Doing the Math on CEO Pay

These days, there's ample outrage about continuously skyrocketing levels of CEO pay. Those who see no problem with the millions doled out to CEOs and other high-ranking executives have usually just used the dismissive "It's the free market" excuse. Lately, though, corporate managements and boards as well as CEO pay apologists have started angling to persuade us that CEO pay isn't that badly out of whack.

Articles in The Wall Street Journal and The Economist have recently tackled the idea of whether we're talking cold, hard cash or not; maybe if one simply looks at immediate take-home pay (i.e., cash money), it's not that bad.

Yes, there is a difference between the compensation that's reported in corporate proxy statements and the actual take-home pay a chief executive officer gets. Total compensation figures reported in proxies include stock options, restricted stock, and other forms of compensation that won't necessarily be accessible by the executives in question immediately and will regularly change in value.

The distinction's worth acknowledging, but it shouldn't convince anyone to let their guards down when it comes to insane CEO pay.

Shock value in pay values
Here's one high-profile example of such a discrepancy, according to the Journal. Last year, General Electric's (NYSE: GE  ) Jeffrey Immelt "made" $21.6 million in total compensation, according to the company's required disclosure in its proxy statement. However, his actual take-home pay paled in comparison; his taxable take-home on his W-2 form was $7.2 million.

GE is one of the companies the Journal highlighted for spearheading the clarification of "realized" pay versus the total pay required to be disclosed by Securities and Exchange Commission rules. Here's the language from GE's proxy statement: "The SEC's calculation of total compensation, as shown in the 2011 Summary Compensation Table set forth on page 26, includes several items that are driven by accounting and actuarial assumptions, which are not necessarily reflective of compensation actually realized by the named executives in a particular year."

Granted, it's difficult not to lock onto the sheer shock value of some of the total compensation figures we see. Still, most of us wouldn't find $7.2 million a "pale" figure for one year's work. And although Immelt's $3.3 million base salary has remained unchanged for several years, he has received $4 million bonuses in 2010 and 2011.

OK, Immelt didn't actually physically take $21.6 million and put it in his bank account last year. Surely investors get it, but whether his realized pay is modest or even appropriate is another question.

Differing realizations
It's certainly good for shareholders to be aware of the difference between "realized" and "realizable" compensation. The Journal said that at least 228 companies mentioned the two terms in their proxy documentation this year, compared to just 119 in 2011. A mere 68 mentioned the two terms in 2009.

Regardless, our society (and most specifically, corporate boards) has allowed CEOs to become something of a protected class whose earning power always seems to increase, even if the rest of society's income doesn't follow suit.

Some of the awards are outlandish. Best Buy's (NYSE: BBY  ) new French CEO Hubert Joly has a base salary of $1.175 million (and estimated total compensation of up to $32 million over a three-year period), but the company's board promised to give him $6.25 million if he couldn't obtain a visa to work in the U.S. Talk about an ugly realization for Best Buy shareholders should that come to pass.

Although there's a chance that the eventual realizable pay could come in lower than it was calculated in the past, let's just say that stock and options awards generally leave chief executives sitting very pretty indeed. Companies like Apple (Nasdaq: AAPL  ) and Google (Nasdaq: GOOG  ) have talked up their $1-per-year base salaries for founders, but Steve Jobs, Sergey Brin, and Larry Page all tallied up total net worth in the billions.

Meanwhile, stock and options can be a double-edged sword. While having skin in the game does align executives with shareholder interests, it can also create the perverse incentive to do everything possible to get that stock price to rise as quickly as possible. In the short term, that can be very dangerous to building foundations for long-term shareholder value.

Are they worth it?
The CEO pay issue has its complexities, but here's some data to bear in mind. Earlier this year, the Associated Press reported that the typical CEO made $9.6 million in total pay last year. Although more pay was in the form of noncash compensation like options, the figure still increased by 6% on a year-over-year basis.

The AP added even more perspective: Americans making the average salary would have to toil for 244 years before making it to the $9.6 million mark. Last year, U.S. workers' median pay rose a scant 1% off the $39,300 annual salary, and the minuscule increase falls short of even keeping up with inflation.

Investors should be aware that there is a difference between "total" and "realized" compensation, and it's fine that companies are trying to make this distinction clearer in their regulatory filings. I wish they'd also make CEO-to-worker pay ratios public as long as they're clarifying disclosures.

Regardless, though, CEO pay apologists seem to be trying to convince investors to think short-term again; CEOs don't pocket all those millions now, darn it! Check back in a few years, though, and mark my words: Some pretty mediocre-performing CEOs will have pocketed mountains of wealth if investors ignore the total compensation issue now.

Shareholders shouldn't ignore the intent and astronomical potential of that total compensation line in each company's proxy statement, and every passing year vote their proxy ballots according to whether they think their CEOs are really worth it.

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Check back at Fool.com for more of Alyce Lomax's columns on environmental, social, and governance issues.

Alyce Lomax does not own shares of any of the companies mentioned in her personal portfolio. The Motley Fool owns shares of Google, Apple, and Best Buy. Motley Fool newsletter services have recommended buying shares of Google and Apple. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (11) | Recommend This Article (21)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 28, 2012, at 6:21 PM, Rockie24 wrote:

    It always amaze me to see how much these unreplacable CEO's are making.

    No one came with an idea to lay off all workers and keep only CEO's in a company? It would save a lot of money for investors.

  • Report this Comment On September 28, 2012, at 6:30 PM, xetn wrote:

    Why don't you report on the federal government's pay scales that are nearly double those of the private sector?

    And while Obama's pay is not huge by corporate standards, his total compensation is well over $50 million when you add in the 24 hour security, food service, two prez jets, personal use of military choppers, etc. Oh and don't forget he has opted out of ObamaCare because the government provided version is much better. He also gets that security for life, and a lovely little pension.

  • Report this Comment On September 28, 2012, at 6:50 PM, RichKenn wrote:

    What is at work here is a de facto conspiracy. They serve on each others' boards!

  • Report this Comment On September 28, 2012, at 7:15 PM, StPeteRoger wrote:

    It would be interesting to know CEO pay compared to the median pay for all company employees. Another interesting comparison would be CEO pay compared to US middle income pay.

  • Report this Comment On September 28, 2012, at 8:37 PM, earledouglas wrote:

    The reason that executive pay has escalated to embarrassing levels is this: Their tax rate is so low. No board director would give a CEO ten million dollars a year if 60% or 70% went to the government in taxes.

  • Report this Comment On September 29, 2012, at 3:08 PM, lowmaple wrote:

    earledouglas: They would give them 100 million.

  • Report this Comment On September 29, 2012, at 5:58 PM, rukdng wrote:

    @extn... surely you don't actually believe what you posted. The President of the United States as compared to whomever. Talk about comparing apples and oranges. How much do you think he should be paid? None of my business because I am a Canadian and don't have to live with Obama but I really don't understand your post.

  • Report this Comment On September 30, 2012, at 11:33 AM, EinraLahs wrote:

    All prior comments and the article itself miss the point of exec compensation. There is one reason top execs are well compensated: they can and do make a huge difference in the success or lack thereof of the company. An exec capable of creating a success story out of a RIMM or a Hewlett Packard or an Intel is well worth whatever it takes to employ him--his compensation is insignificant. And his/her pay is driven up by those talented individuals who work directly for him. Jealousy and envy are a permanent fixture of those less talented and less ambitious.

  • Report this Comment On September 30, 2012, at 1:46 PM, MrSheepish wrote:

    Also following xetn off-topic:

    "Why don't you report on the federal government's pay scales that are nearly double those of the private sector?"

    This is a highly-misleading statement. The government employs highly skilled workers for most of its jobs. If you think it is unreasonable that highly-educated government specialists make more money than the average private-sector worker then I would argue that you do not believe in capitalism.

    On the other hand, if you do an apples-to-apples comparison: government vs private lawyers, government vs private scientists, etc, the actual numbers end up being pretty comparable between the public and the private sectors, as it should be.

  • Report this Comment On September 30, 2012, at 3:11 PM, mark516119966 wrote:

    EinraLahs,

    I agree totally. Us mere mortals could never get done what is needed because of the lack of talent.

    Who could do to Ford what Allen Mulally has? He makes it look so easy that any one could to it.

    What's he worth? I have no idea except whatever it takes to keep him. If only GM could have 1/2 of him right now.

    Pay them what it takes but throw them out on their ear if they fail.

    Home Depot.. I need to say no more.

  • Report this Comment On October 02, 2012, at 12:24 PM, mdk0611 wrote:

    1. Most of the media does NOT make the distinction between "realized" and "realizable" compensation. And they DON'T go with the lower number

    2. Do options and restricted stock REALLY lead to short term decisionmaking? At least part of the answer depends on your definitiuon of "short term" Most options don't vest for 3-4 years, similar to the length of the restrictions on restricted stock. That certainly doesn't lead to spiking the stock price in the next two quarters.

    3. This is part of an overall trend towards paying big dollars to those at the top. Compare Alex Rodriguez's W-2 to Jeff Immelt and see who's is 3X the pay of the other.

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