Executive compensation is a hot topic in the corporate governance world. The discussion and evaluation of the fairness of executive pay practices has ramped up considerably since the arrival of Dodd-Frank, evolving as investor expectations and disclosure trends among public issuers have changed.
Last year, the SEC finalized disclosure rules on how companies should communicate pay versus performance results to shareholders. However, many discussions today still focus primarily on reported compensation, often overlooking the concept of realizable (and realized) compensation. These two terms may sound similar, but they represent vastly different aspects of executive pay.
These two terms may sound similar, but they represent vastly different aspects of executive pay. Admittedly, we are a touch early in thinking about the next disclosure cycle, but as this blog post explains the differences between reported and realizable compensation, we would encourage readers to envision how they might incorporate both perspectives in future compensation disclosures (and internal communications) to better inform their audiences on the true value and linkage of pay programs and company performance.
What is Reported Compensation?
Reported compensation is commonly referenced in the marketplace. These values are included in each public company’s annual proxy statement or annual report, and are readily accessible as they are conveniently summarized in the Summary Compensation Table. Reported compensation amounts are accounting values for all elements of executive compensation, which may include any of the following:
- Base Salary: A fixed annual salary.
- Cash Bonuses: Performance-based or discretionary bonuses.
- Stock Awards: Equity grants such as restricted stock units (RSUs) and performance shares.
- Option Awards: Equity grants such as stock options and stock appreciation rights (SARs).
- Benefits and Other Compensation: Perquisites like healthcare, retirement plans, deferred compensation plans and other non-cash benefits like personal use of corporate aircraft or security services.
Reported compensation of the above elements represents the accounting value of what was delivered to the executive in a given fiscal year. While this is straightforward for base salary and cash bonus, it doesn’t provide a complete story of total take home pay from the annual compensation package, largely due to the design of long-term incentives that are delivered in the form of stock and/or option awards. That’s where realizable compensation comes into play.
What is Realizable Compensation?
Realizable compensation supplements the standard calculation of executive pay. It reflects the current value of an executive’s awarded compensation at a given point in time, taking into consideration a company’s share price, equity award vesting schedules, and in-flight performance against long-term metrics. It reflects the value an executive could realize, or take home, on a given date if timelines and restrictions were to end on that date, making it a more accurate measure of an executive’s consideration received for services provided to the company.
Key Components of Realizable Compensation
- Base Salary and Cash Bonuses: Often similar to reported compensation, as share price does not generally impact these elements of pay.
- Outstanding Stock Value: The value that would be received from exercising any outstanding stock options (generally regardless of vesting status) or vesting any unvested RSUs and/or PSUs, based on a company’s stock price on a certain date and performance achievements at that date.
Why Realizable Compensation Matters
- Highlights Alignment With Performance: Illustrates theoretical take home pay based on performance achieved, clarifying any difference between that and reported compensation, highlighting the link to company performance and the “at-risk” nature of executive compensation.
- Improves Transparency: Realizable compensation provides a clearer picture of how much an executive can potentially take home based on company performance, enhancing transparency in disclosures and bringing the effectiveness of the compensation design programs to the reader’s attention – not just the “how much.”
- Shareholder Perspective: It improves shareholders’ abilities to make informed decisions on Say-on-Pay and director election shareholder votes, instead of solely relying on recommendations from proxy advisory firms. To that end, Zayla has seen an increase in the prevalence of realizable – and realized – compensation disclosures in proxies in recent years as public issuers evolve their disclosure practices to help shareholders make better voting decisions.
Conclusion
Understanding the difference between reported compensation and realizable compensation is crucial when evaluating executive pay. While reported compensation provides a good baseline of data, realizable compensation better illustrates what Named Executive Officers are working to receive from their annual opportunities.
Realizable compensation better underscores the connection between executive pay and company performance, which we believe serves the best interests of shareholders and the company as a whole. As corporate governance continues to evolve, we expect to see more of such communications across the marketplace and encourage all stakeholders to pay close attention when assessing executive pay practices.
