What Does It Mean for an Executive To Make $1 Million?

Topics, Issues, and Controversies in Corporate Governance and Leadership
S T A N F O R D C L O S E R L O O K S E R I E S
stanford closer look series 1
What Does It Mean for an Executive to
“Make” $1 Million?
Introduction
In 2008, Vikram Pandit became the CEO of Citi-
group. 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 com-
pensation package he was offered when appointed
CEO, the New York Times dubbed him “Citigroup’s
quarter-billion dollar man.”1
Despite the headlines, however, Pandit never ac-
tually 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 origi-
nal value, and the nearly $40 million in restricted
shares and stock options awarded to him at promo-
tion were worth only $4 million when they vested
years later (see Exhibit 1).2
As this example suggests, executive compensa-
tion figures are not always what they seem. Exec-
utive pay packages contain a diverse mix of cash
and non-cash incentives, payable in one or mul-
tiple years and subject to accruals, estimates, and
restrictions that often render their ultimate value
quite different from their expected value. The Secu-
rities and Exchange Commission standardizes the
manner in which compensation is quantified and
disclosed to investors in the annual proxy.3
How-
ever, even there, compensation figures comingle
forward- and backward-looking amounts, as well as
fixed and contingent payments, that make it dif-
ficult for investors to understand what compensa-
tion has been promised to executives and what they
eventually earn.
By David F. Larcker, Allan L. McCall, and Brian Tayan
December 14, 2011
Measuring Executive Compensation
Executive compensation can be measured in many
ways, three of which include:
• Expected compensation represents the total ex-
pected value of compensation promised to an ex-
ecutive in a given year. Because not all compen-
sation is received in the year it is awarded, the
value of certain elements must be estimated. The
precision of these estimates will vary depending
on performance- and market-related sensitivi-
ties. For example, the expected value of a salary is
known with a fairly high degree of certainty, be-
cause it is delivered on a pro rata basis through-
out the year based on a promised and fixed
amount. The expected value of a cash bonus is
typically known with less, but still some, preci-
sion because it falls within a range (minimum,
target, and maximum) that is bounded by the
achievement of predetermined objectives.4
The
value of long-term incentives such as restricted
stock, stock options, and long-term cash plans
is known with far less certainty because these
elements are subject to multi-year strategic, fi-
nancial, and stock price results that are unknown
in advance.5
The expected value of long-term in-
centives is therefore measured using a probable-
outcome estimate or market-based valuation.
• Earned compensation represents the total value
of compensation that an executive “earns the
right to keep” as cash is delivered and vesting
restrictions are removed from equity-linked el-
ements. Salary and annual bonuses are earned
over one-year periods. Long-term cash awards
are typically earned at the end of multiple-year
periods.6
Equity awards are earned as they vest.

What Does It Mean for an Executive to “Make” $1 Million?
In the case of restricted stock, the earned value
is determined based on the stock price on the
vesting date. The earned value of stock options
is based on either the Black-Scholes value or the
intrinsic value on the vesting date.7
Note that if
the stock price has appreciated or declined ma-
terially since the original grant date, the earned
value might differ considerably from the original
expected value. In most cases, the total compen-
sation earned in a year comprises some elements
awarded in the current year and other elements
awarded in previous years.
• Realized compensation represents the total val-
ue of compensation that an executive converts
to cash in a given year. For cash awards (salary,
bonus, and long-term cash plans), the earned
value is the same as the realized value.8
For eq-
uity awards, the realized value is the amount of
cash received when the executive ultimately sells
shares or exercises (and sells) stock options.9
If
the executive cashes out these pay elements on
the vesting day, the earned amount will approxi-
mate the realized amount. If the executive holds
equity awards beyond the vesting date, the re-
alized amount will be higher or lower than the
earned amount depending on whether the stock
price subsequently increased or declined. Earned
equity compensation that is retained after the
vesting date therefore remains “at risk” until it
has been sold. Like earned compensation, real-
ized compensation often comprises pay elements
awarded over multiple years and the realized
amount is a function of firm performance over
this period.
These distinctions are important because each fig-
ure conveys different information to corporate
stakeholders. Expected compensation is a forward-
looking view of the reward opportunities available
to an executive. It reflects both the target level of
compensation to attract and retain qualified talent
in a competitive labor market and the mix of pay
opportunities to motivate an executive to achieve
corporate targets.10
The size and mix of expected
compensation therefore provide insight into the
incentives offered to management. By contrast,
earned and realized compensation are backward-
looking views of the rewards that an executive
actually received for his or her efforts. These values
can be compared to corporate performance during
the measurement period to assess the relative pay
versus performance relationship in the compensation
plan. When earned compensation is highly cor-
related with improvements in strategic, financial,
and stock price results, the compensation plan can
be said to offer strong pay for performance. When
earned compensation is uncorrelated with these,
the plan does not offer pay for performance.11
Fi-
nally, earned compensation that has not been real-
ized continues to provide incentive to the executive
because his or her efforts can enhance its future val-
ue; once an executive realizes this value by cashing
out equity grants it no longer provides incentive.12
Unfortunately, the information to assess the in-
centive value of compensation and pay for perfor-
mance is not readily available to shareholders. This
is because expected, earned, and realized compensa-
tion in a given year are rarely disclosed to the public.
Although comprehensive information is mandated
by the SEC and included in the annual proxy, it
is not explicitly summarized along the dimensions
discussed above. Instead, the annual proxy contains
a Summary Compensation Table that combines ex-
pected, earned, and realized amounts (see Exhibit
2). The investor must comb through the explana-
tory notes to calculate these metrics.13
Furthermore, proxy advisory firms do not as-
sist in the matter. For example, in formulating a
recommendation on executive compensation plans,
Institutional Shareholder Services (the largest proxy
advisory firm) compares the year-over-year change
in reported compensation to previous one- and
three-year total shareholder return. This approach is
flawed because it takes a compensation figure that is
predominantly forward-looking and compares it to
backward-looking stock-price changes. A more rea-
sonable methodology would compare the change in
earned compensation to the change in stock-price
during the same measurement period. In addition,
ISS likely overstates the expected value of stock op-
tion plans by assuming that executives hold their
options for the full term (generally ten years) before
exercising them, when research shows that execu-
tives routinely exercise stock options early.14
As a
result, the expected value assigned by ISS tends to

exceed the value that is reported in the Summary
Compensation Table.15
Finally, journalists do not consistently distin-
guish between earned and expected compensation.
For example, a recent article in The New York Times
reported that Viacom CEO Philippe Dauman re-
ceived total compensation of $84.5 million in
2010, more than twice the amount awarded the
previous year. The article quoted a compensation
consultant as stating, “This is spectacular money
but where are the spectacular results?” Noting that
the company’s stock price had barely moved in three
years, he asked: “Is that really worth this award?”16
Had the article reported Dauman’s compensation
on an earned, rather than expected, basis the num-
bers would have looked quite different. Rather than
report a 150 percent increase in compensation from
$34 million to $84.5 million, the article would
have shown a 26 percent increase from $17.2 mil-
lion to $21.6 million. Furthermore, one-quarter of
the nearly 500,000 options that Dauman had been
awarded in previous years vested out-of-the-money
in 2010, indicating that unless he subsequently in-
creased the stock price he stood to earn no value
from these awards, despite the fact that they were
originally reported with an expected value of more
than $7 million. Similarly, much of the $84.5 mil-
lion in compensation granted to Dauman in 2010
was in the form of stock options and performance
units, suggesting that their future value would de-
pend heavily on his ability to increase shareholder
value (see Exhibit 3).17
This article is but one ex-
ample of the confusion that is prevalent between
the incentives that expected compensation provides
for future performance and the rewards that earned
compensation offers for previous performance.
Why This Matters
1. Executive compensation figures are frequently
cited by the press and other third-party observ-
ers. However, these sources rarely distinguish be-
tween expected and earned compensation. What
does it actually mean when we read that a CEO
“made” $1 million in a year?
2. Exhibit 4 shows summary statistics for expected
and earned compensation across a large sample
of companies in fiscal 2010. Among the largest
250 companies, median earned pay was 18 per-
cent less than median expected pay. Within the
sample, individual amounts vary even more sig-
nificantly (higher and lower) based on individual
performance. Why don’t companies voluntarily
disclose these figures so corporate stakeholders
can more readily assess both the incentive value
of compensation and pay for performance?
3. The Dodd-Frank Wall Street Reform Act re-
quires that companies calculate and disclose the
ratio of CEO-to-average-worker pay in the an-
nual proxy. However, corporate observers tend
to calculate this ratio based on the expected
pay of the CEO and earned pay of the average
worker. Wouldn’t a more fair comparison use the
same figure for the numerator and denominator,
such as earned pay for both? In many cases, this
would greatly change the reported results.18

1
As part of his employment agreement, Pandit promised to retain the
after-tax proceeds of the sale as an investment interest in Old Lane.
Source: Eric Dash, “All Told, the Price Tag for Citigroup’s New Chief
is $216 Million,” The New York Times, Mar. 14, 2008.
2
Citigroup, Forms DEF-14A filed Mar. 20, 2009 and Mar. 12, 2010
with the SEC.
3
The Internal Revenue Service also standardizes the calculation of in-
come for tax purposes. Its method is different from that employed by
the SEC and is also different from those discussed below.
4
The degree of precision is largely driven by the plan’s design.
5
Furthermore, financial and stock-price performance might be in-
fluenced by macroeconomic factors that are largely outside of the
executive’s control.
6
Because long-term cash awards require an executive to be employed
through the payment date, they are earned as received (rather than
accrued over the performance period) even though their final value
is generally based on multi-year performance.
7
The Black-Scholes model takes into account the current price, strike
price, expected volatility, risk-free rate, dividend yield, and time to
expiration. When companies value stock option grants they typi-
cally apply a haircut to the time to expiration to take into account
the fact that compensatory options are often non-transferable and
generally not held to expiration because executive tend to exercise
them early. Intrinsic value is a simpler method for estimating earned
value because it is calculated by subtracting the exercise price from
the current stock price. However, it does not take into account the
potential for future gain.
8
In many companies, executives are eligible to participate in non-
qualified deferred compensation plans and supplemental executive
retirement plans (SERPs). In these instances, amounts are “earned”
as they accrue and become vested; however, because they will not be-
come payable until sometime in the future, they effectively become
debt instruments (and executives face the same risks as other debt-
holders) and pay is therefore not “realized” until that future date.
9
That is, earned compensation is the amount of pay that an executive
can cash in, while realized compensation is the amount of pay that
an executive actually cashes in.

10
The compensation mix will include pay elements that are short- or
long-term, accounting- or stock-price based, and fixed or contingent
(risky). To determine the size and mix of incentive compensation,
the board of directors typically benchmarks the compensation pro-
gram against those of a peer group of companies that are similar in
size, industry, complexity, etc.
11
There will almost certainly be pay-for-performance in any contract
that includes large amounts of contingent compensation awards (re-
stricted shares, stock options, long-term cash plans, etc), because the
value of realized pay is directly related to operating and stock price
results. The Pandit example above illustrates this point.
12
For a discussion of the incentive value of equity, see David F. Larck-
er and Brian Tayan, “Sensitivity of CEO Wealth to Stock Price: A
New Tool for Assessing Pay for Performance,” CGRP-10, Sep. 19,
2010, available at: http://www.gsb.stanford.edu/cldr/research/
closer_look.html.
13
In some cases, companies choose to voluntarily disclose realized
compensation in a supplemental disclosure, but this is rare. For
example, in its most recent proxy, Computer Sciences Corporation
outlines the compensation realized by CEO Michael Laphen dur-
ing the previous fiscal year: “The table below provides a different
perspective on compensation that is supplemental to the informa-
tion contained in the Summary Compensation Table. This table pro-
vides details of actual pre-tax income realized by our CEO during
Fiscal 2011 from base salary, annual incentive compensation from
long-term incentive compensation regardless of the year in which
the equity award was granted…. In addition, this table facilitates
comparison of approved or award date values versus actual income
earned and received for each component of compensation. As such,
it provides further evidence of the pay for performance underpin-
ning of our executive compensation program by demonstrating di-
minished realized income, especially in our annual and long term
incentive programs, relative to potential during a period of minimal
appreciation in shareholder value.” Whereas the company had grant-
ed Laphen cash and equity awards with an original expected value of
$7.6 million, he only realized $4.0 million from these awards. This
is significantly less than the $12.5 million reported in the Summary
Compensation Table for the same year. Source Computer Sciences
Corporation, Form DEF 14A, filed Jun. 24, 2011.
14
For this reason, the Financial Accounting Standards Board (FASB)
allows companies to value stock option grants using an expected
term based on previously observed behavior. Source: Chip Heath,
Steven Huddart, and Mark Lang. Psychological factors and stock
option exercise. Quarterly Journal of Economics (May 1999).
15
This methodology significantly disadvantages stock options relative
to restricted stock and other forms of compensation. As a result, if
a company wants to lower its total compensation to gain approval
from ISS, the easiest place to start is to replace stock options with
restricted shares or long-term cash plans (for better or worse).
16
Graham Bowley, “Pay Doubles for Leaders at Viacom,” The New
York Times, Jan. 22, 2011.
17
Viacom, Forms DEF 14A filed Apr. 30, 2007, Apr. 18, 2008, Apr.
17, 2009, Apr. 16, 2010, and Jan. 21, 2011 with the SEC.
18
For a further discussion of the shortcomings of this ratio, see David
F. Larcker and Brian Tayan, “Seven Myths in Executive Compensa-
tion,” CGRP-17, Jun. 6, 2011, available at: http://www.gsb.stan-
ford.edu/cldr/research/ closer_look.html.
David Larcker is the Morgan Stanley Director of the Center
for Leadership Development and Research at the Stanford
Graduate School of Business and senior faculty member
at the Rock Center for Corporate Governance at Stanford
University. Allan McCall is a Ph.D. candidate in account-
ing at the Stanford Graduate School of Business and co-
founder of Compensia, a national executive compensation
consulting firm. Brian Tayan is a researcher with Stanford’s
Center for Leadership Development and Research. Larcker
and Tayan are coauthors of the books A Real Look at
Real World Corporate Governance and Corporate Gov-
ernance Matters. The authors would like to thank Mi-
chelle E. Gutman for research assistance in the preparation
of these materials.
The Stanford Closer Look Series is a collection of short
case studies that explore topics, issues, and controversies
in corporate governance and leadership. The Closer Look
Series is published by the Center for Leadership Devel-
opment and Research at the Stanford Graduate School
of Business and the Rock Center for Corporate Gover-
nance at Stanford University. For more information, visit:
http://www.gsb.stanford.edu/cldr.
Copyright © 2012 by the Board of Trustees of the Leland
Stanford Junior University. All rights reserved.

Exhibit 1 — Reported versus Earned and Realized Compensation: Citigroup
Source: Citigroup, Forms DEF-14A and Forms 4 filed 2008-2010.
Citigroup (C) Stock Price History 2008 - 2010
Vikram Pandit, CEO: Reported Compensation
Year Salary Bonus Stock Options
Non-Equity
Plan
Pension
Change
Other Total
2008 958,333 0 28,830,000 8,432,911 0 0 16,193 38,237,437
2009 125,001 0 0 0 0 0 3,750 128,751
2010 1 0 0 0 0 0 0 1
Vikram Pandit, CEO: Earned Compensation
Vikram Pandit, CEO: Realized Compensation
Non-Equity
Plan
Pension
Change
Other Total
2008 958,333 0 1,961,250 0 0 0 16,193 2,935,776
2009 125,001 0 1,132,504 0 0 0 3,750 1,261,255
2010 1 0 1,346,903 0 0 0 0 1,346,904
Non-Equity
Plan
Pension
Change
Other Total
2008 958,333 0 119,500 0 0 0 16,193 1,094,026
2009 125,001 0 125,239 0 0 0 3,750 253,990
2010 1 0 130,798 0 0 0 0 130,799
Reported compensation includes salary, bonus, and payments under long-term cash bonus plans plus the expected value
of restricted stock and stock options on the grant date. In February 2009, Pandit announced a voluntary reduction in salary
to $1.
Earned compensation includes salary, bonus, and payments under long-term cash bonus plans plus the value of vested re-
stricted stock and stock options as of the vesting date. Restricted shares are valued based on the stock price on the vesting
date; stock options are valued based on their intrinsic value on the vesting date (the amount by which they are trading
“in the money”).
Realized compensation includes salary, bonus, and payments under long-term cash bonus plans plus the value of restricted
stock sold and stock options exercised and sold on the sale date. Realized compensation excludes the proceeds from non-
cumulative preferred stock that was sold and reinvested in common stock on Jul. 24, 2009. All stock sales between 2008
and 2010 were made “to satisfy tax withholding obligations associated with vesting.”
$0
$5
$10
$15
$20
$25
$30
$35
1/2/08 7/2/08 1/2/09 7/2/09 1/2/10 7/2/10

Exhibit 2 — Elements of Executive Compensation
Notes: 2009 restricted stock awards first vest in 2011 and therefore no restricted stock was earned in 2010. The earned
value of option awards is calculated as the intrinsic (“in-the-money”) value of options on the vesting date. Wandell did
not exercise any option awards or sell stock awards in 2010. The expected value of cash plans equals the target amount
for 2010, payable in 2011 and 2013. The realized value of other benefits excludes a non-qualified deferred compensation
plan contribution of $16,201.
Compensation
Element
Expected Earned Realized
Summary Compensation
Table
Salary Target amount Actual amount Earned, Realized
Cash Bonus Target amount
Actual amount (between the minimum and
maximum amount)
Earned, Realized
Restricted Stock
Fair value on grant
date (stock price)
Fair value on
vesting date
Value realized upon
sale
Expected
Stock Options
Fair value on grant
date (Black-Scholes)
Fair value on
vesting date
Value realized upon
sale
Expected
Non-Equity Plans Target amount
Actual amount
(lump sum)
Earned, Realized
Pension Actuarial amount
Actual amount in
retirement
Expected, Earned
Other Benefits Actual amount
Expected, Earned,
Realized
Example: Keith Wandell, CEO: Harley Davidson (2010)
Expected Earned Realized Reported
Salary $ 975,000 $ 975,037 $ 975,037 $ 975,037
Bonus 0 0 0 0
Stock Awards 1,381,199 0 0 1,381,199
Option Awards 1,636,681 698,906 0 1,636,681
Non-Equity Plans 2,600,357 2,340,090 2,340,090 2,340,090
Pension 0 0 0 0
Other Benefits 83,490 83,490 67,289 83,490
Total $ 6,676,727 $ 4,097,523 $ 3,382,416 $ 6,416,498
Source: Harley-Davidson, Forms DEF-14A, filed Mar. 19, 2010 and Mar. 25, 2011 with the SEC.

Exhibit 3 — Reported versus Earned Compensation: Viacom
Source: Viacom, Forms DEF 14A, filed Apr. 30, 2007, Apr. 18, 2008, Apr. 17, 2009, Apr. 16, 2010, and Jan. 21, 2011 with the
SEC.
Philippe Dauman, CEO: Viacom (2009 and 2010)
2010 Reported Earned
Salary $ 2,625,000 $ 2,625,000
Bonus 0 0
Stock Awards 41,833,309 5,919,015
Option Awards 28,620,000 1,599,827
Non-Equity Plans 11,250,000 11,250,000
Change in Pension 45,793 45,793
All Other 141,206 141,206
Total $ 84,515,308 $ 21,580,841
Options Original Grant Strike Value (1/4) Notes
1/31/2006 3,171 $41.48 0 out of the money
5/29/2007 491,400 $43.86 0 out of the money
6/4/2008 521,739 $35.26 86,087 $35.92 on 6/4/2010
6/3/2009 458,015 $22.70 1513740 $37.00 on 6/3/2010
Restricted Shares Original Grant Value (1/4)
9/11/2006 287,242 $ 2,424,322 $33.76 per share
Performance Units
1/1/2007 113,796 $ 3,494,675 $30.71 per unit
2009 Reported Earned
Salary $ 2,500,000 $ 2,500,000
Bonus 0 0
Stock Awards 12,688,932 1,869,227
Option Awards 5,999,997 0
Non-Equity Plans 12,540,000 12,540,000
Change in Pension 37,911 37,911
All Other 243,150 243,150
Total $ 34,009,990 $ 17,190,288
Options Original Grant Strike Value (1/4) Notes
1/31/2005 1,465 $47.10 0 out of the money
1/31/2006 3,171 $41.48 0 out of the money
5/29/2007 491,400 $43.86 0 out of the money
6/4/2008 521,739 $35.26 0 out of the money
Restricted Shares Original Grant Value (1/4)
9/11/2006 287,242 $ 1,869,227 $26.03 per share

Exhibit 4 — Summary Statistics: Total CEO Compensation, Various Methods
Sample includes 2,471 companies with fiscal years ending between June 2010 and January 2011. Summary Compensation
Table data represents the total value of compensation as reported in the annual proxy. Institutional Shareholder Service
data reflects total compensation under ISS methodology. In particular, ISS calculates the value of stock option grants using
the full term (generally ten years) rather than an abbreviated term. Expected and earned compensation values are calcu-
lated using the methodologies discussed earlier, with earned stock option value based on intrinsic value.
Mean Compensation (2010)
Median Compensation (2010)
Source: Equilar compensation data. Calculations by the authors.
Decile
Market
Capitalization
(in millions)
Summary
Compensation
Table
Institutional
Shareholder
Services
Expected Value
Earned
Value
Highest $ 39,982 $ 14,130,597 $ 17,595,544 $ 13,181,418 $ 12,018,347
7,132 7,904,858 9,911,257 7,380,223 7,034,703
3,375 6,037,811 7,781,580 5,879,114 5,229,651
2,079 4,646,368 5,760,233 4,547,047 3,910,954
1,326 3,872,349 4,833,941 3,888,635 3,377,383
863 2,877,698 3,642,764 2,862,030 2,444,539
585 2,520,118 3,038,112 2,512,779 2,124,444
378 1,988,675 2,563,376 2,126,550 1,768,966
246 1,516,684 1,836,673 1,570,411 1,282,740
Lowest 143 1,160,671 1,405,679 1,238,572 1,029,749
Decile
Market
Capitalization
(in millions)
Summary
Compensation
Table
Institutional
Shareholder
Services
Expected Value
Earned
Value
Highest $ 22,522 $ 12,220,817 $ 15,312,751 $ 11,210,876 $ 9,218,322
6,895 6,932,325 8,878,721 6,763,005 5,696,422
3,257 5,245,581 6,669,452 4,837,471 3,799,896
2,061 4,046,318 5,006,225 3,942,680 3,046,327
1,312 3,093,924 4,024,939 3,159,052 2,437,328
853 2,360,580 3,129,763 2,328,114 1,873,891
574 2,074,024 2,574,915 2,073,491 1,700,898
372 1,415,159 1,894,097 1,577,976 1,200,413
241 1,190,955 1,411,867 1,226,952 976,996
Lowest 149 858,204 1,045,605 865,041 794,706

What Does It Mean for an Executive To Make $1 Million?

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What Does It Mean for an Executive To Make $1 Million?