Edited by Demetris Nicolaou, CFA
Member of the Board
The CFA Society of
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Investors should analyze both the amounts paid to key executives for managing the company’s affairs, and the manner in which compensation is provided to determine whether compensation paid to its executives is commensurate with the executives’ level of responsibilities and performance, and provides appropriate incentives.
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Reasons for Reviewing Executive Compensation Disclosures. Disclosures of how much, in what manner, and on what basis executive management is paid shed light on the board’s stewardship of shareowner assets. Furthermore, they allow Investors to evaluate whether the compensation is reasonable in light of the apparent return to the company in terms of performance.
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Implications for Shareowners. The manner in which executive management is compensated can affect shareowner value in a number of ways. A flawed compensation program may encourage executives to make decisions that generate additional compensation to them through short-term gains, rather than implement an appropriate strategy that focuses on long-term growth. It also could dilute the ownership positions of existing shareowners. On the other hand, an appropriately designed program can create incentives for company executives to generate positive results for shareowners.
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Things to Consider. When reviewing a company’s executive compensation disclosures, investors should examine the reported:
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• Remuneration/Compensation strategy. An examination of the terms and conditions of the company’s executive compensation program, together with an analysis of summaries of agreements with executives, will help Investors determine whether the program rewards long-term growth, or short-term increases in share value. This review should include a determination of whether the remuneration/compensation committee uses consultants to set pay for company executives, or whether it relies on internal sources. Investors also should focus on whether the rewards offered to management are based on the performance of the company relative to its competitors or other peers, or on some other metric.
• Executive compensation. Analysis of the actual compensation paid to the company’s top executives during recent years and the elements of the compensation packages offered to key employees can help Investors determine whether the company is receiving adequate returns for the investment it has made in executive management.
• Share-based compensation terms. Examination of the terms of this type of remuneration program, including the total shares offered to key executives and other employees, should alert Investors to how the program can affect shares outstanding, dilution of shareowner interests, and share values. Investors also should determine whether the company seeks shareowner approval for creation or amendments to such plans.
• Stock-option expensing. Compensation, regardless of whether it is paid in cash, shares or share options, involves payment for services received and should appear as an expense on the income statement.
• Performance-based compensation. Investors should determine whether stock options and stock grants, as well as stock-appreciation rights and other performance-based compensation programs are linked to the long-term profitability and share-price performance of the Company relative to its competitors and peers. The purpose of compensation is to reward management for gains attributable directly to superior performance, and linking pay to performance is one way to achieve this purpose.
• Option repricing. Investors should remain aware of efforts by the company to reprice downward the strike prices of stock options previously granted. Changes in the strike price remove the incentives the original options created for management, and therefore reduce the link between long-term profitability and performance and management remuneration.
• Share ownership of management. Investors should determine whether members of management have share holdings other than those related to stock option grants. Such holdings may align the interests of company executives with those of shareowners.
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Where to find information about executive compensation:
• In many countries, companies report information about executive compensation in their annual reports. In some cases, disclosures about amounts paid to individual executives is voluntary, although accounting standards setters and securities regulators are increasingly making such disclosures compulsory.
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The CFA Society of
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