Working Today, Paid Tomorrow

6/7/2010


These days, both the government and investors are pushing to limit executive pay.

One result of that trend is the decline in perquisites, such as club memberships and personal travel on the corporate jet. A study commissioned by The Wall Street Journal found CEO perks fell 34% last year, with the median chief executive receiving $138,693 in “other compensation.” But while perks garner plenty of headlines, a bigger issue is stock compensation, which is not on the decline.

Stock compensation has historically been considered one of the best ways to align management’s incentives with those of shareholders. The theory holds that stock options, restricted stock, and other forms of deferred stock-based pay encourage management not to take excessive risks because a big portion of their pay is on the line.

The table below shows that stock compensation represented 12% of earnings for companies in the S&P 500 Index last year. The financials and technology sectors paid out the largest proportion of their earnings in the form of stock-based compensation. Between them, technology and financial companies accounted for 55% of the index’s total stock-based compensation, both for last year and for the last four years combined.

SECTOR ANALYSIS
Last year, the S&P 500 Index’s financials sector paid out stock-based compensation equal to 29% of earnings before special items, versus 12% for the broader index. But going forward, after the sector’s earnings recover, we expect a return to levels more common in prior years. Over the last four years, the financial and technology sectors combined to pay out more than half of the index’s stock-based compensation. Data exclude 30 index companies without four years of history.
Stock Compensation as % of
—–—— Earnings Before Special Items —–——
Total Stock
Compensation,
Last 4 Yrs.
($Billions)
Last
Year
(%)
1 Year
Earlier
(%)
2 Years
Earlier
(%)
3 Years
Earlier
(%)
Last 4
Years
(%)
Cons. Discretionary
12
NA
8
8
14
20.0
Consumer Staples
5
6
5
5
5
13.7
Energy
9
4
3
2
3
13.1
Financials
29
NA
13
9
25
64.0
Health Care
7
9
9
11
9
24.1
Industrials
8
7
7
7
7
14.9
Materials
11
40
6
5
8
5.2
Technology
17
18
16
16
17
54.5
Telecom
5
5
NA
8
16
3.1
Utilities
4
3
3
4
3
3.0
Total for Indx. Stks.
12
20
9
8
11
215.7
NA Not Available because sector lost money.

Stock compensation as a percentage of index earnings appears high in the last two years because of unusually low profits. Total stock compensation rose 5% over the last three years, while the index’s earnings declined 28% excluding special items.

While the topic of CEO pay gets far more play than it warrants, the numbers do offer some insight about the prevalence of stock-based compensation. The Journal’s survey, which reviewed 200 U.S. companies that generated revenue of more than $4 billion last year, found median CEO compensation of $6.95 million last year. While perks account for only a tiny portion of that pay, long-term incentives (grants for stock options, restricted stock, and performance-based cash and equity awards) represented more than 60% of total CEO compensation.

Given the modest uptrend over the last three years, which includes difficult periods for many companies, investors should expect stock-based compensation to continue rising. However, most companies already report such pay as an operating expense, so the costs are not hidden.


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