CFO Corner: What the Heck is Realizable Pay (and why you need to know…now)

Dan Walter, Performensation

In
the good old days, determining total compensation was fairly easy. Always
wrong, but easy. For any given year you just added up what you paid people in
base pay, what you expected to pay them in bonuses, other cash incentives, and
the Fair Value (or a reasonable equivalent) of equity at the time it was
granted. Public companies disclosed this information and shareholders were left
to make their own projections from there. There has been a fairly rapid
movement to a measurement called “realizable pay” (the current/recent value of
outstanding pay). This metric may also be combined with “realized pay” (the
value of exercised or otherwise delivered pay) in an attempt to provide a more
accurate picture of total compensation and its alignment to company
performance.

If
you are a publicly traded company you are likely in the process of dealing with
Say on Pay as Proxy season approaches. Many past Say on Pay issues have
included complaints regarding disconnects between pay disclosed and the
financial performance of the company. Much of this has been attributed to the
method of calculating compensation that we have all used for years. Realizable
pay is the newest “answer” for this long time issue.

What
is Realizable Pay?

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Realizable Pay (“RP”) is pay measured at the end of the
measurement period and includes the value of full value awards, such as
Restricted Stock and RSUs and in the money stock options. Since this
measurement uses real values, it better reflects the pay delivered and more
tightly links to corporate performance and Total Shareholder Return over the
period of the award. That being said, it is not a flawless measurement.

We
will surely see a hailstorm of analysis regarding this relatively new popular
metric. Evaluations performed by some of the major voices in the compensation
industry have already declared RP to be an excellent measurement of pay versus
performance. Of course others have quickly pointed out RPs inherent flaws. I am
sure we will see rapid evolution and customized versions, but the time to get
on board is now.

Beginning
February 1, 2013, ISS will begin using realizable pay in its analysis of
S&P 500 CEOs if a company’s compensation policies fall into the high or
medium concern category. This new approach will be a welcome change for
companies that have delivered pay in line with performance. For an unlucky (or
poorly compensating) minority, this new evaluation may provide the final
argument needed to tip the scales to a negative Say on Pay vote. As will all
measurements like this, we can expect that the use of realizable pay by other
institutional investors and their advisors will spread quickly, even to those
companies not in the S&P 500. As a reference, I have included an excerpt
from the recently updated ISS “Evaluating Pay
for Performance Alignment”
document that describes their process for calculating realizable pay.

Calculating Realizable Pay

Realizable pay will include all non-incentive compensation amounts
paid over the measurement period (as reported in the Summary Compensation
Table), plus the updated value of equity or long-term cash incentive awards
made during the period and either earned or, if the award remains on-going,
revalued at target level as of the end of the measurement period. Total
realizable value for these grants and payments will thus be the sum of the
following:

·
Base Salary reported for all years in the measurement period;

·
Bonus reported for all years;

·
Short-term (typically annual) awards reported as Non-equity Incentive
Plan Compensation for all years;

·  For
all prospective long-term cash awards made during the measurement period, the
earned value of the award (if earned during the same measurement period) or its target
value in the case of on-going award cycles;

·  For
all share-based awards made during the measurement period, the value (based on
stock price as of the end of the measurement period) of awards made during the
period (less any shares/units forfeited due to failure to meet performance
criteria based on complete and clear disclosure); or, if awards remain
on-going, the target level of such awards;

·  For
stock options granted during the measurement period, the net value realized
with respect to such granted options which were also exercised during the
period; for options granted but not exercised during the measurement period,
ISS will re-calculate the option value, using the Black-Scholes option pricing
model, as of the end of the measurement period;

·
Change in Pension Value and Nonqualified Deferred Compensation Earnings
reported for all years; and

·  All
Other Compensation reported for all years.

Take
the time to get familiar with this new addition to the essential ingredients of
Executive (and other) Compensation. If you’re in the S&P 500 you probably
have about a week before your CEO calls you in to discuss this topic. If you
are not in the S&P 500 you probably have three weeks before people start
asking. Feel free to reach out if you have questions. ~Dan

Dan Walter is the
President and CEO of Performensation an independent compensation consultant focused on the needs of
small and mid-sized public and private companies. Dan’s unique perspective and
expertise includes equity compensation, executive compensation,
performance-based pay and talent management issues. Dan is a co-author of “The Decision Makers Guide to Equity Compensation”, “If I’d Only Know That”, “GEOnomics 2011” and “Equity Alternatives.”
Dan is on the board of the National Center for Employee Ownership, a partner in the ShareComp virtual conferences and the founder of Equity Compensation Experts, a free networking group. Dan is frequently requested as a
dynamic and humorous speaker covering compensation and motivation topics.
Connect with him on LinkedIn or follow
him on Twitter at @Performensation and @SayOnPay