In our latest Q&A interview with people who use Calcbench in their financial analysis, we speak with Stephen O’Byrne, President of Shareholder Value Advisors. O’Byrne’s firm helps companies design better management incentive plans and measure shareholder value at the group and divisional levels using economic profit concepts. 

In this interview, Calcbench talks to O’Byrne about why investors should focus on executive compensation, how to evaluate executive pay with the new disclosures, and how Calcbench can help investors with this analysis. 

Let’s start at the top. Why should investors pay attention to executive compensation? 

Simple: because when pay practices are connected with shareholder interests, investors have a better chance of achieving higher returns. So investors should study executive compensation to be sure that alignment between pay and shareholder interests does exist.

How has executive compensation been evolving? 

Proxy advisers have become increasingly aggressive about reinforcing the conventional wisdom that executives should have expected pay at the median. For some companies, this has been effective. But practices such as targeting dollar pay and percentage pay at risk can disconnect company leaders from shareholder interests. For example, when stock prices drop, companies often grant more shares to meet target dollar amounts; that insulates executives from the decline while shareholders suffer.

At the same time, there’s a small but growing group of companies that have been paying executives with private equity-like compensation. For some executives, such as Elon Musk (Tesla), Tim Cook (Apple), and Sundar Pichai (Google), they receive large upfront grants instead of annual grants to create stronger incentives. 

So what should investors focus on? 

It’s important to measure the strength and cost efficiency of incentive programs using “realizable” or “mark to market” pay. Doing this has become much easier with the introduction of new disclosure requirements that report compensation on a mark-to-market basis.

The single most important thing investors can do is measure key pay dimensions over time. I look at four dimensions: 

1. Pay leverage, or the sensitivity of pay to relative company performance.

2. Pay alignment which is the correlation of changes in pay with changes in performance.

3. Pay premiums at industry average performance, or performance-adjusted cost. 

4. Relative pay risk, which looks at pay risk relative to the risk of the company.

Pay alignment and relative pay risk are the two components of pay leverage and help you understand why the company is achieving (or failing to achieve) a strong incentive.  Pay leverage and the pay premium at industry average performance help you assess the cost-efficiency of the CEO’s incentive. Ultimately, you want to relate these pay dimensions to future returns to improve your investment strategy. 

What drew you to Calcbench?

Calcbench has an easy-to-use interface that allows me to download data for a substantial sample of companies, directly into Excel. The addition of the Pay versus Performance (PvP) data and the existing summary compensation table data are very useful for my analysis. I also find the tracing and search features to be helpful. I search proxies for terms like “fixed shares” and directly access the relevant text in underlying documents. 

If you’d like to know more about the compensation data Calcbench tracks and how to use that information in financial analysis, be sure to see our previous posts on the compensation data we have!