While the value of CEOs’ pay packages jumped in 2010 — the median value among S&P 500 companies surged 20%, to $10.6 million, according to ISS Corporate Services — the increase may not be the most significant change in executive compensation. The structure of executives’ compensation also is shifting, and simplifying, in major ways.
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“Most companies are in a back-to-basics mode,” says Peter Miterko, managing director with compensation consultancy Pearl Meyer & Partners. More firms are linking pay to performance through a mix of measures like return on assets, return on equity, and total shareholder return, he says. (Note: registration is required for access to the ISS paper.)
And information from compensation consultant Equilar shows a bit over half of companies — 50.4% — now using three metrics to assess performance and determine CEOs’ short-term compensation. The most popular metric: earnings or EPS, with non-financial measures like quality or safety increasingly coming into play.
Within long-term compensation plans, the average number of performance metrics used in 2010 was 1.68, a rate that’s been fairly constant in recent years. But at the same time, the percentage of companies using two or more metrics grew to 48.8% from 45.9% between 2008 and 2010. The most common metric in Equilar’s compilation: total shareholder return, in use by two of every five companies, with earnings next, at about one in three.
Hitting Benchmarks for Value
“Companies are saying that we need to hit benchmarks,” Miterko says. “If we do, we know that we’ll end up with long-term value creation for shareholders.”
A number of firms also are eliminating or reducing compensation that isn’t tied to performance. For instance, of the first 100 companies in the Fortune 500 that filed proxy statements this year, nearly 40 had eliminated tax gross-ups, according to an analysis by Clearbridge Compensation Group.
In addition, many firms are using a mix of incentives, rather than relying mainly on one tool, such as stock options, says Clearbridge partner Yonat Assayag. And according to a recent edition of the Ayco Compensation & Benefits Digest, 84% of companies use stock options or stock appreciation rights (SARs); 64% use time-vesting restricted stock or restricted stock units, and 36% use performance shares. Ayco Co. L.P. provides financial counseling and education.
The Dodd-Frank Effect
Several forces are behind the shifts in executive compensation packages. A major driver, not surprisingly, is the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Section 951 say-on-pay provision, titled “Shareholder Vote on Executive Compensation Disclosures,” says that at least than once every three years shareholders will be able to vote to approve the compensation of executives. The next provision — typically referred to as “say-on-frequency,” stipulates that at least once every 6 years, shareholders can vote to determine whether the “say on pay” vote will occur every one, two or three years.
For most public companies, these two provisions were effective this year, says Assayag. “This has been the focus for the 2011 proxy season.” While the topic, particularly of say-on-pay, has been under discussion in boardrooms for several years, the passage of Dodd-Frank made it official, Assayag adds.
Along with legislation, heightened scrutiny of executive pay instigated by shareholders and the media, as well as government entities, also has increased companies’ interest in trying to more tightly link performance and compensation, says Aaron Boyd, Equilar’s head of research. “Companies want to show that pay is in line with performance,” he says, noting that the economid downturn certainly accelerated that shift.
What They’ve ‘Said on Pay’
Of the 2,252 companies from the Russell 3000 that held say-on-pay votes this year between Jan. 21 and June 30, 38 companies failed to win approval from a majority of their shareholders. Another 40 squeaked by with approval levels of 50% to 59%, according to an Equilar report.
But shareholders strongly signaled an interest in more-frequent say-on-pay votes. As of June 30, voters at 1,792 supported an annual vote, compared with just 412 companies having investor support for a triennial vote, according to ISS. (Again, registration is required for access.)
The primary reason firms failed, or came close to failing, in their say-on-pay votes was a “perceived disconnect between pay and performance,” says Amy Borrus, deputy director with the Council of Institutional Investors.
For instance, nearly a third of companies that gained at least 90% approval in the say-on-pay votes also were in the top quartile when it came to total shareholder return over the past three years. In contrast, just 5% of firms that failed their say-on-pay votes were in the top quartile for returns, Equilar found.
Shareholders also seemed to be sending a message to firms whose CEOs enjoyed outsize jumps in compensation. The median CEO pay increase at firms that failed their say-on-pay votes was 52%, according to Equilar. In contrast, the growth was 17% at firms garnering 90% support. Equilar’s report notes that firms “with the biggest jumps in pay over the past year were more susceptible to negative votes than those with smaller changes.”
Nonbinding, but Impactful
Although the say-on-pay votes are non-binding, they offer shareholders a way to signal their dissatisfaction. “This is like a warning sign,” Assayag says. The legislation also has helped boost dialogue between companies and their shareholders, and has prompted boards to take a closer look at the structure of executives’ compensation packages, compensation experts say.
Some votes have prompted litigation, after firms went ahead with compensation packages that failed to win approval in say-on-pay votes, says John Nixon, a partner focused on executive compensation with the law firm of Duane Morris LLP. “There are plaintiffs looking for these scenarios, alleging that boards are breaching their fiduciary duties by pushing through the compensation package,” he says.
One such case is Laborers’ Local #231 Pension Fund and Plumbers Local No. 137 Pension Fund vs. Umpqua Holdings Corp., parent company of Umpqua Bank in Oregon. More than 60% of shareholders voted against the proposed pay package, which included a 61% jump in the CEO’s pay, despite a negative stockholder return of 7.7%, Nixon reports. The complaint alleges that “the Umpqua Board’s decisions to increase CEO and top executive pay in 2010, despite the Company’s severely impaired financial results, were disloyal, irrational and unreasonable, and not the product of a valid exercise of business judgment,” according to this summary from ExecutiveLoyalty.org. So far, about a half-dozen such lawsuits have been filed and are underway, Nixon says.
The votes also offer a way to identify outliers. “It’s a useful way to call out companies that are off the charts with pay,” says the Council of Institutional Investors’ Borrus. Even so, say-on-pay is “not a panacea for runaway pay,” she notes, adding that she didn’t really expect that. With median CEO pay back to eight figures, “there are enormously large gains for the CEO at a time when unemployment is persistently high and other wages haven’t budged.”
