An Activist View of CEO Compensation

Understanding CEO compensation plans is a continuing challenge for directors and investors. The disclosure of these plans is dictated by SEC rules that rely heavily on the “fair value” of awards at the time they are granted. The problem with these numbers is that they are static and do not reflect how pay changes with performance. Activist fund ValueAct Capital has developed a framework to address this problem. Their approach is to strip down and systematically reconstruct the compensation figures in the annual proxy, allowing for a step-by-step evaluation of the conditions under which variable pay is realized. In this Closer Look, we examine this framework in detail. We ask: How useful is this framework in understanding the relation between pay and performance? Are large “minimum” payments indicative of managerial abuse? What insights does this analysis provide into the governance quality of different firms? How might a board monitor to ensure that the CEO is not taking on excessive risk? What does it say about SEC rules that the results of this analysis are vastly different from the figures provided in the annual proxy?