Background/Objectives Frederic W. Cook Mercer Human Resource Consulting Research on CEO Compensation for Business Roundtable The media has been flooded with many distorted, misleading and oftentimes erroneous statistics on CEO compensation that portray U.S. CEOs and board governance in a negative light. Most often these relate to escalating CEO pay ratios (relative to the pay of the average worker) and CEO pay changes that seemingly have no relationship to company performance. The effect has been to undermine public confidence that CEOs and boards are acting in the best interests of their companies, shareholders, employees and communities. Business Roundtable, an association of 160 CEOs of leading U.S. companies, engaged Frederic W. Cook & Co. (1) to examine commonly-reported assertions on CEO compensation in the business media and to develop a sound base of facts to assess what is right and wrong with executive compensation. Frederic W. Cook & Co., in turn, contracted with Mercer Human Resources Consulting (2) to access their highly regarded data base on CEO compensation at 350 large corporations. The database has been consistently compiled for over 14 years, and is the data source for The Wall Street Journal s annual Survey of CEO Compensation. Common Errors/Better Measurement Methods Media reports on CEO compensation make several errors in reporting CEO pay that serve to inflame rather than inform public opinion. They: 1. Use Averages Rather than Medians In executive compensation reporting, outliers pull the averages up above the median Median statistics are more representative of the practices of a large group (1) (2) Frederic W. Cook & Co., Inc. is an independent executive compensation consulting firm providing advice on executive compensation design to corporations and their board compensation committees since 1973. Mercer Human Resources Consulting is a global HR consulting firm providing advice on human resource policies, practices and pay levels, including executive compensation.
2. Include Realized Option Gains in Annual Compensation Realized option gains often represent many past years option grants exercised in a single year (i.e., they often represent many years of compensation). Instead of realized gains, CEO pay calculations should include annual stock option grant values (measured by Black-Scholes or binomial models), as will be required for proxy reporting under new SEC rules 3. Extrapolate from an Unrepresentative Sample The media sometimes summarizes the pay practices for all CEOs with pay data from only the very largest companies; only CEOs at the very largest companies are compensated at the levels widely referred to as that of the average CEO CEO pay statistics should be referenced accurately and applied responsibly 4. Choose Inflammatory Statistics Statistics may be chosen selectively, out of context, or in a manner that is misleading Defensible CEO Pay Data and Trends Using the Mercer 350 CEO pay database and the preferred measurement methods described above, we constructed three charts to better inform public debate on CEO pay: Charts A & B Mercer Median CEO Pay Trend Data Shows annual compound growth rates in components of CEO total compensation from 1995 through 2005 Compound growth rate in CEO pay elements is compared with compound growth rate in various Mercer median 350 company financial metrics that logically relate to those pay elements Chart C Growth in Median CEO Total Direct Compensation Shows the absolute amount of median CEO total direct compensation for each year of the period covered Trends should be measured and reported in a consistent manner year-overyear -2-
Chart A MERCER MEDIAN CEO PAY TREND DATA ($000) Mercer 350 Median CEO Pay ($000) 1995 2005 CAGR 1. Salary $729.0 $975.0 3.0% 2. Bonus 1 703.0 1,433.7 7.4% 3. Long-Term 1 1,287.5 4,421.5 13.1% 4. Total $2,719.5 $6,830.2 9.6% Mercer 350 Median Financial Metrics ($mil) 1. Revenue $5,055.7 $7,627.5 4.2% 2. Net Income 261.5 590.5 8.5% 3. Market Cap 4,324.6 10,078.4 8.8% 4. TSR Index 1.00 2.57 9.9% 1 Derived median
Chart B Changes in CEO Pay vs. Total Shareholder Return 3.50 3.00 3.32 3.17 Median TSR Median CEO Total Direct Comp. 2.50 Indexed Change 2.00 1.50 1.00 0.50 0.00 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 (1) Mercer 350 database; continued incumbents only
Growth in Median CEO Total Direct Compensation Chart C Total compensation includes salary, earned annual bonus, grant value of restricted shares and stock options, and target value of earnout of any other new performance-based cash or equity awards. $8,000 Median CEO Total Compensation ($000) $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $2,719 $3,239 $3,957 $4,591 $4,988 $5,223 $7,037 $6,102 $6,210 $7,043 $6,830 2005: 3% decrease 2004: 13% increase 5-yr CAGR = 5.5% 10-yr CAGR = 9.6% $0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: Mercer 350 database (350 large-cap general industrial and service companies with median market cap of $10 billion); all incumbents.