Why Corporate CEO Pay is Routinely Undercounted


An Institute for New Economic Thinking Working Paper by William Lazonick and Matt Hopkins reveals that much reporting on executive pay relies on systems of measurement that underreport real compensation

An Institute for New Economic Thinking Working Paper by William Lazonick and Matt Hopkins (PDF) has revealed that executive pay is routinely undercounted by media outlets, and even by critics of excessive executive pay such as the AFL-CIO. That’s because their calculation of those earnings is based on “fair value” estimates of the stock-based pay of these CEOs. Those estimates are reported in the Summary Compensation Table of the definitive proxy statement (Form DEF 14A) that each publicly listed company files annually with the U.S. Securities and Exchange Commission (SEC).

But, Lazonick and Hopkins note, “the very same proxy statements also report the actual realized gains of these CEOs in the Option Exercises and Stock Vested Table”, adding that “It is the realized gains on stock-based pay, not fair-value estimates, that enter into the total compensation that a CEO actually takes home and reports as income in his or her income-tax return.”

Measuring actual realized gains instead of estimated fair value of stock can make a big difference to the overall compensation package for a corporate executive, they write:

“In 2014 average total compensation of the 500 highest-paid executives named on corporate proxy statements based on actual realized gains was $34.3 million, with 81 percent coming from stock-based pay. But average total compensation of the 500 highest paid based on estimated fair value was $19.3 million, with 62 percent attributable to stock- based pay. The excess of total actual realized-gains compensation over total estimated fair-value compensation was greatest in those years when the stock market was booming.”

Their paper explains the origin of the “fair value” estimate, and how it came supplant actual realized gains in measuring executive compensation, to the point that this faulty measure has been institutionally embraced by the SEC and codified in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

That measure, they warn, “will tend to underestimate inequality, substituting fictitious estimates for actual known amounts of income that CEOs put into their bank accounts and declare in their income-tax returns.”

Writing in the Atlantic, Lazonick and Hopkins provide a detailed account of the discrepancy between the two measurements as applied to the incomes of a number of leading American CEOs. And they draw out the wider political and economic implications:

“These executive-compensation figures are so large that they can appear abstract, even meaningless, to the ordinary worker,” they write in the Atlantic. “When someone is already making tens of millions of dollars, what’s the significance of tens of millions more? What most people do not realize is that the corporate behavior that results in this level of extreme wealth is largely responsible for the decades-long erosion of the American middle class. America’s severe and persistent income inequality is not just about how much these executives have been able to secure as compensation. It is more fundamentally about how senior executives have been able to boost their stock-based pay, while the average American worker faces wage stagnation.”

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