What Is Camouflage Compensation?

Camouflage compensation refers to pay and/or benefits granted to upper-echelon employees that are obscured in nature or may not be disclosed clearly in mandatory company filings. Generally, individuals who are awarded such compensation are CEOs, directors, managing directors and other high-level executives who receive it in addition to their normal salary, incentives and perks.

Key Takeaways

  • Camouflage compensation is pay or benefits that accrue to upper management of a firm, but which are occluded in financial statements so as to hide their true nature or value.
  • The purpose is to increase upper-level compensation while staying under the radar from shareholders or investors who may not approve.
  • The practice has been derided by regulators, who instead favor greater transparency and disclosure of executive compensation.

Understanding Camouflage Compensation

Given the huge growth of executive compensation over the past few decades, camouflage compensation has gotten the attention of regulators, investors and academics, and calls have been made to reform the practice. A 2006 vote by the Securities and Exchange Commission (SEC) in favor of expanded disclosure of executive compensation for consultants, directors and employees was considered a necessary step, but just a starting point. 

 In some cases of camouflage compensation, the compensation is fully disclosed but in such a way that it is very difficult for the average investor to decipher the true value of an individual's gross pay package. Such a compensation strategy may make it easier for a company to attract top talent but may have the effect of setting off alarms with regulators or shareholders, such as individuals or large institutional investors, because it tends not to be linked to performance.

Some types of camouflage compensation include non-qualified deferred compensation plans, supplemental executive retirement plans (SERPs), stock options, stock appreciation rights and share grants — all potential places where compensation can be hidden from analysts and shareholders. Camouflage compensation may also be executed though retirement payment packages, sometimes called a "golden parachute," in which an executive is granted a generous payment upon termination. 

Camouflage Compensation Criticism

A 2005 study entitled Executive Compensation at Fannie Mae: A Case Study of Perverse Incentives, Nonperformance Pay, and Camouflage analyzed the use of camouflage compensation and incentives at the government-sponsored enterprise between 2000 and 2004. It published the following findings related to camouflage compensation:

  • It tends to reward executives for reporting high earnings but fails to require the return of such compensation if earnings were misstated. Such a structure incentivized the inflation of earnings. 
  • Fannie Mae's compensation structure provided rich rewards for executives who were pushed out due to failure. The expectation of such pay packages led to risky behavior.
  • If executives retired after many years of flawless service, the value of their retirement packages would be mostly unrelated to their own performance.
  • With its opaque disclosures, Fannie Mae obscured the fact and value of retirement packages paid to executives.