In June, Equilar completed an analysis of CEO compensation trends at Silicon Valley’s 150 largest companies (as determined by the San Jose Mercury News). The study focused on total direct compensation (TDC) and year-over-year changes among the primary components of total pay.

We found that, in contrast to rising pay trends at larger indices like the S&P500, CEO pay at Silicon Valley companies fell significantly—by 13.1% from 2004 to 2005. This drop was driven in large part by the declining value of new stock option awards, which fell by 34.9%. Base salaries and bonuses, by contrast, both increased slightly. The following article investigates the key findings of Equilar’s annual Silicon Valley 150 CEO compensation study and analyzes the changes in greater detail.


Total Compensation

This study’s definition of TDC includes base salary, bonus, the estimated value of stock option awards (as calculated by Equilar utilizing the Black-Scholes methodology), restricted stock awards, long-term incentive plan (LTIP) payouts, and other compensation.

From 2004 to 2005, median CEO TDC fell by 13.1%.  In 2005, CEOs received a median total pay package of $2,630,473, while in 2004 this value was $3,025,489. To help place current compensation trends in a broader context, the chart below displays the median value of Silicon Valley 150 CEO compensation over the last five fiscal years.



Cash Compensation

In marked contrast to trends in overall CEO pay, median total cash compensation (base salary and bonus) increased 8.5% between 2004 and 2005, rising from $719,600 to $780,560.

• CEO base salaries grew by 5.6%, reaching a median value of $465,876 in 2005, as opposed to $441,066 in the year previous.
  
  
• Median bonus levels increased by 8.7%. In 2005, CEOs received a median bonus of $295,875.  In 2004, this value was $272,289.  While the value of bonuses climbed, the prevalence of bonus awards dipped slightly from 79.9% to 78.8%.

Long-Term Incentives

The median value of long-term incentive pay, consisting of new stock option grants, restricted stock awards, and LTIP payouts, fell to $1,639,855 in 2005, a 26.8% decline from the 2004 median value of $2,240,697.

• The median grant date present value of CEO stock option grants decreased by 34.9% from 2004 to 2005. Last year, the median CEO stock option award had a value of $1,309,163. In 2004, that amount was $2,011,588. Despite the precipitous decline in stock option award values, the prevalence of stock option awards remained nearly flat, dropping only slightly from 80.1% in 2004 to 78.8% in 2005.
  
  
• For CEOs receiving restricted stock awards, the median value of such awards increased to $1,117,500 in 2005, a rise of 33.5%. In 2004, the median value of restricted stock awards was $837,000. Mirroring equity compensation trends across the U.S., the percentage of CEOs receiving restricted stock increased to 25.3% in 2005.

• LTIP payouts among Silicon Valley 150 companies were extremely rare, with only 1.4% of CEOs receiving a payout in 2005. In 2004, no CEO received an LTIP payout.
  

Stock Option Trends

The recent 34.9% drop in the median value of CEO stock option awards is part of a long-term decline in stock option values at Silicon Valley 150 companies. The chart below shows the median value of CEO stock option awards from 2001 to 2005. During this period, award values fell from $2,497,121 to $1,309,163.



Numerous factors have contributed to the sharp decline in the value of stock option awards, including the adoption of FAS123(R), pressure from institutional investors for less dilutive forms of stock compensation, and relatively tepid stock market performance.

This last factor may be the most significant, as it has an important role in the valuation of stock option awards. Stock price volatility will often have the greatest impact on the value of stock options. The following chart examines median historical volatility (as calculated by Equilar over a three-year period for each company) and the median volatility reported by each company for their FAS123(R) assumptions at Silicon Valley 150 companies.



As volatility measures fall, the estimated value of otherwise identical option awards will decline. As the chart clearly demonstrates, relatively flat stock market performance since the end of 2003 has translated into reduced volatility assumptions in option valuation models. From 2003 to 2005, the median historical volatility for Silicon Valley 150 companies dropped from 86.6% to 61.3%.  The data indicates another important trend.  During this same period, the difference between historical volatility and reported volatility narrowed each year, closing the gap from 9.6% to 3.1% over the entire period.

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