CEO pay up 5% propelled by gains in long-term incentives

CEO pay up 5% propelled by gains in long-term incentives

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New Mercer analysis shows CEO pay up 5% propelled by gains in long-term incentives

  • August 17, 2015
  • United States, New York

Mercer’s latest analysis of compensation for CEOs at 174 companies in the S&P 500 reveals that total direct compensation (TDC) increased by a median 5% in 2014 with long-term incentives (LTI) rising by a median 6% and representing 69% of total pay. Year-over-year, this increase in TDC is slightly higher than the 4% growth seen in 2013. Overall, median TDC and LTI increased to nearly $10.3 million and $7.1 million, respectively.

“Long-term incentives are fueling overall pay increases,” said Ted Jarvis, Mercer’s Global Director of Executive Compensation Data, Research, and Publications. “While short-term incentives increased this year also, growth was slower than in previous years of the current economic recovery due to a combination of slowing fundamentals and more rigorous performance conditions.”

According to Mercer’s analysis, base salaries changed little in 2014. The median base salary for CEOs at the S&P 500 rose to nearly $1.2 million; base pay for CEOs at the S&P 100 remained flat at $1.5 million. As a result, base salary has shrunk to 12% of total compensation for CEOs at the S&P 500 and to 10% for CEOs at the S&P 100.

“As CEO pay receives more scrutiny from stakeholders, companies have responded by holding the line on fixed compensation and focusing more on other pay elements that are tied to performance,” said Tracy Bean, a Partner with Mercer specializing in executive compensation.

Short-term incentive (STI) payouts increased by 4% in 2014 to just shy of $2 million following a median increase of more than 8% in 2013. “The high payouts reflect strong performance, but at a decelerating rate that is consistent with the maturing economic recovery,” said Mr. Jarvis. “Many companies paid above-target short-term incentives for several years after the downturn to recognize executives and employees for rising business performance.”

According to Ms. Bean, as the business climate has stabilized the bar has been raised as to what target performance will look like. As a result, establishing performance goals and setting performance levels remain a significant challenge for companies and their boards even in an economically stable environment. “Recognizing that each company is unique, boards should identify measures that make sense for the business. Diligent boards consider both internal and external factors in the goal-setting process, including the budget, historical growth patterns, and industry projections, but most importantly, they periodically evaluate these measures as to how strongly they link to desired business results.”

When measured against the metrics in each company’s respective STI plans, S&P 100 companies performed slightly better than smaller firms in 2014. Actual STI as a percentage of target was 133% for S&P 100 companies and 121% for Other 400 companies. “Performance outcomes are more predictable now,” said Mr. Jarvis. “While it’s possible to forecast twelve-month results with comparatively greater accuracy than at the height of the crisis, there is still a wide gap between expectations as reflected in target goals and actual outcomes. If target setting was accurate most of the time, median payouts would be 100%.”

Long-term incentives

Mercer’s analysis reveals the largest pay gap between S&P 100 and Other 400 companies, both in absolute and percentage terms, exists in LTI. CEOs at the S&P 100 received a median 72% more in LTI ($10.6 million) than CEOs at the Other 400 companies ($6.1 million).

As LTI values increased in 2014, so did the use of performance-based LTI. More than 90% of companies applied some kind of performance metric to their LTI plan, a longstanding trend as stock options lose favor and a growing number of companies utilize performance-based LTI. About two-thirds (67%) of companies granted stock options in 2014, which was down from 73% in 2012. “This decline is likely due to shareholder concerns of dilution and run rate, and some shareholder groups’ view that stock options are not performance-based pay,” said Mr. Jarvis. 

As in past years, companies preferred a portfolio of LTI awards over granting only one vehicle. The most prevalent LTI portfolio in 2014 was the combination of stock options, performance-based LTI and service-vesting LTI, used at one-third of companies. “The three different types of LTI awards each have advantages and disadvantages,” said Mr. Jarvis. “Companies that choose to use all three vehicles believe the combination strikes the correct balance between incentivizing and retaining their senior leaders.” Other common LTI portfolios included stock options with performance-based shares) and service-vesting shares with performance-based shares.

According to Ms. Bean, companies migrating from options to performance- based stock awards face new challenges. “Relative Total Shareholder Return (TSR) is the most popular performance measure since it’s easy to explain, and shareholders and other stakeholders respond favorably to measures using stock price performance. For other companies, however, relative TSR may not make sense particularly if their stock price doesn’t move in concert with a particular peer group.”

Mercer’s analysis is based on compensation data from 35 companies in the S&P 100 and 139 other companies in the S&P 500 (Other 400). In 2014, median revenue for these companies was $11,946 million.

About Mercer

Mercer is a global consulting leader in talent, health, retirement and investments. Mercer helps clients around the world advance the health, wealth and performance of their most vital asset – their people. Mercer’s more than 20,000 employees are based in more than 40 countries and the firm operates in over 130 countries. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), a global professional services firm offering clients advice and solutions in the areas of risk, strategy and people. With 57,000 employees worldwide and annual revenue exceeding $13 billion, Marsh & McLennan Companies is also the parent company of Marsh, a leader in insurance broking and risk management; Guy Carpenter, a leader in providing risk and reinsurance intermediary services; and Oliver Wyman, a leader in management consulting. For more information, visit www.mercer.com. Follow Mercer on Twitter @Mercer.

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