The New ROX Index

Somewhat surprisingly then, a new Exequity study of the top 20 companies in the S&P 500, the MidCap 400, and the SmallCap 600 showed that some of the most pilloried CEOs delivered shareholder returns that handily beat many of the paragons of virtuous executive pay. Or that the top executive teams of some of the most criticized companies turned in some of the very best "Return on Executive" scores in 2006.

Most companies as well as investors, in fact, can't always tell if they are paying for performance. The reason is that 95 percent of all pay analyses simply look at whether executives are awarded "competitive pay" opportunities. They add up base salaries, target annual incentive awards, and long-term incentives valued as of the date of grant using valuation models such as Black-Scholes for stock options. But importantly, while most financial models accept Black-Scholes as a predictor of value, the measurement does not calculate the amount of pay actually earned. Black-Scholes measures the theoretical value of the opportunity given at the date of grant, however, from that point forward, the true spread value of the option is entirely based on stock price, but few seem to be measuring that.

So how might true performance be gauged? While companies reference a variety of financial metrics, it begs the more efficient question: Why not just measure stock price performance itself, as that is ultimately what shareholders are asking of management? The most rational measurement of pay would then be to consider what an executive earned during a given period along with the executive's wealth created through the value of his or her equity.

The new proxy rules governing executive pay disclosures now provide a better platform for gathering pay information that can be compared on a consistent basis. Exequity has analyzed the new 2007 proxy disclosures with an eye toward comparing relative measures of shareholder value added¹ in comparison to the "real cost" of the executive team.² Through measuring the total value forwarded by the company to an executive— through all vehicles of compensation, including equity appreciation— and comparing this expenditure to the company's change in shareholder value over the year, we can derive a fundamentally new way of looking at compensation, the company's "return on executives" or ROX .

Large-Cap Companies and the Top 5 The median ROX score for the 20 largest companies in the S&P 500 — that is, the median amount of shareholder value delivered in 2006 for each real dollar of total pay for the top five executives was $299. There are numerous surprises: Several pilloried companies and their executive teams score quite high on the ROX metric while some companies viewed as being exemplary in their executive pay practices do not.

CEO Pay at Large-Cap, Mid- Cap and Small-Cap Companies We expanded this analysis by looking at the CEO's pay at each of the study companies. As expected, the value enhancement for each dollar delivered to the CEO was lower for the smaller companies. The median shareholder value delivered for each dollar of CEO pay in 2006 for the mid-cap companies was $73, versus $66 for the small-cap companies. The range of ROX scores for these companies was tighter than for large-cap companies, reflecting the greater leverage a top executive group can apparently make at a large company.

The ROX scores generally tend to bear out the notion that executives of large companies have the potential to preside over more substantial value creation, and that, when they do, the return on the pay delivered to the executive group reflects more extreme results. We believe that the ROX metric provides companies with a useful tool to evaluate the executive team's performance over time in relation to executives at peer organizations, and to gain a better understanding of how wellspent the company's executive pay truly is.

Overall, the ROX coefficient seems to be an improvement over the more typical analysis that currently is performed to determine the cost of the executive team in relation to shareholder wealth generated under the executives' stewardship. After all, isn't that ultimately what shareholders are asking—to get the best bang for their buck?