What Does it Mean for an Executive to 'Make' $1 Million?

8 Pages Posted: 15 Dec 2011 Last revised: 3 Sep 2013

See all articles by David F. Larcker

David F. Larcker

Stanford University - Graduate School of Business

Allan L. McCall

Stanford University - Graduate School of Business

Brian Tayan

Stanford University - Graduate School of Business

Date Written: December 14, 2011

Abstract

The press and other third-party observers frequently discuss executive compensation. However, executive compensation figures are not always what they seem. Executive pay packages contain a diverse mix of cash and non-cash incentives, payable in one or multiple years and subject to accruals, estimates, and restrictions that often render their ultimate value quite different from their expected value. Even total compensation figures disclosed in the annual proxy comingle forward- and backward-looking amounts as well as fixed and contingent payments that make it difficult for investors to understand what compensation has been promised to executives and what they eventually earn.

We untangle the mess and examine three basic methods for calculating compensation: expected value, earned value, and realized value. We discuss the applicability of each, illustrating concepts with real examples and summary statistics.

Why don't companies voluntarily disclose these figures so stakeholders can better evaluate incentives and pay for performance?

Topics, Issues and Controversies in Corporate Governance and Leadership: The Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important. Larcker and Tayan are co-authors of the book Corporate Governance Matters, and A Real Look at Real World Corporate Governance.

Keywords: corporate governance, executive compensation, earned versus realized pay, Black Scholes

JEL Classification: G30, G34, M4, M14

Suggested Citation

Larcker, David F. and McCall, Allan L. and Tayan, Brian, What Does it Mean for an Executive to 'Make' $1 Million? (December 14, 2011). Rock Center for Corporate Governance at Stanford University Closer Look Series: Topics, Issues and Controversies in Corporate Governance No. CGRP-22. Available at SSRN: https://ssrn.com/abstract=1972627 or http://dx.doi.org/10.2139/ssrn.1972627

David F. Larcker (Contact Author)

Stanford University - Graduate School of Business ( email )

Graduate School of Business
518 Memorial Way
Stanford, CA 94305-5015
United States
650-725-6159 (Phone)

Allan L. McCall

Stanford University - Graduate School of Business ( email )

Stanford, CA 94305
United States

Brian Tayan

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

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