Performance Pay Up, Options Down
The latest studies confirm more employers are choosing pay tied to performance over stock options for their executive ranks.
By Kristen B. Frasch
Though not surprising, the latest research on executive compensation confirms companies are moving away from stock options and toward more performance awards as stockholders, shareholders, boards and the public cast ever-skeptical eyes on pay for pay's sake, not tied to actionable goals.
The latest analysis of compensation and benefits for CEOs at 240 companies in the Standard & Poor's 500 from New York-based Mercer shows use of performance awards continues to climb. Performance shares, used by 41 percent of those companies in 2011, became a majority practice in 2013, used by 51 percent of respondents.
At the same time, the prevalence of stock options continued to fall in 2013, with just 25 percent of S&P 500 CEOs receiving option grants, down 10 percentage points since 2011.
"In practice, performance awards are more closely aligned to explicit financial or operational outcomes than stock options," says Ted Jarvis, Mercer's global director of data, research and publications. That said, though, "the performance measures and associated goals must reflect the company's strategic objectives for performance shares to be meaningful incentives."
Similar to Mercer's study, Aon Hewitt's recently released annual compensation survey of 294 business and benefits leaders at mostly publicly held U.S. organizations shows alignment of executive compensation with company performance as one of the top three priorities, at 60 percent, when determining pay-and-rewards packages. The only thing topping that was pay competitiveness relative to the external market, with 73 percent citing it as a primary concern.
Overall, Chicago-based Aon Hewitt's release states, its 2014 numbers reflect an "overwhelming move to offense, with pay-for-performance driving alignment."
Towers Watson's CEO-compensation analysis earlier this year -- based on 430 S&P 1500 companies that filed proxies disclosing 2013 pay by late March -- showed that, although CEO salaries remained relatively unchanged in 2013 (increasing 2.7 percent, nearly the same as in 2012), the shift to performance-based plans was most definitely up.
That study showed nearly eight in 10 (78 percent) of companies awarding performance-based long-term incentive awards last year, compared with 67 percent in 2011, and 58 percent of companies awarding stock options in 2013, down from 64 percent in 2011.
It also showed total-shareholder return remaining as the most prevalent performance metric companies use in long-term incentive plans: Four in 10 companies (39 percent) offering performance awards used TSR to measure executives' performance last year, while 32 percent used earnings per share.
"Most companies are managing their executive compensation programs thoughtfully, responding to continuing pressure from stakeholders to ensure a strong link between pay and performance," says Todd Lippincott, North America leader of executive compensation consulting at New York-based Towers Watson.
The problem is, LTIs are still not necessarily aligned with executives' actual performance levels, according to the Towers Watson report.
For the highest-performing companies -- those in the top third of TSR performance, at 124 percent at the median for three years -- "we see that CEOs earned 150 percent of LTI granted at the median, or 50 percent above target opportunity, with realizable pay roughly the same," it states. However, CEOs at the bottom-performing companies, with median three-year TSR of 14 percent, had earned LTIs just 10 percent below target.
"These results raise some concerns," the Towers Watson report says, "as they reveal a wide spread of TSR performance, yet a much narrower spread of incentive payout. They suggest that both LTI mix and design may need to be reconsidered, especially if these results persist over time.
"For pay mix," it says, "the shift away from stock options to performance-based LTI vehicles may limit LTI's upside potential over periods of strong performance." For LTI design, these findings suggest "that performance-plan thresholds [and significant levels of restricted stock] may protect awards" at lower-performing companies.
What should HR and benefits professionals do with all this? Towers Watson suggests a solid rethinking of the pay-for-performance/award relationship.
"For example," it says, "boards for these lower-performing companies may question if 14 percent three-year TSR performance warrants awards only slightly below target. Boards of the higher-performing companies may question if payouts at 150 percent of target adequately reward executives who have more than doubled their companies' market value."
Overall, the findings "show us that the pay-for-performance curve may not be sensitive enough to performance on the high or low ends of the TSR scale," it states.
Given today's "sharp focus on pay for performance," it says, "this is a fundamentally important issue for companies to explore."
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