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gsb.stanford.edu/cldr What Does It Mean for an Executive To “Make” $1 Million? Professor David F. Larcker Center for Leadership Development & Research Stanford Graduate School of Business

13. What Does It Mean for an Executive To “Make” $1 Million?

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Page 1: 13. What Does It Mean for an Executive To “Make” $1 Million?

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What Does It Mean for an Executive To “Make” $1 Million?

Professor David F. Larcker

Center for Leadership Development & Research

Stanford Graduate School of Business

Page 2: 13. What Does It Mean for an Executive To “Make” $1 Million?

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Compensation at Citigroup

• When Vikram Pandit became CEO of Citigroup in 2008, the New York Times dubbed him the “quarter-billion dollar man.”

– Received $165 million from sale of Old Lane hedge fund to Citigroup (proceeds reinvested)

– Promised $40 million compensation contract (primarily equity)

• Despite the headlines, however, Pandit never received this money.

– Investment in hedge fund worth only a fraction when sold

– Equity grants worth only $4 million when vested

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Compensation at Citigroup

$-

$5

$10

$15

$20

$25

$30

$35

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10

Citigroup (C) Stock Price History - 2008 to 2010

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Compensation at Citigroup

2008 2009 2010 2008 2009 2010 2008 2009 2010

Salary 958,333 125,001 1 958,333 125,001 1 958,333 125,001 1

Bonus 0 0 0 0 0 0 0 0 0

Stock 28,830,000 0 0 1,961,250 1,132,504 1,346,903 119,500 125,239 130,798

Options 8,432,911 0 0 0 0 0 0 0 0

Other 16,193 3,750 0 16,193 3,750 0 16,193 3,750 0

Total 38,237,437 128,751 1 2,935,776 1,261,255 1,346,904 1,094,026 253,990 130,799

Reported Compensation Earned Compensation Realized Compensation

Methodology Found at: http://www.gsb.stanford.edu/sites/default/files/22_MeasuringPay.pdf

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Compensation Reporting

• CEO compensation figures are not always what they seem.

• Reported compensation figures include a mix of cash and non-cash incentives, payable in one or multiple years, and are subject to accruals, estimates, and restrictions.

• As a result, the ultimate value of compensation is often quite different from its expected value.

• The SEC standardizes reporting requirements. However, even these comingle forward- and backward-looking amounts, and fixed and contingent payments.

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Measuring CEO Compensation

There are three general ways to measure compensation:

1. Expected. Total value promised to executive. Because not all compensation is received in the year it is awarded, some elements must be estimated. The precision of these estimates will depend on performance and market-related sensitivities.

2. Earned. Total value that an executive “earns the right to keep.” In most cases, the amount earned in a year is derived from compensation granted over multiple years.

3. Realized. Total value that an executive converts to cash in a given year. Realized compensation is also often derived from grants awarded over multiple years.

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Measuring CEO Compensation

Elements of Executive Compensation

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Example: Harley-Davidson

Expected Earned Realized SEC Proxy

Salary $ 975,000 $ 975,037 $ 975,037 975,037

Cash Bonus 0 0 0 0

Stock Awards 1,381,199 0 0 1,381,199

Option Awards 1,636,681 698,906 0 1,636,681

Non-Equity Plans 2,600,357 2,340,090 2,340,090 2,340,090

Pension 0 0 0 0

Other Benefits 83,490 83,490 67,289 83,490

Total $ 6,676,727 $ 4,097,523 $ 3,382,416 6,416,498

Keith Wandell, CEO of Harley-Davidson (2010)

Methodology Found at: http://www.gsb.stanford.edu/sites/default/files/22_MeasuringPay.pdf

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Measuring CEO Compensation

These distinctions are important because each figure conveys different information.

• Expected compensation is a forward-looking view of reward opportunities available to an executive. The size and mix of expected compensation provide insight into the incentives offered to management.

• Earned and realized compensation are backward-looking views of the rewards that an executive actually received for his or her efforts. These values can be used to assess pay-for-performance.

Incentives and pay-for-performance are both very important, but their calculations are not the same.

Page 10: 13. What Does It Mean for an Executive To “Make” $1 Million?

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Challenges in Assessing Compensation

The information to properly evaluate the incentive value of compensation and pay-for-performance is not readily available to shareholders.

1. Summary compensation figures in the annual proxy combine expected, earned, and realized amounts.

2. Proxy advisory firms compare changes in reported compensation to previous total share price performance, making a false comparison.

3. Journalists do not consistently distinguish between earned and expected amounts.

Page 11: 13. What Does It Mean for an Executive To “Make” $1 Million?

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Challenges in Assessing Compensation

• A recent article reported that Viacom CEO Philippe Dauman received a pay increase of 150 percent.

• One analyst commented, “This is spectacular money but where are the spectacular results?”

• Earned compensation figures, however, were not the same as those reported. Philippe Dauman, CEO of Viacom (2009-2010)

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Why This Matters

• Executive compensation figures are frequently cited by the press and third-party observers. However, these sources rarely distinguish between expected and earned pay.

– What does it actually mean when we read that a CEO “made” $1 million?

• Earned compensation often differs significantly from expected pay, based on individual performance.

– Why don’t companies voluntarily disclose these amounts so stakeholders can assess incentives and pay-for-performance?

Page 13: 13. What Does It Mean for an Executive To “Make” $1 Million?

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Summary Statistics: Total CEO Compensation

Mean Compensation (2010)

Sample includes 2,471 companies with fiscal years ending between June 2010 and January 2011.

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Summary Statistics: Total CEO Compensation

Median Compensation (2010)

DecileMarket Cap(in millions)

SEC ProxyInstitutional Shareholder

ServicesExpected Value

EarnedValue

Highest $ 22,522 $ 12,220,817 $ 15,312,751 $ 11,210,876 $ 9,218,322

6,895 6,932,325 8,878,721 6,763,005 5,696,422

3,257 5,245,581 6,669,452 4,837,471 3,799,896

2,061 4,046,318 5,006,225 3,942,680 3,046,327

1,312 3,093,924 4,024,939 3,159,052 2,437,328

853 2,360,580 3,129,763 2,328,114 1,873,891

574 2,074,024 2,574,915 2,073,491 1,700,898

372 1,415,159 1,894,097 1,577,976 1,200,413

241 1,190,955 1,411,867 1,226,952 976,996

Lowest 149 858,204 1,045,605 865,041 794,706

Sample includes 2,471 companies with fiscal years ending between June 2010 and January 2011.

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References

• Eric Dash. All Told, the Price Tag for Citigroup’s New Chief is $216 Million. The New York Times. March 14, 2008.

• Citigroup. Forms DEF-14A and Forms 4. SEC. 2008-2010.

• Harley-Davidson. Forms DEF-14A and Forms 4. SEC. 2010-2011.

• Graham Bowley. Pay Doubles for Leaders at Viacom. The New York Times. January 22, 2011.

• Viacom. Forms DEF-14A. SEC. 2007-2011.

• Equilar Compensation Data.