Realized Pay - Explained
Reportable, Realizable, Realized Pay
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Table of ContentsWhat is Realized Pay?How is Realized Pay Determined? The Rules Proposed by SEC for Actual Pay DisclosureAcademic Research on Realized Pay
What is Realized Pay?
The pay reporting methods required for disclosure to public companies continues to be a debate, especially as companies, shareholders, regulators, and other advisors focus on pay for performance. Traditionally, there are three ways to calculate and potentially disclose pay: realizable, reported, and realized pay. The different parts of the pay life-cycle are represented by components that comprise each pay methodology.
How is Realized Pay Determined?
There are three types of pay disclosures.
- Reported Pay - Being the first stage in the cycle, this part relays what is initially granted, even though its not earned during the fiscal year. As required by the SEC, reported pay is to be disclosed in the SCT (summary compensation table) of annual proxies.
- Realizable Pay - This portion covers the center of the cycle, and it leverages on the pay opportunity prior to the exercise or vesting of equity to an executive after grant.
- Realized Pay - Also called actual pay, it is the true pay received by an executive during the fiscal year, in addition to exercised or vested equity.
Although these three processes of calculating pay happen in a cycle, if one is disclosed over another, or side by side, confusion may arise in trying to understand the actual meaning of each compensation amount. Do they represent the pay structure, the actual compensation received, or comprise both? Although realized pay accurately addresses what executives take home, and reported and realizable pay give a better understanding of the pay structure and likely pay opportunities, no methodology provides a complete picture.
The Rules Proposed by SEC for Actual Pay Disclosure
To provide more transparency on pay vs. performance, the SEC proposed a rule in April 2015 which if implemented as conceived would make public companies disclose company executives realized pay. The formal definition of actual pay according to the SEC is total compensation based on the report in the SCT with two modifications. First, the aggregate change in the actuarial present value of the accumulated benefit under all defined benefit pension plans plus the cost of service under all such pension plans will be subtracted from SCT overall compensation. Second, equity awards, including stocks, options, performance shares and units will be valued at the vesting date fair value as opposed to granting date fair value. Therefore, certain long-term compensations will be excluded from actual pay, e.g. not yet vested incentive awards and equity. Upon the finalization of the rule, a clear explanation would be required from companies, highlighting the CEOs actual pay and other NEOs average actual pay. Although the proposed rule has not been made official, realized pay is already being discussed in annual proxies by many companies. Based on Equilars 2016 Compensation and Governance Outlook report, there was a jump from 1.7% to 13.7% in the disclosure of realized pay in the proxies of S&P 500 companies between 2011 and 2015. By making available an alternative to SCT reported pay, companies clarify the distinction between the amount paid and granted to executives throughout the fiscal year, and the actual amount taken by the executives to the bank. By clarifying the difference between reported and realized pay, the story told by companies can be well related to pay for performance.
Academic Research on Realized Pay
- CEO pay and corporate governance in the US: Perceptions, facts, and challenges, Kaplan, S. N. (2013). Journal of Applied Corporate Finance, 25(2), 8-25. This article uses a wide variety of statistics and research to explain three popular perceptions on CEO compensation in public companies and US governance. The study found that although the average pay received by CEOs saw a substantial increase in the 1990s; it has since experienced a decline of over 30% from the peak reached in 2000. It concludes that there is a reasonable correlation between corporate performance and the pay of US CEOs.
- Regulating bankers' pay, Bebchuk, L. A., & Spamann, H. (2009). geo. Lj, 98, 247. This article uses statistical studies to explain how incentives for excessive risk-taking have been produced by banks executive pay and how a reformation can be done on such pay. A combination of equity-based awards and capital structure of banks binds the compensation of executives to a common notion on bank asset value. The study finds that corporate governance reforms focused on aligning the structure of executive pay arrangements with common shareholders bank interests like votes of advisory shareholders on compensation plans, restricted stock awards use, director independence and oversight increase is shown to not eliminate the problem.
- The economic value of volatility timing using realized volatility, Fleming, J., Kirby, C., & Ostdiek, B. (2003). Journal of Financial Economics, 67(3), 473-509. This study measures the economic value of realized instability approach in relation to investment decisions. The results show that the value of switching from daily to intradaily returns to create an estimate of the conditional covariance matrix can be consequential. According to these findings, it is estimated that a risk-averse investor would consider paying 50 to 200 basis points per year to have a record of the analyzed gains in portfolio performance.
- Realized returns and the default and prepayment experience of financial leasing contracts, Lease, R. C., McConnell, J. J., & Schallheim, J. S. (1990). Financial Management, 11-20. This paper examines the impact of realized return on default and prepayment experience of financial leasing contracts. The study suggests that actual returns often exceed contractual yields for full-term leases.
- Realized volatility and variance: Options via swaps, Carr, P., & Lee, R. (2007). Risk, 20(5), 76-83. This study creates pricing and hedging options strategies on realized variance and volatility. The authors use variance and volatility swaps to price and hedge variance and volatility options.
- Executive compensation in Europe: Realized gains from stock-based pay, Kotnik, P., Sakin, M. E., & Gudura, D. (2018). Institute for New Economic Thinking Working Paper Series, (78). This paper examines executive pay in Europe. The result show heterogeneity among countries in terms of the levels of the CEO pay and concludes that a large proportion of the executive pay is stock-based.
- When Is Income Realized?, Magill, R. (1933). Harvard Law Review, 46(6), 933-953. This article looks at the concept of realized income, what it means and when it can be applied to the employee compensation.
- Wall Street and Main Street: What contributes to the rise in the highest incomes?, Kaplan, S. N., & Rauh, J. (2009). The Review of Financial Studies, 23(3), 1004-1050. A study of how much of the top level income distribution is explained by four sectors non- In this study, researchers look at the factors that determine the high income of the C-suite. It analyzes why Wall Street accounts for a disproportionate number of the highest income top executives compared to non-financial executives.
- The realization effect: Risk-taking after realized versus paper losses, Imas, A. (2016). American Economic Review, 106(8), 2086-2109. In this paper, the author looks at how previous losses affect risk tolerance. It finds that realized loss makes investors risk-averse while paper loss encourages risk tolerance.
- Realized Income and Wealth for Owners of Closely Held Farms and Businesses: A Comparison, Steuerle, E. (1984). Public Finance Quarterly, 12(4), 407-424. This study compares the realized income and wealth of owners of closely held farms and businesses.