Use of performance awards continues to rise

Use of performance awards continues to rise

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Use of performance awards continues to rise, new Mercer study finds

  • 11 August 2014
  • United States, New York

Mercer’s latest analysis of compensation and benefits for CEOs at 240 companies in the S&P 500 reveals CEOs earned, a median total compensation package of $9,656,000 with approximately two-thirds of the value coming from long-term incentive grants. Pay in the form of long-term incentives climbed to a median $6,457,000, a median year-over-year change of 4%.

Utilization of time-vesting restricted stock was relatively steady over the past three years (22% of the sample companies granted them in 2013). Performance shares, used by 41% of S&P 500 companies in 2011, became a majority practice in 2013 used by 51% of companies surveyed. Among S&P 100 companies, the 50% threshold was crossed in 2012, and usage increased to 56% in 2013. The prevalence of stock options continued to fall in 2013 with just 25% of S&P 500 CEOs receiving option grants (down 10 percentage points since 2011).

The substitution of full-value performance awards for time-vesting option grants is a long-term trend in response to a longstanding criticism that options lack line of sight to actionable goals. “In practice, performance awards are more closely aligned to explicit financial or operational outcomes than stock options,” said Ted Jarvis, Mercer’s Global Director of Data, Research and Publications. “However, the performance measures and associated goals must reflect the company’s strategic objectives for performance shares to be meaningful incentives.”

According to David Cross, Partner with Mercer’s Executive Rewards practice, “Companies are facing pressure from external advisory groups to adopt certain policies and practices used among their peers, including metrics and goals. This is a ‘safe’ approach that mitigates risk, but does not necessarily result in programs that best align with shareholder value. Benchmarking isn’t a substitute for well-designed programs that appropriately reflect the business strategy.”

The granting of a single type of long-term vehicle is distinctly a minority practice among companies in the S&P 500, with just 3% of CEOs receiving options only, 3% receiving restricted stock only and 9% receiving performance shares or performance cash only. Approximately one-third of the CEOs were granted a combination of all three, with an average weighting of 28% options, 30% restricted stock and 42% performance awards. Typically, performance awards account for the greatest proportional value when they are granted in combination with another type of long-term vehicle.

The shift from options to performance shares is likely to continue. “Performance shares are seen to have greater impact by management while options are frequently considered reflective of overall market movement and less impacted by management. If that perspective persists, options will continue to decline for some time,” said Mr. Cross.

Total direct compensation

Total direct compensation (the sum of base salary, short-term payouts and expected value of long-term incentives) increased to a median $9,656,000 in 2013. CEOs at S&P 100 companies earned considerably more (a median $14,408,000 with a median increase of 3%). CEOs at S&P 500 companies not in the S&P 100 (“Other 400”) earned less (a median $8,547,000), but recognized a larger year-over-year gain of 5%.

“While compensation to CEOs at the largest companies exceeds that for the Other 400, the S&P 100 companies were less generous in increasing annual bonuses and long-term incentives,” said Mr. Jarvis. “If this trend continues, we may witness pay compression as the smaller companies catch up with the big ones.”

According to Mr. Jarvis, there are a few explanations for the compression. “The biggest players appropriately match to similarly sized companies, but there may be smaller companies that also use these companies as peers. These comparisons may or may not be valid, but the outcome is certain since companies tend to target compensation at or above the median of their peer group. Compensation ratchets upward as lower-paying companies raise compensation simply to keep at their designated target.”

However, Mr. Jarvis cautions that companies seldom provide much context about how they apply peer matches. “Undisclosed factors, like whether the data is size-adjusted through regression or other normalizations and if a discount is applied to large-company CEOs to keep the comparisons relevant, confirm a critical communication gap in proxy reporting.”

Mercer analyzed proxy disclosures for 240 companies in the S&P 500 that disclosed compensation data for 2011-2013 as of April 30, 2014. Year-over-year percent changes are calculated on a company-by-company (rather than median-to-median) basis. To download the survey results, visit http://www.mercer.com/insights/point/2014/ceo-compensation-mercer-study.html.

About Mercer

Mercer is a global 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 42 countries and the firm operates in over 130 countries. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), a global team of professional services companies offering clients advice and solutions in the areas of risk, strategy, and human capital. With over 55,000 employees worldwide and annual revenue exceeding $12 billion, Marsh & McLennan Companies is also the parent company of Marsh, a global leader in insurance broking and risk management; Guy Carpenter, a global leader in providing risk and reinsurance intermediary services; and Oliver Wyman, a global leader in management consulting. For more information, visit www.mercer.com. Follow Mercer on Twitter @MercerInsights.

 

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