Mercer’s latest analysis of compensation for CEOs in the S&P 500 reveals that total direct compensation declined from a median of $10.6 million in 2014 to $10.3 million in 2015. This decrease – the first in at least five years – is primarily attributable to lower short-term incentives, which fell from $2.0 million in 2014 to $1.9 million in 2015, the smallest payout relative to target since 2011. The lower pay also tracks a decrease in median revenue among the companies, from $9.7 billion in 2014 to $9.4 billion in 2015.
“When revenue goes down, profit metrics are likely to be affected,” said Ted Jarvis, Mercer’s Global Director of Executive Rewards Data, Research and Publications. “Since virtually all companies incorporate profit in some form in their short-term incentives, it stands to reason that payouts associated with these metrics would be reduced.”
According to Mercer’s analysis, long-term incentives barely budged in 2015, up just 1% to $7.4 million. The growth came from smaller companies in the S&P 500, namely those companies not in the S&P 100 (Other 400). Companies in the S&P 100, the largest companies in the S&P 500, reduced long-term incentives by 4% to $11.1 million.
“The S&P 100 companies reined in many key areas of pay last year. For this group, median base salaries were unchanged from 2014 levels, whereas salaries for the Other 400 went up just more than 1%,” said Mr. Jarvis. “Also, the short-term incentive payout for CEOs of the S&P 100 fell significantly, from 131% of target last year to 111% in 2015. These incentives for the Other 400 experienced a sharp decline in 2015, as well – to 108% of target from 118% in 2014.” According to Mr. Jarvis, the disparity between larger and smaller companies may be due to the Energy sector, which has higher representation in the S&P 100 than the Other 400, and the skid in oil prices, which delivered an economic blow to the industry.
Use of stock options continues to decline
The past five years witnessed an inverse usage of long-term incentive vehicles as the prevalence of stock options among S&P 500 companies shrank to 57% in 2015 from 72% in 2011. Over the same period, performance share usage increased from 76% to 87% and time-vesting shares remained steady at 59%. “These disparities between the S&P 100 and the Other 400 in usage may be explained by the recent ascent of performance shares among the Other 400 companies, whereas the S&P 100 companies have been a consistently strong user of these vehicles between 2011 and 2015,” said Mr. Jarvis.
Additionally, the S&P 100 has notably reduced its reliance on both service-vesting shares and stock options. In 2011, companies in the S&P 100 granted service-vesting restricted stock at a rate of 59% and stock options at a rate of 73%. In the most recently completed fiscal year, 46% of these companies granted time-based stock and 50% granted stock options. “If these trends continue, grants of stock options will become a minority practice among this group in the future,” said Mr. Jarvis.
According to Jack Connell, a Partner with Mercer specializing in executive compensation, “Stock options lead to the biggest burn rate and overall dilution given their lengthy timeframe. As third-party proxy advisors push companies to manage burn rate and overhang, option use will decline relative to full-value shares.” Time-vesting options, the most common type, can also cause an irreversible hit to the income, which is not the case for some performance-based awards. “The growth in full-value, performance-based share awards and diminishment in option usage reflects a rational bias towards the most efficient use of shares from an accounting perspective and in response to the views of proxy advisory firms,” said Mr. Connell.
Longtime industry pay ranks disrupted
Mercer’s analysis finds that CEOs in the Consumer Discretionary sector received the highest compensation, with median total direct compensation of $12.3 million; the Utilities sector had the lowest pay with median total direct compensation of $9.2 million. Healthcare – the highest-paying sector in 2014 – declined to $11.8 million in 2015 from $12.4 million in 2014. “The Consumer Discretionary sector paid the highest base salaries for each of the past five years, and its 2015 target bonus opportunity at 170% of base was second only to the Financial Services sector,” said Mr. Jarvis. “Actual payouts were relatively generous at 117% of target, which raised the median value of short-term incentives to $2.8 million and median total cash to $4.0 million.”
Short- and long-term incentives were sharply delineated across sectors. “Primarily in response to the nosedive in oil prices, short-term bonuses in the Energy industry swooned from a five-year high of $2.2 million in 2014 to $1.4 million in 2015,” said Mr. Jarvis. “CEOs in the Healthcare and Financial Services industries, which confronted regulatory pressure in 2015, saw bonuses rise – especially within Healthcare, increasing to $2.2 million from $1.9 million in 2014.” Long-term incentives reached or approached all-time highs in the Consumer Discretionary, Consumer Staples, Energy and Utilities industries, but fell in the Financial Services, Healthcare, Industrials, Information Technology and Materials sectors.
“Proxy advisory firms and governance watchdogs are mainly concerned about pay for performance and advocates for effective target setting and responsible long-term incentive granting practices,” said Mr. Connell. “These organizations exert pressure on companies to create a rational alignment of pay to performance. In 2015, revenues in the Energy sector fell 45%, showing linkage at a high level. For the S&P 500, however, the portion of companies that paid above-target bonuses is not necessarily justified by revenue growth or profit.”
Is pay for performance working?
Mercer’s analysis shows inconsistent evidence of a linkage between pay and performance. CEOs heading companies in the bottom quartiles of one-year revenue growth or one-year total shareholder return received the lowest bonuses, confirming a strong correlation. However, these CEOs have the highest salaries on the basis of three-year compound annual growth in revenue and total shareholder return, and the highest long-term incentives on the basis of three-year compound annual growth in revenue and one-year total shareholder return. Additionally, at $12.4 million the median total direct compensation far exceeds the $10.3 million earned by the top-quartile contenders in three-year compound annual growth of revenue.
“Compensation committees should pay compensation higher than the median for higher than median performance and lower than the median for lower than median performance,” said Mr. Connell. “It comes down to the quality of the goal setting. If projected revenue and income growth are not at median, it is tough to justify median targeted pay. If the goals are unrealistic – either too high or too low – the balance of the whole incentive is thrown off.”
Mercer’s analysis is based on compensation data from 93 companies in the S&P 100 and 362 other companies in the S&P 500 (Other 400). In 2015, median revenue for these companies was $9,474 million.
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