Your EP is now followed by over 300,000 analysts

Posted by Marc Hodak on April 26, 2015 under Executive compensation, Pay for performance | 2 Comments to Read


If you are a corporate director, you might not know that executive compensation at your company is now being evaluated, in part, based on your economic profit (EP). The people doing these evaluations are any of the over 300,000 security analysts with access to the new Bloomberg Pay Index, a daily ranking of executive pay for performance (discussed here by Bloomberg’s Laura Marcinek), This index provides a compensation efficiency score based on the ratio of total pay against EP. For instance, Tim Cook—highlighted by Bloomberg as the best CEO bargain—had 2014 pay of $65 million, which was just 0.2 percent of Apple’s three-year average EP.

Two things stand out about this index. First, these data are directly available to the analysts—many of whom are skeptical of the quality of current proxy advisor recommendations—without the intermediation of their governance groups that may be advising them on their proxies. So, this index is likely to have some impact on proxy voting.

Secondly, this index will underlie an increasing number of media reports on compensation governance. It is already behind a stream of articles commenting on pay for specific executives.

What is truly revolutionary about this index is the EP performance metric Bloomberg uses in determining pay for performance. This use of EP represents a breakthrough for three reasons:

  1. By using an accounting-based measure, as opposed to a stock-based measure such as TSR, the index tracks pay for performance over which management has significant control. In contrast, about 85 percent of stock price movement in any given year is attributable to “exogenous” (i.e., non-management) factors, such as industry trends or macro events. Even over periods as long as four years, less than half of the stock price movement may be creditable to management actions and decisions.
  1. This index validates EP as a key, if not the key, indicator of value creation. While EPS is much better known and more carefully monitored, theory and evidence suggest that stock prices will track EP better over time for mature, capital intensive companies, which characterizes the companies most likely to pop up on Bloomberg terminals. What has been accepted as a mathematical fact in academia for decades is finally emerging into the mainstream business media.
  1. This index reflects an increasing awareness and acceptance among institutional investors of EP is a key metric to track. It is doubtful that Bloomberg would have made EP the numerator in this index if the majority of analysts to whom they sell their services were not ready to accept it.

No one has implemented more EP-based measurement systems and incentive plans than I have. Thus, I am gratified that EP is finally being recognized for the key indicator of value creation that it is.

I do have a quibble with how Bloomberg is calculating its pay index. They use the three-year average EP as their denominator. In the case of Apple, where Tim Cook is considered such a bargain, much of Apple’s EP was created during Steve Jobs’ tenure before 2012. Cook and the rest of his team did contribute a lot to that performance, and deserve fair credit in that regard, but whoever was to be Jobs’ successor would have benefitted from that towering EP legacy, and will for years to come. It would be more relevant to look at how much EP has changed, comparing the company’s recent value added to their executive’s recent pay. Looking at the change in EP would also put Larry Ellison’s controversial pay package into better perspective.

Nevertheless, with EP now in front of hundreds of thousands of investors trying to evaluate pay for performance, perhaps management should also be paying attention to EP, as well.

  • Tom said,

    With Bloomberg’s stamp of approval on EP, it would behoove you to specify a simple definition of EP that you like.
    Maybe here?

    Specifically, how valuable is EP to a big company that is heavily and actively reorganizing, with multiple big projects?

  • Marc Hodak said,

    Thanks Tom for providing that link. I’m not exactly sure how Bloomberg calculates EP. There are a number of ways one can do it from public data.

    We encourage our clients to develop a version of the measure tailored to their company, as shown here:

    You’re also correct that EP is not the perfect measure for all situations. I highlight the pros and cons of various metrics here: But if I had to chose one metric, especially for a multi-year review period for large companies, it would definitely be EP.

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