Shareholders at thousands of companies are getting ready to cast their Say-on-Pay votes and many will base their votes on a potentially flawed interpretation of overall alignment of CEO pay to company performance, concludes a study by Pay Governance, LLC, one of the nation’s premier independent compensation consulting firms.

Proxy advisors – such as ISS and Glass Lewis – provide Say-on-Pay recommendations that guide institutional shareholders in their voting. The single most powerful determinant of whether their recommendations will be positive or negative is the overall alignment of CEO pay to company performance – measured primarily by Total Shareholder Return (TSR).

Many large companies receive “high concern” or “medium concern” ratings for pay-for-performance alignment – and in more extreme cases, “against” recommendations for Say-on-Pay votes from Institutional Shareholder Services – despite the reality that, when properly measured, their pay programs exhibit true alignment. This may adversely affect the outcomes of Say-on-Pay votes, according to Pay Governance’s just released Viewpoint on Executive Compensation.

Pay Governance found strong alignment of a company’s TSR with realizable CEO pay. Realizable pay is the sum of actual cash compensation earned, the aggregate value of in-the-money stock options the current value of restricted shares, actual payout from performance share or cash plans, plus the estimated value of outstanding performance share or performance contingent cash. The alignment between pay and performance found in these measurements is directly linked to the substantial amounts of stock-based incentives in these compensation packages. Other assessment methods cannot provide this clear linkage of pay and performance because the time period used to measure pay opportunity is usually not concurrent with the one used to measure performance.

“We conducted a review of CEO pay and performance alignment at large companies using the realizable pay model and a pay opportunity tool which simulates the new ISS Relative Degree of Alignment (RDA) test,” said Pay Governance managing partner Ira Kay. “Using realizable pay, we found a better than 91 percent alignment with TSR. This supports our believe that realizable pay is the preferable measure of pay to look at when comparing pay to performance.”

Most evaluations of pay for performance by shareholder advisors tend to only look at pay opportunity –cash compensation and the value of equity incentives on the date of grant – which can create the appearance of high pay compared to performance even if that performance, and consequently realizable pay, is low.

“We have consistently used realizable pay to make comparisons between compensation and performance,” said Pay Governance partner Ben Stradley. “We usually make comparisons over three-year periods, but we’ve been able to use longer periods of time capturing an individual executive’s compensation over an entire career.”

Using both tests, approximately 86 percent of the companies exhibited the same levels of alignment versus misalignment of pay with performance. In more than 10 percent of the cases, however, the opportunity-based test found misalignment (high pay opportunity with low TSR) when pay was actually aligned with performance.

For its pay for performance study, Pay Governance examined long-term stock-based incentives for CEOs who had served three or more years at 374 S7P 500 companies filing proxy statements from 2008 through 2010. The study was limited to companies that had filed proxy statements and had held Say-on-Pay votes by mid June 2011. These firms had median revenues of $8 billion and market capitalizations of $11.7 billion.

For a full copy of the study, please visit www.paygovernance.com.

About Pay Governance

Pay Governance LLC is an independent executive compensation advisory firm. Our focus is on providing sound advice and counsel on how pay programs attract, retain, and motivate executives to create shareholder value. The firm helps compensation committees and management ensure that compensation programs align pay with performance, while being supportive of appropriate corporate governance and risk structures. For more information, please visit www.paygovernance.com.