Other metrics challenge shareholder return for determining incentive rewards

By Stephen Miller, CEBS Jul 10, 2017

The value of CEO pay packages has steadily risen as companies shift away from discretionary bonuses and stock options toward more-rigorous approaches to pay for performance, new research finds.

CEO Pay Trends 2017, the most recent report by Equilar, a Redwood City, Calif.-based compensation research firm, looks at CEO pay at Equilar 500 companies—the 500 largest U.S.-based publicly traded companies measured by revenue—from 2011 through 2016. Top executive pay at these corporations rose an average of 6.1 percent from 2015 to 2016 to a median $11 million—the biggest annual gain since 2013, the researchers found.

"Median CEO pay packages consistently climbed each year over the five-year study period examined for this report," said Matthew Goforth, Equilar research manager and lead author of the study. "At the same time, boards continue to tweak incentive pay to align CEO interests with both company strategy and shareholder returns over the long term."

Over the study period, a growing number of companies started granting performance-based long-term incentives (LTI) to their chief executives, reaching 81.5 percent of Equilar 500 companies in 2016. Meanwhile, the prevalence of CEOs receiving time-based stock options fell to a five-year low of 50 percent in 2016.

Performance-based incentives are awarded on the achievement of predetermined performance goals, whereas restricted stock typically vests over a certain period of time. Stock options mix tenure and performance incentives, in that they allow the options holder to buy company shares at a predetermined price after a specified vesting period; if the stock goes up in value, the options holder can buy it at a discount.

But increasingly active shareholder groups have opposed using stock options as a long-term incentive, viewing them as too loosely linked to an executive's performance since macroeconomic trends can lift stock prices across the board, irrespective of an executive's leadership.

"There is no doubt that proxy advisors and large institutional investors have influenced pay design, particularly with respect to the growing use of performance-based equity plans and a continued shift away from stock options, in both prevalence of usage and weight," said Virginia Rhodes, lead consultant at the Atlanta office of Meridian Compensation Partners, a pay consultancy. "These factors, coupled with the expense associated with options, have many companies opting for time-based restricted stock to provide the retentive element in their programs, as needed."

Among other key findings from the report:

• The health care sector reported the largest CEO pay packages in 2016 at a median $13.3 million.
  
  
• Median value of stock awards climbed more than 9 percent between 2015 and 2016, and 43 percent since 2012.
  
  
• On average, CEOs received about 32 percent of total reported compensation in cash, 65 percent in equity and 3 percent in other compensation in 2016.
  
  
• Nearly 55 percent of reported LTI mix was performance-based in 2016 at the median, up from 49.9 percent in 2012.
  

Companies that filed a proxy statement or disclosed compensation information in an amended 10-K filing by May 1, 2017, were included in the fiscal 2016 year. Only CEOs who served at least one full fiscal year were included in the sample size.

Executive Performance Metrics

Another recent Equilar report shows that relative total shareholder return (rTSR) continues to be the most popular measurement tying CEO pay to performance in S&P 500 companies—a sampling of 500 of the largest U.S. companies across a range of industries.

This metric measures the relative performance of different companies' stocks and shares over time, combining share price appreciation and dividends paid to shareholders.

However, Executive Long-Term Incentive Plans: Pay for Performance Trends shows that return on capital (ROC) and earnings per share (EPS) saw a bump while rTSR flattened in fiscal 2015—the most recent year for which comprehensive pay data is available for this group of companies.

"Both compensation committees and shareholders are looking for the best links between pay and performance," Goforth said. "Though rTSR helps balance executive pay with shareholder returns, profits and return on company investments have emerged as consensus picks for tying day-to-day operations to long-term value creation."

"Many companies are challenged with defining how to measure their success, and who they will measure themselves against, as peer groups are not always easily defined based solely on size or industry sector," added Craig Rubino, director of corporate services for E*Trade Financial Corporate Services in Atlanta. "Similarly, the time period for tracking rTSR can produce varying results, which creates additional complexities to consider."

For these reasons, companies often include more than one metric, "allowing them to also track performance based on goals like internal restructuring, product growth or other business line measurements," he said.

Among other performance metric trends cited in the report:

• Only ROC consistently increased as a CEO-pay metric every year over the study period, rising from 26.1 percent in 2011 to 30.6 percent in 2015.
  
  
• While EPS declined each year between 2011 and 2014, use of this metric in 2015 increased from 27.3 percent of companies to 29.2 percent, though still below its high in 2011 of 34.6 percent.
  

When ROC or EPS were included as a performance award metric, they were most commonly weighted 100 percent—in other words, receipt of the award was fully dependent on meeting goals tied to those particular measurements.

"Most compensation committees want to design clear and understandable incentives, so linking one or two performance metrics to a single award is common," Goforth said.

Public companies in the U.S. will be required to disclose the ratio of CEO pay to median employee pay in their 2018 proxy statements—reporting on fiscal year 2017—and many are already working through the calculations involved.

Higher CFO Pay Spurred by Bigger Bonuses and LTI Grants Median total direct compensation for chief financial officers (CFOs) at 80 companies in the S&P 500 grew to $4 million in 2016, a new study by HR consultancy Mercer shows. Median long-term incentives (LTIs) increased to $2.2 million and bonuses were paid out at 119 percent of target in 2016, a notable increase over payouts in 2015 of 108 percent. Base salary constitutes a smaller percentage of CFO pay while LTIs account for more. "It's not just the CEO whose compensation is being weighted towards variable elements," said Ted Jarvis, Mercer's global director of executive rewards data, research and publications. "All members of the C-suite have basically followed the same trajectory, and we don't see any indication that this trend will reverse." Base salary accounted for 21 percent of total direct compensation for CFOs in 2012; by 2016, it had shrunk to 18 percent. Over the same time period, LTIs increased from 57 percent to 59 percent of total pay. The CFO to CEO pay ratio, which has hovered around one-third over the past few years, did not change in 2016. However, the range is wide. At the 10th percentile, CFOs earned 24 percent of the CEO's compensation and tended to be more heavily weighted toward base salary. At the 90th percentile, they earned 47 percent of the CEO's compensation. "We suspect some of this differential may be related to industry or corporate size," Jarvis said.

Source: The Society for Human Resource Management (SHRM) 

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