Dating back to the Great Depression in the 1930s, U.S. publicly traded companies have been required to disclose what their top executives earn, with the rationale being sunlight is the best disinfectant against bad practices.
Whether that notion has been effective or not is open to debate. Nonetheless, two methods are typically used today to measure 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 80 percent or more of a CEO’s pay package at large companies.
The granted pay method measures what stock awards are worth each year on the date they’re granted to executives by the company’s board of directors. Financial models estimate the fair value of these shares. That amount is published in the summary compensation table of a company’s proxy statements.
The thing is, granted shares almost always have strings attached. Executives don’t get them right away.
Restricted stock, for example, is unsellable until the shares vest. Vesting typically occurs in increments over three years or so — creating a retention incentive when headhunters come calling. If the executive leaves for a new job, he or she forfeits unvested shares, potentially walking away from a lot of equity.
With performance shares, financial or operational targets must be hit. If these goals are only partially achieved or are missed, then a portion — or all — of performance shares are withheld.
Finally, stock option awards also are subject to vesting schedules spanning one to five years. And options are worthless unless the company’s share price increases above the grant-date strike price.
So, the realized pay method counts the value of restricted stock only upon vesting and performance shares when they are released to executives.
For stock options, realized pay recognizes value when options are exercised — in other words, purchased by the CEO at the grant-date share price.
If the company’s stock price has increased since the grant date, the CEO is acquiring shares at a discount to current value. He or she can sell the shares and pocket the difference or hold onto them in expectation of further gains.
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 soar to record highs — boosting the value of equity compensation for public company executives.
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September 05, 2021 at 06:58PM
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How we calculated the pay of San Diego's CEOs - The San Diego Union-Tribune
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