Breaking Down Realized and Realizable Pay- NACD BoardVision
This edition of NACD BoardVision goes beyond definitions to break down realized and realizable pay. Join Christopher Clark, publisher of NACD's Directorship Magazine and Eric Hosken, Partner at Compensation Advisory Partners as they talk about how compensation regulations affect businesses today.
>> Christopher Clark: Hi. I'm Christopher Clark, publisher of NACD "Directorship" magazine, and this is "BoardVision". Our topic today is one of my favorite ones, realized and realizable pay. I'm joined today by Eric Hosken of Compensation Advisory Partners. Welcome, Eric.
>> Eric Hosken: Thanks. Thanks for having me.
>> Christopher Clark: The conversation about those terms have been somewhat definitional. I want to go beyond that, and I would like you to answer how you make those terms and situations right for your company in particular.
>> Eric Hosken: Well, I think that it's evolving over time how companies are approaching alternative pay definitions, but really what it comes down to is that say on pay has made the pay and performance relationship a very important piece of the executive compensation story that a company's trying to tell. And the summary compensation table, the mandated disclosure of pay really falls short as a tool to demonstrate the pay in performance relationship. So companies have moved to these alternative pay definitions as a way to say how can we better tell our pay for performance story. So first thing that a company has to think through is do they need an alternative pay definition because if you go to alternative pay definition, it's going to confuse your disclosure a little bit. It's actually going to make things unclear because people are not going to be used to seeing disclosure in this way -
>> Christopher Clark: And you're saying more confusing.
>> Eric Hosken: More confusing. So people point out there's more just noise. There's multiple definitions of pay. You might see a target pay. You might see a summary comp table pay. Now you throw in a realized or realizable pay, it better be serving some purpose if you're going to add it into your disclosure. So most of the companies that initially move towards disclosing realized or realizable pay did it to demonstrate that summary compensation table pay was overstating the pay and making it look like the pay for performance relationship with the company was misaligned when if you looked at an alternative definition of pay, there was stronger alignment or closer alignment, and typically that alignment was total shareholder return went down. Summary comp table pay may have stayed flat or gone up, but if you looked at realized pay or realizable pay, those were lower than what the summary comp table pay was and were more in alignment with the movement in stock price.
>> Christopher Clark: So would you agree that in terms of a tool, it's complementary spelled with an "e" to the traditional, and it's supposed to be less confusing or more accurate in terms of the overall disclosure.
>> Eric Hosken: Yes. So it's more accurate in that summary comp table pay has one real big problem with that, and that is that the biggest single part of pay for a CEO or other senior executive is the long-term incentive pay, and most of that is stock price based and moves with stock price. Unfortunately, the required disclosure in summary comp table shows the grant date value of the pay. So for a stock option, it's the Black-Scholes value. value. For restricted stock, it's the face value on the date of grant. For performance plans, it's the target value of the date of grant or the fair value at the date of grant. So in all those cases, it's an opportunity, but it's not the amount that the executive is ultimately going to earn or could potentially earn, and that's really where the superiority of realized or realizable pay come into play is that they are better at showing how stock price movement will translate into movement in the compensation that the CEO actually takes home or the C, or the pay that the CEO could potentially take home.
>> Christopher Clark: What are the specific benefits, which you touched on, but also the larger risks?
>> Eric Hosken: The key benefit is it's a better way to tell your pay and performance story, and it's a way to say to shareholders don't look at the summary comp table pay. That gives you a misleading picture. Look at the realized pay. Look at the realizable pay. You'll see that our CEO is not taking that much money home and doesn't have that much potential value in the package. The risks are that once you do this once, you set a precedent -
>> Christopher Clark: You can't stop -
>> Eric Hosken: You set a precedent, and if you stop, it raises a red flag, or it might raise eyebrows about, oh, the story probably changed, and they want to selectively disclose the relationship. When it looks good or makes their story look better, they'll disclose it, but when it works against them, they won't.
>> Christopher Clark: If you could give our viewership either a heads up or an outlook for the tail end of 2014 in terms of the overall compensation design process? What would you say to them?
>> Eric Hosken: I'd say, you know, you should be looking at realized and realizable pay internally no matter what. They're useful ways of looking at the pay and performance relationship and looking at how much pay either was actually earned by your executives or could potentially be earned. I think the decision about whether to disclose it is a different one, and you really have to think about what does this add to the story we're telling to investors in our proxy statement, and is it something that we'd be comfortable disclosing year over year. I just would want to caution, there's one other thing out there, which is that there's regulation on pay disclosure. So the SEC is taking a very long time to implement Dodd Frank requirements on pay. One of them is enhanced disclosure of the pay and performance relationship. Right now, there's really more questions than answers. We know that there's some enhanced disclosure that's going to be required, but we don't know who it's going to apply to. We don't know how they're going to define pay. We don't know how they're going to define performance, and we don't know what time period they're going to look at it over. So there's a lot of open issues, but that could, in an ideal world, that might create a standard way of showing alternative pay definitions, which would make it easier for investors to compare across organizations, but unlikely that that's going to be the outcome.
>> Christopher Clark: Eric, I wanted to thank you for being spot on today.
>> Eric Hosken: Well, thank you for having me.
>> Christopher Clark: On behalf of NACD and Compensatory Advisory Partners, thank you for viewing today. I'm Chris Clark, and this is "BoardVision".
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