An Interesting Error In Timmy’s analysis of Equilar’s Calculations Of CEO Pay

18581603_1454960587902203_7934923190499350154_n Well, interesting to me anyway. As to whether it is an error or not, I’ll let you judge. Please do attempt to judge. Comments saying “I hate Timmy” are about as much use as “Al Gore is fat”.

The story so far: Timmy says Contrary To AP/Equilar’s Research The Top US CEOs Did Not Average $11.5 Million Last Year and his reason for saying that is accounting for stock options. For example

The top-paid CEO last year was Thomas Rutledge of Charter Communications, at $98 million. The vast majority of that came from stock and option awards included as part of a new five-year employment agreement, and Charter’s stock will need to more than double for Rutledge to collect the full amount.

So, for the purposes of discussion, let’s assume that when we think of CEO “pay” we need to be aware that lots of it is not salary, but stock options paying out. We also need to be aware that those options don’t vest in a single year – as in the above, they’ll typically vest over a time period, perhaps 5 years. But Timmy then continues:

But the stock award is over 5 years. So, it’s much, much, more accurate to say that he got $20 million last year, one fifth of the 5 year stock award. The reason Equilar report it the way they do is because the company has had to expense that stock award in the year it was granted… And yes, they then take the mean average of all of the pay packets to give us what the average CEO gets paid. But those top numbers are always going to be inflated by the few CEOs who got multi-year stock awards in any one year. The AP/Equilar measure of CEO pay seriously overstates matters because they’re allocating multi-year stock awards to pay in the year of issuance, not over the period they vest.

If there were only a few CEOs earning big bucks, then Timmy would be right: some years that average earnings would blip up, when they got their awards; but then again other years it would blip down, when they didn’t. But actually, there are loads of CEOs (many of whom will likely, I think, have overlapping awards) so in the end is just averages out; and the above analysis doesn’t reveal any major error in Equilar’s calculations.

But there is an error, a smaller one, ironically hinted at in the quote he quotes: …and Charter’s stock will need to more than double for Rutledge to collect the full amount. Which is they’re calculating as though all these awards will pay out at full value, which of course they won’t all do. I didn’t notice it myself; that’s also from another Timmy column.

19 thoughts on “An Interesting Error In Timmy’s analysis of Equilar’s Calculations Of CEO Pay”

  1. Were Rutledge as skilled and hard working as the average Montana rancher, he should make as much.



    Minor point: “Total compensation includes […] stock and options valued at grant date”, agreeing with Phil@1 (which doesn’t negate the point that the options might never vest at all).

    Major point: “Median total compensation for the CEOs included in this year’s study totaled $11.5 million”

    Median, not mean.

    WAPO has “The typical big-company CEO raked in $11.5 million”, avoiding the use of the ambiguous “average”. Same for Equilar. Worstall jumps from the “typical CEO” to the “average CEO” to “mean average compensation” without, apparently, even understanding that there’s an important distinction there.

    So yes, Worstall is completely wrong, but not in quite the way you thought.


  3. Steve Bloom – Yes, Timmy is fat, but please don’t forget that there are differing views on the shape of Timmy’s fatness.

    P.S. Do we really care if it’s $11,500,000 or $8,000,000 or $14,000,000? Even a large error results in a really, really large number. More than the average worker would make in several lifetimes.


  4. It’s really quite simple: If Timmy is fat, and Al Gore is fat, then Timmy is Al Gore.

    [It’s a fair cop -W]


  5. It seems like an interesting error (assuming I understand it) because if someone has worked out that you shouldn’t include the full value in year 1 because it will pay out over 5 years, then the obvious next step would seem to be to try and include the payouts for that year from awards given in earlier years. As you say, if these awards are common, then this should average out and it should matter too much if you include the full value in year 1, or try to calculate the payouts in that year from earlier awards (apart from not knowing how much they will actually pay out).


  6. Let’s see. Based on this article only:

    Timmy confuses mean and median.
    Timmy doesn’t understand accounting for options including Black-Scholes.
    Timmy doesn’t mention that the CEO can get rather more than the stated pay as well as rather less, depending on how the companies stock does.

    So why is Timmy interesting?

    [I’m not desperately interested in the mean / median point. None of the language around this is really clear enough to be sure of what they mean, and anyway I think we’re back to the averaging point: it doesn’t matter. I think Timmy understands the accounting better than you, but again that’s not the main point. Why is Timmy interesting? Because he raised this point, of course -W]

    If Timmy was interesting, he would discuss how the trade off between paying dividends to shareholders vs buying back stock was distorted by CEO stock options.

    [Now you’re being silly. You’re saying people are only interesting if they discuss your hobby horses. That might be an interesting thing to discuss, but it isn’t *all* we can discuss -W]

    #7 “it should NOT matter too much”, I think you meant.


  7. Equilar is perfectly clear that they’re calculating median compensation, there’s even a comment on Worstall’s article from a (far too polite, IMO) Equilar employee confirming this (no replay from Worstall). It’s also perfectly clear that Worstall is making an argument about the mean compensation, an argument that doesn’t apply at all to the median (and, similarly, your point about averaging also doesn’t apply to the median).

    I think you ought to care more about this–for highly skewed distributions, the mean and median can be very different and have very different statistical properties. Confusing the two is one of the standard ways of lying about things like who benefits from proposed tax changes.

    And CEO compensation is somewhat skewed; in the 2015 Equilar survey, cited here:

    median was $10.3 million and mean was $12.2 million. (That article also includes some good illustrations of how wildly different the mean and median can be.)

    [I’d expect CEO pay to be skewed, but your figures show less than I’d expect. But you’re evading the point. Does putting all the compensation into the first year, as Equilar do, skew the results as Timmy claims, or not, as I claim? -W]


  8. Under reasonable assumptions about the distribution of multiple-year awards, I believe you are correct that it averages out for the mean, so I agree that Worstall’s argument is incorrect on that count. The median is less sensitive to that kind of skewing, so the reasonable assumptions about the distribution can be a lot weaker. Thus I believe your argument is largely irrelevant for the Equilar number Worstall cited, and Worstall is still wrong.

    wrt the skewness of CEO compensation, I also expected a larger difference, so tracking down the actual numbers was worthwhile.


  9. #10 The mean isn’t changed, I agree, with only some quibbles about how Black-Scholes isn’t exact.

    Isn’t the median skewed low with multi-year events?


  10. > his consulting bill, which is around seven years overdue.

    Post it, please. It’s always useful to know who pays their bills and who walks away from their promises. Walkaway is kind of a business model to be wary of.


  11. WC:

    [I regret to say that DP doesn’t mean Data Processing to me. But don’t tell anyone -W]

    Huh? So what does ‘DP’ mean to you? I promise not to tell anyone else.


  12. Russell:

    I’d be happy if Timmy paid his consulting bill, which is around seven years overdue.

    Erm. May one assume Russell is confident in the truth, as a defense against libel?


  13. Erm, confident as I am in the market for a cost-effective Portugese collection agency., to pursue slippery Tim through the eurocourts.


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