Non-GAAP CEOs Make More, But They Shouldn’t

CEOs of firms that rely on non-GAAP reporting measures often earn “excessive” compensation packages despite showing weak operating performance while boards continue to fuel the disparity, according to new study.

The paper, released by researchers at Massachusetts Institute of Technology this month, says that CEOs of S&P 500 firms that made large positive adjustments to hit non-GAAP earnings between 2010 and 2015 got paid $2.7 million (or 23 percent more) on average more than their expected annual compensation if GAAP numbers were used.

That’s despite the fact that the same CEOs cashing large paychecks -- on average -- showed poor contemporaneous stock returns and subpar future operating performance.

The study theorizes how CEOs and management are able to boost their pay using non-GAAP numbers: control of the earnings press release to focus on positive results; use of compensation consultants that skew CEO performance by comparing to other “peer” group companies that use non-GAAP numbers; and the CEO’s ability to control the board nominating process to pick and choose a board that is sympathetic to non-GAAP metrics.

Shareholders are also to blame for the CEO pay issue with the authors arguing that they are not acting as effective monitors of CEO pay despite shareholder advisory votes on the compensation committee report.

“Over 97 percent of these votes approve such reports,” the report states. “[Negative] votes occur only in cases where the CEO’s pay is egregiously high or directly contrary to company performance.”

The report, however, focuses on board and compensation committee’s role in the non-GAAP pay issue.

“Our findings raise the broader question: why do boards of directors – specifically, the compensation committees of boards – reward their CEOs with excessive pay based in large part on non-GAAP numbers that are not well correlated with the company’s financial performance?” the authors ask. “Concerns about CEO compensation have been on the radar screen of the regulators and Congress for quite some time. Many shareholder activists and academics have also been strident in their criticism of CEO pay that is disconnected to a company’s financial performance.”