Stock awards have become a key compensation vehicle used by boards in their efforts to better align pay and performance for the long term, almost entirely replacing stock options. It is one of the main findings from a new report, CEO and Executive Compensation Practices: 2018 Edition, a collaboration by The Conference Board, Gallagher, and MyLogIQ.
In 2017, full value stock awards (including restricted stock, vesting upon the completion of a service period, and performance-based shares) grew by 17.9 percent in the Russell 3000 and by 10.8 percent in the S&P 500, an increase from 2016. The most significant growth occurred in the health care industry, at 110.8 percent, following a similarly significant increase in 2016 of 154.6 percent. Two other sectors – energy and information technology – also reported large increases of about 30 percent. Today, these awards represent almost 50 percent of total CEO pay in the S&P 500 and almost 40 percent in the Russell 3000. By way of comparison, in 2010, these percentages were 32 percent and 23 percent, respectively.
The report documents trends and developments in CEO and senior management compensation at companies that issue equity securities registered with the U.S. Securities and Exchange Commission (SEC) and were included in the Russell 3000 index as of May 2018. The study of disclosed compensation elements is complemented by a review of the major features of short-term and long-term incentive plans (STIs and LTIs) in a subset of 100 mid-market companies included in the Russell 3000 index as of May 2018. The report also examines say-on-pay resolutions and shareholder proposals on issues of executive pay that went to a vote at Russell 3000 companies in this proxy season, and reviews data from the first year of pay ratio disclosure, which became mandatory for many U.S. public companies in 2018.
“If one moves past the headlines about some lofty paychecks and pay ratios, in the last few years the main story regarding CEO compensation is a story of a renewed focus on testing new long-term performance drivers,” said Matteo Tonello, Managing Director of Corporate Leadership at The Conference Board and a co-author. “Our annual CEO and Executive Compensation Practices study has developed into the most comprehensive benchmarking publication on the executive compensation of U.S. public companies, covering, unlike others, the entire Russell 3000 universe.”
“This report chronicles the larger amount of performance-based pay across the board, but particularly with mid- and small-market cap companies,” added James Reda, Managing Director, Executive Compensation Consulting at Gallagher, and a co-author. “When other performance measures are added to long-term compensation planning goals, there is less reliance on the total shareholder return (TSR) component of the compensation formula. It is not clear how the current changes in tax reform will affect the level and types of long-term incentive, which continues to be a larger part of executive pay.”
Other key findings include:
• The pay growth rate for named executive officers (NEOs) outpaces CEOs’. The median Russell 3000 NEO, excluding the CEO, earned $1,486,450 in 2017, resulting in one- and eight-year increases of, respectively, 13.2 percent and 55.7 percent — an annual rate of increase that is almost four percentage points higher than for chief executives. “Median 2017 earnings for an S&P 500 NEO were $3,798,040, still less than a third of what the median CEO of companies in the index took home in the same year, but more than double the earnings for Russell 3000 NEOs,” said Paul Hodgson, partner of governance research firm BHJ Partners and also a co-author of the study. “On the other hand, the increase over 2016 pay for S&P 500 NEOs was lower than that for Russell 3000 NEOs both in the short and long-term, 9 percent and 37.3 percent respectively over eight years.”
• Contrary to popular belief, CEO pay at larger companies is stable or even declining, while smaller firms are playing catch-up with double-digit raises for their chief executives. Companies with revenues less than $100 million saw increases for their CEOs at more than 20.5 percent, while CEOs in the next bracket up, $100 million to $999 million, had increases of 14.4 percent. However, CEOs in the largest companies ($25-49.9 billion and $50 billion plus) received, respectively, a decrease in pay (-7 percent) and a relatively modest raise (1.4 percent). Among financial services firms, several asset value brackets saw total compensation declines, and there was no real pattern to the changes in contrast to the analysis by revenue. In the lowest asset value bracket (less than $500 million) total compensation fell by more than 8 percent, while in the next bracket up ($500-$999 million) total compensation increased by more than 80 percent.
• Companies continue the trend towards granting two or more types of long-term incentive plans (LTIs). All three major LTI vehicles (appreciation awards, time-based awards, and performance-based awards) have increased in prevalence from 2016 to 2017. There has been a slight uptick in appreciation award usage from 2016 to 2017, with prevalence increasing slightly to 46 percent in 2017. Time-based awards exploded in 2017, increasing in prevalence to 74 percent after falling from 66 percent in 2014 to 64 percent in 2016. In the same period, the use of performance-based awards, mostly performance shares, rose from 64 percent in 2014 to 77 percent in 2016, and have again grown in usage in 2017 to 80 percent. This continues the impetus of companies to demonstrate to their investors that longer-term incentives are more focused on strict performance measurement. Stock options have come under fire recently, with many commentators viewing performance awards that measure achievement over three years as midterm incentives. Stock options vesting over three to five years, and retained beyond that before exercise in many cases, are more often viewed as longer term. In addition, with retention clauses being added to many different types of equity awards—restricted stock, in particular—these are also viewed as longer term.
• The number of shareholder-sponsored proposals on executive compensation put to a vote at 2017 AGMs has declined sharply from prior years, in a sign that shareholders are more satisfied with company practices and the increased engagement with directors. In 2017, Russell 3000 companies voted on 30 shareholder proposals on executive compensation, compared to the 45 included in voting ballots in 2016 and 132 in 2010. Following the regulatory introduction of the say-on-pay vote, companies have been more prone to proactively seek the support of investors on these matters. In turn, investors have limited their submissions on executive pay to more specific and narrowly formulated requests to introduce clawback policies to recoup incentive pay (seven proposals, or 23.33 percent), link compensation to performance (three proposals, or 10 percent) or limit (or request a shareholder vote on) death benefit payments (“golden coffins”) (two proposals, or 6.67 percent of the total).
• The analysis of the newly required pay ratio disclosure displays substantial variation across indexes, business industries and company size groups, suggesting that this information should be interpreted with caution and preferably excluded from peer comparisons. For the first time, in 2018, most U.S. public companies included in the compensation section of their proxy statements the disclosure of the ratio between CEO pay and median employee pay. However, the flexibility allowed by SEC rules in the choice of the methodology for the calculation of pay ratios reduces the comparability of disclosure across different issuers. The review of such disclosure reveals wide variations, with a median for the Russell 3000 of 70:1 (compared to a median of 158:1 in the S&P 500) and a range from 0:1 to 5908:1. In the industry analysis of Russell 3000 companies, the lowest median ratio (40.5:1) is found in the financial sectors, where the generous rewards offered to bankers skews the median-employee compensation used as a denominator in the calculation. However, even in this sector, the range can be broad, with some financial services firms reporting that their CEOs earned as much as 696 times the salary of a median employee in 2017. The segmentation of data confirms that pay disparities are directly correlated to company size: companies with revenue below $100 million, for example, disclosed a median ratio of 15:1, compared to the 249:1 ratio among firms with an annual turnover of $50 billion and over.
• Companies have been choosing a less-is-more approach to pay ratio disclosure, forgoing the option of adding a supplemental pay ratio to the proxy statement. Less than 15 percent of Russell 3000 companies chose to provide alternative calculations to supplement the prescribed pay ratio with an additional (often, lower) ratio. In those cases where such supplemental ratio is offered, the most frequent types of adjustment used are the one excluding certain elements of CEO compensation (in most cases, one-time or multi-year equity grants offered in special circ*mstances) and the one reflecting “add backs” for health and dental benefits. The former type was reported by 5.58 percent of Russell 3000 companies and 7.73 percent of S&P 500 companies, while the latter was reported by 4.58 percent of Russell 3000 companies and 7.48 percent of S&P 500 companies. While there is no clear direct correlation between supplemental pay ratio disclosure and company size, approximately 21 percent of financial companies with asset valued at $100 billion or more did include a supplemental pay ratio in their proxy statement, and it was always to reflect the health-and-benefit add-back. Similarly, 12 percent of companies with annual revenue exceeding $50 billion used the supplemental pay ratio to underscore the impact on the calculation of extraordinary equity grants, compared to 1.74 percent of smaller companies with an annual turnover of less than $100 million. Given the rule on the de minimis exemptions for the determination of the prescribed pay ratio, a very small number of the examined companies chose not to use it and instead disclosed a supplemental pay ratio to highlight the extent to which non-US employees’ pay affects the ratio calculation.
