A data-driven approach to tenure and CEO compensation
In the nuanced realm of executive compensation, long-standing rules of thumb have traditionally guided the positioning of target pay levels for new CEOs. Common wisdom dictates that CEOs should reach the median pay level for their peer group within three to four years of their tenure. But is this guideline backed by data, and does it apply in most cases?
Compensation committees scrutinize decisions on pay levels and structures, which carry significant weight — and the landscape of executive compensation can be intricate. Because of this, striking the right balance between attracting top-tier talent and maintaining equitable pay scales is a challenge. This balancing act garners attention from a spectrum of stakeholders, including shareholders, regulators and the public.
The question remains: how do we align CEO target pay opportunity with experience and market expectations? In this article, we’ll delve into the topic and offer insights to navigate this terrain with evidence-based confidence.
Methodology and data analysis
In our research, we focused on the relationship between CEO tenure and compensation at S&P 500 companies. The analysis encompasses three primary areas: base salaries, target total cash compensation (which includes base salaries plus target annual bonuses) and target total direct compensation (comprising target total cash plus the grant value of equity compensation). We analyzed the compensation trends of early career (first two years), mid-career (three to five and six to seven years) and late career (eight years and longer) CEOs.
Central to our analysis was the establishment of revenue size groupings and the exclusion of certain data points to minimize distortion and maximize clarity. Understanding that company size plays a pivotal role in the level of executive compensation, we segmented the S&P 500 companies into ten distinct groups based on their annual revenues. These groupings were intentionally designed to reflect a range that was narrow enough to minimize the variability of target pay attributable to company size, ensuring a more accurate analysis based on tenure.
Each group represents a tier of revenue, with increments set to capture the nuances of compensation levels based on size. While we initially examined ten size groups, our analysis focuses on six. We eliminated revenue ranges greater than $50 billion from our primary analysis due to the limited number of companies at each CEO tenure level within each size range, which could skew the results. As such, our analysis prioritizes the most robust datasets to ensure accuracy and reliability in our findings.
Furthermore, to refine our dataset and focus on the most relevant and representative compensation figures, we excluded former CEOs, founders and interim CEOs. We also excluded discretionary annual incentives and special long-term incentive awards since these one-time awards and grants are extraordinary by definition and do not form part of ongoing compensation.
Evaluating the rule of thumb: A closer look at CEO compensation across tenures
Early career (first two years):
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The path to the median
In the initial stages of a CEO’s tenure—the first two years—our research unveils a clear trend: compensation often falls below the group median for companies of similar sizes. For example, in organizations generating $5B to $10 billion in revenue, which is the tier with the most companies, the median newly appointed CEOs base salary is at 95% of the overall median for the size group, with their overall target cash compensation slightly lower at 92%.
The gap becomes more pronounced in total direct compensation, which factors in long-term incentives, dropping to 73% of the overall median for the size group. This significant variance, especially in long-term incentives, indicates a cautious compensation approach for new CEOs, compared to their more seasoned counterparts.
Across the size groups analyzed, the early career CEOs’ compensation packages—comprising base salary, target total cash, and total direct compensation—averaged 93%, 94%, and 80% of the overall median, respectively, indicating a more conservative stance on remuneration during the initial phase of their leadership.
Mid-career CEOs (three years to seven years):
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Around the median
Moving into the mid-career phase, covering CEOs with three to seven years of service, the influence of tenure on compensation positioning becomes less pronounced. We found that CEOs within the three-to-five-year tenure bracket typically achieve compensation levels closely aligned with the overall median for their size groupings. For example, in organizations generating $5 billion to $10 billion in revenue, the median mid-career CEO’s base salary, target total cash compensation, and target total direct compensation closely match the median for the size group at 101%, 100%, and 100%, respectively. This pattern holds consistently across the analyzed size groups, where on average, base salaries reach the 100% mark, target total cash compensation is slightly above at 101%, and total direct compensation also aligns at 100% of the median.
For CEOs at the six-to-seven-year mark, within the $5 billion to $10 billion revenue range, base salary, target total cash compensation, and target total direct compensation were recorded at 108%, 104%, and 100% of the median, respectively. Across the size groups, base salaries and target total cash compensation both averaged at 99% of the median, while total direct compensation rose to 104%, indicating that target compensation is generally aligned with the median, based on the tenure within the mid-career spectrum.
Late career CEOs (eight years and longer):
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Late career CEOs (eight years and longer):The compensation positioning changes for CEOs with eight or more years of tenure. For this seasoned group, the base salary generally aligns with the overall median for the size groupings. Late career CEOs for companies with revenues between $5B to $10 billion have base salaries and target total cash closely aligned with the median of the overall group, indicating little variance due to tenure. However, there is striking differentiation in total direct compensation, which increases to 127% of the median, reflecting long-term dedication and presumed impact on corporate performance. The pattern is similar across the size groups, with late-career CEOs consistently receiving total compensation packages that surpass the median of the overall group. On average across the size groups, late-career CEO base salary levels were 102% of the median, target total cash compensation was 108% of the median, and total direct compensation was 122% of the median.
Synthesizing insights for executive compensation strategies
This comprehensive analysis of CEO compensation trends across different tenure stages within the S&P 500 has illuminated the complexities of executive pay and the factors influencing it. Our findings refine, rather than challenge, the traditional rule of thumb that suggests newly minted CEOs should reach median pay levels within three to four years.
We reveal a nuanced compensation landscape that merits a tailored approach, especially notable in the significant elevation of long-term incentives for late-career CEOs. This elevation underscores the value placed on experience and sustained performance, suggesting that achieving the median serves as a reasonable benchmark for midcareer CEOs, while also providing a clear rationale for more substantial rewards, particularly in longterm incentives, as a CEO’s tenure progresses.
Our analysis also reveals that, on average, total target direct compensation for early-career CEOs typically aligns with the 25th percentile across size groupings, whereas late-career CEOs’ compensation nears the 75th percentile. This distribution emphasizes a progression from belowmedian levels at the outset of a CEO’s tenure to above-median levels late in their tenure.
For compensation committees, these findings advocate for a strategic and flexible compensation framework that not only aims to attract and retain talent through competitive early and mid-career pay but also rewards the enduring contributions of late-career leaders. The data suggest that at the late-career level, compensation committees look to long-term incentives as the key differentiator in pay, further enhancing mid- to long-term payfor-performance alignment. By aligning target compensation strategies with consideration of experience and performance, companies can better ensure that their leadership is motivated and recognized for long-term success and that pay aligns with shareholder value creation.