Why Do CEOs Get Paid So Much? A New Rule Offers More Transparency

Wharton’s Wayne Guay explains how a new disclosure requirement gives investors a clearer understanding of exactly how much compensation company CEOs realize from stock and option awards.

Investors now have a clearer understanding of exactly how much compensation company CEOs realize from equity grants after a regulatory mandate last year required additional disclosures about changes in the value of unvested restricted stock and stock options. The new regulation, referred to as “compensation actually paid” is part of a “Pay Versus Performance” disclosure requirement by the Securities and Exchange Commission (SEC). It gives effect to a provision under the 2010 Dodd-Frank Act that sought to “better align executive compensation with corporate results,” a Wall Street Journal report noted.

Adopted by the SEC in August 2022 and brought into effect from October 2022, the new regulation requires companies “to disclose in a clear manner the relationship” between the executive compensation actually paid by companies and their financial performance. Previously, companies were required to report the value of stock grants or options on the date/s they were awarded, but not the changes in value of those grants between the grant date and the vesting date.

“We’ve added another measure that gets at understanding some of the incentives that the executives have, because it’s capturing changes in the values of their equity awards over time,” Wharton accounting professor Wayne Guay said on the Wharton Business Daily radio show that airs on SiriusXM. (Listen to the full podcast above.) “This is the way that most companies tie their senior executives’ compensation and wealth to company and shareholder performance.”

Guay noted that the new requirement is “an additional measure” of disclosure of executive compensation. “It isn’t a substitute for what we’ve been thinking about as total compensation. Firms will still have to disclose the grant date values of the compensation that they’re paying their executives.” Much of the disclosures under the new regulation could have been culled from companies’ regulatory filings, he pointed out. “But now it’s being reported in a more salient way so that investors can better understand some of these incentives.”

Greater Transparency Reveals Why CEOs Get Paid So Much

Stock and option grants typically vest over several years, often as a function of pre-determined milestones in a company’s performance. Guay noted that the new regulation will incorporate changes in the value of not only the current year’s equity awards, but also unvested equity awards that have been granted in prior years. That information enables a clearer view of how a CEO’s realized compensation evolves over time, and the “incentive alignment” it has with shareholder returns, he added.

Greater transparency around stock awards is especially important because they typically make up about two-thirds of CEO compensation. Early results from the new disclosures indicate a large gap between the grant date value of the CEO compensation, and the compensation CEOs actually realized. In 2022, about two-thirds of the top executives at S&P 500 companies realized lower pay than they were originally awarded, at least on paper, according to a Wall Street Journal report based on analysis of data from MyLogIQ, a provider of SEC compliance and disclosure intelligence products.

At the same time, some 140 CEOs earned more money than expected, and at 46 companies the CEOs realized compensation at least double what boards paid them for the year in 2022, the report pointed out. Among those who saw the value of their stock awards decline was Tesla’s CEO Elon Musk (a $10 billion loss) and Amazon’s CEO Andy Jassy ($149 million). Google parent Alphabet’s chief executive Sundar Pichai topped the list of grant-date CEO compensation with a pay package originally valued at $226 million, but his pay as calculated under the new rules shrank by $110 million, the Journal report noted.

Those declines in the values of unvested stock awards largely reflect the downcast sentiment in the stock markets in 2022, Guay said. Over the 2022 calendar year, the S&P 500 was down some 20%, he pointed out, its weakest performance since 2008. When stock returns are poor, the value of CEOs’ unvested stock and options decline, and this loss of value can more than offset the value of new compensation granted in the current year. The opposite can be true when stock price performance is strong. “Again, it draws our attention to the fact that much of CEO compensation is tied to shareholder value.”

Disclosures on the change in value of stock awards will also reveal the degree of personal stakes CEOs have in their companies’ performance. “Institutional investors will push back on CEOs that they perceive to not have enough skin in the game,” said Guay. “Most CEOs are expected to hold a lot of stock in their company. That’s what shareholders want to see.” The new disclosures also address criticism that CEO compensation “is not sufficiently tied to performance,” he added. U.S. CEOs, in general, have strong pay-for-performance (and much stronger than CEOs in other countries), and these new disclosures should help emphasize that point.

Protecting CEOs From Unfair Criticism Over Compensation

The new regulations could prove helpful to CEOs, too, especially when they face criticism over their compensation. The CEO of a company is in the spotlight when its fortunes decline as a result of setbacks across the economy or in its specific industry, and more so if that CEO’s compensation is perceived as being overly high, Guay said. In that setting, the disclosures could help CEOs emphasize that their wealth declined substantially along with shareholders because their stock awards lost value, he added.

“Granted, [CEOs] are quite wealthy. But when the stock price suffers, they’re in it with shareholders and they’re often some of the biggest losers,” Guay said. “On the other [hand], when the stock price goes up, they are often some of the big winners.”

At the same time, Guay noted that caution is in order if the new disclosures are used to compare compensation across CEOs. The new disclosures may help compare realized compensation across CEOs in the same industry that experience similar financial performance. At the same time, comparing “compensation actually paid” for CEOs across industries can be less informative when those industries experience very different performance. He pointed out that in 2022, for instance, CEOs of energy companies “did exceptionally well” in terms of realized compensation because energy prices were high over the course of the year. The converse is also true, where for example, the telecom industry struggled in 2022, and hurt CEO compensation in that industry across the board. The new disclosures will indeed indicate that energy CEOs realized much higher pay than telecom CEOs in 2022, but that fact is largely due to the stronger stock price performance of the energy companies run by those CEOs.