soared to record highs.
New this year in the Union-Tribune’s executive compensation reporting is three-year annualized total shareholder return. Since CEO stock grants usually have a three- to four-year retention or performance horizons, we felt showing how the company’s stock performed over that time frame was valuable to readers.
Annualized returns show the compound annual growth rates of the stock over the three-year period — including share price gains or losses, plus dividends. It shows the average return each year on a percentage basis.
