The SEC should replace the current Summary Compensation Table definition of total pay with a realized pay figure that reflects the impact of stock price fluctuations, according to a recent Harvard Business Review article by William Lazonick, a professor of economics at the University of Massachusetts at Lowell and researcher Matt Hopkins. The article, echoing a similar piece the authors published in The Atlantic last fall, decries the use of Summary Compensation Table pay by the SEC and other stakeholders, including "labor unions, progressive think tanks, and the media," not to mention investors. The purpose of the article is to encourage realized pay in pay ratio comparisons and warn that failure to do so will result in significant inaccuracies.
The article emphasizes the somewhat obvious point that when company stock price is improving, realized pay (which includes the value of stock grants when vested rather than an estimate of their grant-date value) is often higher than Summary Compensation Table pay for an individual CEO. The authors attempt to buttress their argument by comparing realized pay for the 500 highest paid CEOs to the Summary Compensation pay totals for these same individuals for 2006 through 2015 (although it is not clear how the 500 were picked in the first place). In the authors' view, this discrepancy leads investors and other stakeholders to consistently underestimate CEO pay and will result in smaller pay ratios than are actually the case. However, the article fails to recognize that the reverse is also true - in times of lower stock price performance, realized pay may significantly lag Summary Compensation Table pay since it will reflect the loss of value to the CEO inherent in his or her stock-based awards.
The authors take their arguments a step further stating "As a growing body of research demonstrates [pointing to Professor Lazonick's own research], [the potential for gains from ] stock options and stock awards can incentivize executives to do buybacks, price gouge, offshore, lay off workers, do financially driven M&A deals, dodge taxes, engage in false financial reporting, and so on, all for the sake of boosting the company’s stock price." However, the article does not recognize that among larger companies, the majority of long-term compensation is delivered in the form of performance awards, meaning that executives do not receive compensation -- regardless of the stock price -- unless performance thresholds are achieved. According to the FW Cook 2016 Top 250 Report, 55% of long-term awards were in the form of performance awards. In addition, it is the role of the Board to ensure that incentive programs are aligned with company strategy and not incentivizing behavior contrary to the company, and in the Center's experience, Boards are paying close attention to these issues, for example, with some removing the impact of stock buybacks and others including the impact as reinforcing management's role to engage in efficient capital allocation.
The benefit to realized pay is not that it will shame companies by revealing "hidden compensation" for CEOs, but that it reflects what the executive actually took home based on performance, allowing investors to determine whether pay and performance are aligned at each individual issuer. It is for this reason that the Center joined with The Conference Board Governance Center and the Society for Corporate Governance to issue a Conceptual Framework for how to consider and use both realized and realizable pay along with the Summary Compensation Table approach mandated by the SEC and to propose standardized definitions to allow companies to more completely explain their pay for performance connection in their plans.