Stock Picking by the CEO's Paycheck

Measure Performance

"What you want to do in reviewing the CD&A is to see if there is any meat behind the alignment of an executives pay for performance", says Eleanor Bloxham, founder and chief executive of the Value Alliance Company and the Corporate Governance Alliance.

By this she means what performance measures the board uses, how they are aligned with pay and why these measures (be they earnings growth, revenue growth or relative performance versus peers) are important. 

Second, like Hightower, Bloxham said investors should look at how pay is tied to strategic goals the firm has outlined in the CD&A.  Third, check if the pay is protected from down cycles in the industry.  Bloxham said there should be no adjustments to protect pay if a firm's industry hits a downcycle, nor should there be adjustments for bad events or regular repricing of stock options.  Bloxham recommended investors also look closely at the severance a CEO would receive, or pay he or she would get if there was a change of control at the company. 

"It's important to understand what the incentive might be to sell the company at a low price" she said, something that would not be in the best interest of shareholders.

Lastly, Bloxham advised that investors take a look at the increases in CEO pay versus the firm's employees. The number for the employees can be found in the salary and benefits line on a company's income statement.  This will give investors an idea of whether the CEO's pay is accelerating at a faster pace than the employees.

Compare Across Peer Group

For Jack Dolmat-Connell, president and CEO of DolmatConnell& Partners, a Waltham, Massachusetts-based compensaton consulting firm, the peer group is the place to start. 

"You want to see that it is the same size," he said.  This means making sure the companies in the peer group have a revenue base and market capitalization similar to that of the company whose stock an investor owns.

Dolmat-Connell also said investors should make sure CEO pay is being measured against other CEOs who run like-sized companies, and not companies that are much bigger. Comparing a CEO's pay to a peer group of larger firms could be the board stacking the deck. That is because they don't want their CEO's pay to be at the top of the peer group for fear it could attract unwanted attention.  Because CEOs of bigger companies usually get paid more, the board could give a good sized payout to the chief of a smaller firm, without coming under fire because the peer comparison would put their pay in the middle of the group.

Second, check and see how the company performed versus the peer group. 

"It takes a little bit of digging," he said, "but its gives you some strong measures to determine if your CEO's pay is merited." 

He recommended looking at a company's one-year and three-year return against the peer group.  The one-year return will let you know if short term incentives like salary increases and bonuses are fair, while the three-year return will show investors if longer term rewards like stock options are appropriate.

Dolmat-Connell also looks at the level of executive and director ownership in a company.  He said those with higher ownership tend to perform better. And by ownership, Dolmat-Connell means how many real shares those executives own, so exclude their stock options in this calculation.

Fourth, he checks out the bonus metrics a board uses -- what does the board use to tie executive pay to the elements that drive shareholder value? Then he goes a step further -- if the board says the goals were to increase net income and revenue by 10 percent in the last year, he looks at whether those targets exceed or lag what was delivered by the company's peers.

"The last thing to look at are the long term incentive vehicles," he said.

Dolmat-Connell said stock options are a better way of rewarding a CEO for increasing shareholder value than restricted shares.  That is because restricted shares are given as long as an executive stays a certain amount of time. With stock options, the executive only benefits if the stock rises to levels above the options exercise price. 

"If you have a high concentration of time-based restricted stock, the company probably isn't expected to perform that well, or isn't performing well," he said.

CONTINUED : What is Variable Pay Linked To?

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