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What Does It Mean for an Executive to “Make” $1 Million?

May 27, 2012 • GLOBAL ECONOMY, FINANCE & BANKING, BUSINESS & INNOVATION, Capitalism in the 21st Century, Global Capital Markets

By David F. Larcker, Allan McCall, & Brian Tayan

Compensation figures commingle forward and backward, which makes it difficult for investors to understand what compensation has been promised to executives and what they eventually earn.

In 2008, Vikram Pandit became the CEO of Citigroup. Pandit had joined the company six months prior as Head of Investment Banking and Alternative Investments after Citigroup purchased the hedge fund he managed, Old Lane Partners, for $800 million. Between the $165.2 million in proceeds Pandit accrued in the sale and the $40 million compensation package he was offered when appointed CEO, the New York Times dubbed him “Citigroup’s quarter-billion dollar man.”

Despite the headlines, however, Pandit never actually received this amount of money. By the time Pandit’s share of Old Lane Partners was liquidated in May 2008, it was worth a fraction of the original value, and the nearly $40 million in restricted shares and stock options awarded to him at promotion were worth only $4 million when they vested years later (see Exhibit 1).

 

EX1-Reported-versus-Earned-and-Realized-Compensation--Citigroup

 

As this example suggests, 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. The Securities and Exchange Commission standardizes the manner in which compensation is quantified and disclosed to investors in the annual proxy. However, even there, compensation figures commingle 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.

 
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