CEO and Executive Compensation Practices: 2017 Edition

Matteo Tonello is Managing Director at The Conference Board, Inc. This post relates to CEO and Executive Compensation Practices: 2017 Edition, an annual benchmarking report authored by Dr. Tonello with Paul Hodgson of BHJ Partners and James Reda of Arthur J. Gallagher & Co. For details regarding how to obtain a copy of the report, contact Related research from the Program on Corporate Governance includes: Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here); and The Growth of Executive Pay by Lucian Bebchuk and Yaniv Grinstein.

The Conference Board, in collaboration with Arthur J. Gallagher & Co. and MylogIQ, recently released CEO and Executive Compensation Practices: 2017 Edition, which documents trends and developments on senior management compensation at companies issuing equity securities registered with the US Securities and Exchange Commission (SEC) and, as of May 2017, included in the Russell 3000 Index.

The report has been designed to reflect the changing landscape of executive compensation and its disclosure. In addition to benchmarks on individual elements of compensation packages, the report provides details on shareholder advisory votes on executive compensation (say-on-pay) and outlines the major practices on board oversight of compensation design. Moreover, the study reviews the evolving features of short-term and long-term incentive plans (STIs and LTIs) and performance metrics in a sub-sample of mid-market companies included in the Russell 3000 index.

Compensation data is examined and segmented by business industry and company size (measured in terms of annual revenue). For the purpose of the industry analysis, the report aggregates companies within 10 industry groups, using the applicable Global Industry Classification Standard (GICS) codes. In addition, to highlight differences between small and large companies, findings in the Russell 3000 index are compared with those from the S&P 500 Index. The S&P 500, or subset of the S&P 500, is also used to further investigate certain compensation practices, such as changes in pension value, perquisites, and incentive plans. Figures and illustrations used throughout the report refer to the Russell 3000 analysis unless otherwise specified.

The following are some of the Key Findings from the study.

Total CEO Compensation

Total CEO compensation in the Russell 3000 increased in 2016 at higher rates than those seen in 2015, marking the seventh consecutive year of growth. Median total compensation for the CEO of an S&P 500 company was US$11,472,740 in 2016, while the Russell 3000 counterpart earned US$3,843,380. In the Russell 3000, the median total CEO compensation was 5.9 percent higher than in 2015 and 54.8 percent higher than in 2010. Over the years, the growth rate in the Russell 3000 has been faster than the one recorded for the larger group of companies in the S&P 500: more specifically, in the S&P 500, while total CEO pay increased 6.3 percent in 2016, the overall growth percentage since 2010 was 27.7 percent or about half the rate seen in the Russell 3000.

With the exception of the largest companies by revenue, the change in pension value in 2016 did not have a marked and widespread effect on CEO pay growth, suggesting that most companies have fully adjusted to the extensive updates that the Society of Actuaries had made to mortality tables in 2015. Excluding the pension adjustment figure, growth rates were 4.9 percent and 4.8 percent, respectively, for the Russell 3000 and the S&P 500. While the overall increase of total CEO compensation is consistent with a stock market that closed the year positively, it is interesting to note that the time period when decisions were made about base salary and equity compensation was one of the most volatile since the financial crisis of 2008. Without that volatility, the growth rate of total compensation in 2016 might have been higher.

Despite the upward trend seen across the Russell 3000, several industries exposed to market weaknesses and uncertainties reported a total CEO compensation decline in 2016. According to the industry analysis, while the largest increase across the seven-year period was observed among health care companies (90.2 percent at the median), the total CEO compensation for that industry actually fell back in 2016, by 7.4 percent. The other industries in which total pay declined were consumer discretionary, energy, and telecommunications services, reflecting a combination of factors including the fluctuating figures on consumer confidence and discretionary spending, commodities pricing pressures, climate change concerns, and expanding levels of market concentration and saturation. The two largest increases in CEO compensation were in materials and utilities, both over 30 percent, but these followed a marked decline in 2015 for both sectors.

Gains in total compensation for CEOs of mid-market organizations far outpaced those of the largest organizations. Even though the S&P 500 showed a slightly higher 2016 total CEO compensation growth rate than the Russell 3000, the analysis by revenue and asset value disputes the existence of a direct correlation between such growth rate and the size of the company. By annual revenue, the overall growth was primarily driven by companies in the mid-market brackets (US$5–9.9 billion and US$10–24.9 billion), which reported total CEO compensation rises by 8.8 percent and 12.7 percent. In contrast, CEOs of the largest companies (US$25–49.9 billion and US$50 billion or higher revenue), received more modest raises of 4.5 and 4.8 percent respectively. The same observation applies to mid-market financial companies by asset value (US$10–24.9 billion, for which total CEO compensation went up by 34.1 percent in a single year), while the smallest financial firms reported compensation declines. On the other hand, lower increases for very large companies are justified by the already exceptional pay packages that their CEOs are offered: 10 percent of CEOs in the S&P 500 earned as much as US$21.3 million in 2016, compared to a median total CEO compensation in the Russell 3000 of US$3.8 million.

The highest-paid CEOs are found among materials and consumer staples companies, even though the lowest median figures seen among financial sector firms may be skewed by the composition of the index. The highest-paid CEOs at the median are in materials companies, at US$5,393, 510, while the lowest-paid are CEOs of financial firms: among the latter group, however, the significantly lower median total compensation of US$2,425,890 appears to be a reflection of the large number of smaller financial organizations included in the Russell 3000 universe. More specifically, 272 of the 470 financial companies in the index are in the US$1–9.9 billion asset value group, for which CEO compensation levels are much lower than what is paid by the 38 large financial institutions in the index that carry more than US$100 billion in assets. Despite some very well-paid financials CEOs, the average total compensation for the sector is also the lowest at US$4,427,450, while the highest were consumer staples CEOs with an average total pay of US$7,859,240.

Individual CEO compensation elements and compensation mix

Exceptional financial market performance continued to fuel the recourse to equity-based compensation, with the pay mix analysis confirming the inexorable rise of stock awards at the expense of both annual bonus and stock options. Compensation committees of boards of directors have continued to take advantage of high equity valuations to increase the amount of pay at risk and shift the weighting of compensation elements from cash to stock. Up from 22.8 percent in 2010 to 36.7 percent in 2016 in the Russell 3000 and from 32 percent to 47.4 percent in the S&P 500, stock awards occupy a greater portion of total pay than ever before. Only seven year ago, base salary represented 30.25 percent of the typical CEO pay mix, a share that fell consistently over time to reach 23.93 percent in 2016; in the S&P 500, it went from 14.22 percent in 2010 to 11.3 percent last year.

In general, as widely documented since the financial crisis of 2008, the weight of stock options in the typical compensation package has been gradually reduced, mostly due to their volatility and concerns on their real effectiveness as performance motivators. However, in the Russell 3000, their decline has become less marked more recently, with their share of the total compensation offering falling by less than a percentage point in each of the six years under study; and in the S&P 500, while the overall trend is confirmed downward (from 17.7 percent in 2010 to 14 percent in 2016), their use actually rose slightly in 2011, 2013, and 2015. In both indices, the percentage of total pay represented by the annual bonus has fallen from around a quarter to less than one-fifth since 2010.

More light on the relevance of stock options is shed by the analysis of compensation disclosure data by industry. This compensation vehicle almost disappeared among companies in business sectors such as energy, financials, real estate, telecommunications services and utilities. In contrast, it remains the largest portion of pay for health care CEOs, at nearly two-fifths of the total pie, increasing from just over a quarter in 2010.

Stark differences in pay models emerge from the Russell 3000 analysis by company size. The group of smallest firms with revenues under US$100 million, a class of its own, pays its CEOs 28 percent in salary, two-fifths in stock options (up from a third a year ago), and between 13 percent and 16 percent in bonus and stock awards, respectively. This pay package is remarkably different from the one adopted by larger companies, where the weight of stock options does not exceed 20 percent and stock awards count for 37 to 45 percent of the total value, and where CEOs receive more in the form of cash bonus and less in the form of base salary. Notably, companies with revenues of US$50 billion and more and assets of US$100 billion or more attract the best talent in the market through the allure of large equity rewards and deliver almost half of total compensation in stock grants.

Increases in base salary vary considerably by index: in the Russell 3000, the median salary rise mimics the growth rate of total compensation; in the S&P 500, there was little or no base salary movement. Low inflation rates and the shift to compensation in the form of equity awards continue to explain the moderate raise in base salary. In 2016, median base salary rise for CEOs in the Russell 3000 was 4.6 percent, compared to less than a percentage point in the S&P 500. By means of comparison, for 2016, The Conference Board recently reported an overall base salary increase for the general workforce of US public companies of 3 percent, the same as in each of the last seven years. [1] A more detailed breakdown by revenue and asset value confirms that base salary rises for CEOs in the largest companies lagged those in the smallest by significant amounts. Only those CEOs leading the very largest companies, US$50 billion and more in revenue, received an increase of more than five percent. Most others were less than two percent.

In the industry analysis, the largest base salary gains in 2016 were seen among utilities companies (9 percent) and the lowest among consumer discretionary firms (0.1 percent); over the seven-year period of 2010–2016, however, utilities CEOs still lag behind their colleagues in all other industries: their base salary rose only 10.72 percent in the aggregate, while it was CEOs of telecommunications services firms who benefitted from the highest overall growth rate (41.45 percent).

The double-digit stock market gains of 2016 translated into year-end cash rewards for CEOs: After the sharp decline last year, annual bonuses recovered strongly, and some financial companies reported staggering increases of more than 40 percent. In 2016, cash bonuses grew by more than 10 percent in the Russell 3000 and by more than 8 percent in the S&P 500—in many cases, offsetting the year-on-year drop that had been registered in 2015 and attributed to the meager annual return of the stock market following a period of high volatility (the S&P 500 Total Return, a measure combining stock appreciation and dividend income, closed 2016 at +12.25 percent, compared to the +1.19 percent of 2015). However, in the S&P 500 Index, when compared to other compensation elements and if the entire six-year period is considered, annual bonuses showed the lowest aggregate gains—their value had a mere 0.78 percent uptick, compared to the 12.82 percent growth rate of base salary and the 98.78 percent rise in the value of stock awards. (In the Russell 3000, the median annual bonus rose 20.28 percent in six years, still a fraction of the 264.98 percent increase reported for the value of stock awards).

However, even in an expansionary year as 2016, annual bonuses were affected by the cyclical fortunes of underperforming industries, such as consumer discretionary, consumer staples, health care and telecommunications services, and registered median declines for companies in all of those groups. While cash bonuses grew overall in financials by 10.6 percent in 2016, the analysis by asset value shows extraordinarily wide variation in the level of such growth, with CEOs of leading companies with asset value in the US$50–99.9 billion group reporting staggering bonus increases of nearly 50 percent in value (and almost 500 percent over the six-year period).

In addition to expanding their share of the total compensation mix, stock awards have been growing in value and offsetting the softening of stock option grants. In 2016, the median Russell 3000 CEO received US$1.4 million worth of company shares, while the counterpart in the S&P 500 received US$5.4 million—marking a growth rate of 12.4 percent in the Russell 3000 and of almost eight percent in the S&P 500. Even more remarkable is the trajectory that this component of pay has followed over the last few years: In the 2010–2016 period, the value of stock awarded to CEOs has risen 265 percent in the Russell 3000 and almost 100 percent in the S&P 500. Energy companies were the most generous in terms of stock grants in 2016, awarding $3 million at the median, while health care companies reported the lowest amounts (US$402,000). Over the six-year period, the highest median increase in stock award value was tenfold and seen among consumer staples organizations. The analysis by company size reveals a direct correlation between the value of stock grants to CEOs and the size of their employer.

This steady pattern has countered the decline in the value of stock options offered to chief executives: Fewer than half of CEOs in the Russell 3000 received stock options, and in the S&P 500, they dropped in value by 8.6 percent. Only in materials companies did median stock option values increase, though still not to levels seen for this industry earlier in the study period. As mentioned before, in financial companies stock options have virtually disappeared from compensation packages, and have actually disappeared in small to mid-market companies in other industries—except for the trend bucking “under US$100 million in revenue” companies, where, although they dropped back a little from 2015, are still at far higher value than in 2010.

The value of disclosed perks surged in 2016 among the largest company groups and in the consumer discretionary, consumer staples, and utilities industries. Largest companies by revenue continue to report relevant CEO pay increases driven by adjustments to pension value. Change in pension value increased at the median by 733.5 percent and by 396.5 percent for the CEOs in the largest two revenue brackets, but showed no change in the smallest two. The overall change, in both the Russell 3000 and the S&P 500, was not significant. By industry, the seeming hyperactivity in change in pension values for CEOs of utilities firms appears to be based on the widespread provision of the benefit rather than any other influence. While the median value of disclosed perks grew merely by 2 percent and 2.6 percent, respectively, in the Russell 3000 and the S&P 500, it skyrocketed in consumer discretionary (38.7 percent higher than 2015), consumer staples (24.1 percent) and utilities (28.7 percent). Some of the largest companies also defied the shareholder scrutiny that had contributed to the curbing of perquisites in recent years: in a reversal of that earlier trend, in 2016, firms with annual revenue of US$5–9.9 billion and those with revenue of at least US$50 billion offered perks valued, respectively, about 30 and 20 percent higher than those reported in 2015.

NEO Compensation

The total compensation of other senior executives continues to rise, though increases lag those of CEOs and the gap between the two groups widens. The median Russell 3000 named executive officer (NEO), excluding the CEO, earned US$1,472,730 in 2016, resulting in one- and six-year increases of, respectively, 5.6 percent and 40.7 percent—rates that are lower than those observed for chief executives. Median 2016 total earnings for an S&P 500 NEO were US$3,596,180, less than a third of what the median CEO of companies in the index were paid in the same year but more than double the earnings for Russell 3000 NEOs. On the other hand, the increase for S&P 500 NEOs was lower than that for Russell 3000 NEOs, both in the short and long-term (it was 3.4 percent in 2016 over 2015 and 23.9 percent over six years). With lower increases for NEOs, the gap between their pay and that of CEOs is unlikely to narrow, though pay for Russell 3000 NEOs may be catching up with their large company counterparts.

As with CEOs, changes in pension value and non-qualified compensation had a far less marked influence on pay change in 2016. Compared to the above figures, which include the change in pension value, increases over 2015 figures that exclude this amount were 5.1 percent and 3.2 percent for the Russell 3000 and the S&P 500, respectively.

Stock awards represent a much lower portion of total NEO compensation in the Russell 3000 than in the S&P 500, and there are stark industry differences in their use. Median stock awards in the Russell 3000 are worth not much more than base salary, US$431,060 compared to US$394,000. In contrast, in the S&P 500, median stock awards at more than US$1.4 million are worth more than double the median base salary of around US$600,000. But energy, information technology, and real estate NEOs saw stock awards roughly double their salaries, while in health care, consumer staples, and financials, NEOs received considerably less than their salary in stock awards, with the balance for health care NEOs being made up out of stock options.

While the numbers for NEOs are much more contained, the shift in equity-based compensation from stock options to stock awards observed for CEOs has affected even the pay practices of other senior executives. In line with the finding for the two indices, an analysis by company size, measured by both revenue and asset value also shows an increasing emphasis on stock awards as companies get larger and larger. In fact, in the smallest revenue bracket, under US$100 million, the median stock award was zero (indicating that less than 50 percent of the sample offered this form of pay; stock incentives were more likely to be delivered as stock options in this bracket), while in the very largest companies, those with US$50 billion or more in revenue, median stock awards were worth US$3,209,540 (or almost three times the value of base salary). Despite differences in practice, the portion of total compensation represented by stock awards has been steadily growing in both the Russell 3000 and the S&P 500, from just over a fifth in 2010 to almost a third in 2016 and less than 30 percent in 2010 to over two-fifths in 2016 for the two indices, respectively. At the same time, stock options have seen a fairly steady decline, perhaps most starkly in the S&P 500, from around 15 percent in 2011 and 2010 to just over 11 percent of pay in 2016.

The biggest change in practice by sector was seen in the telecommunication services and information technology sectors. Respectively, stock awards grew from around 25 percent to around 45 percent and from around 23 percent to 43 percent from 2010 to 2016.

While the pecking order of NEO pay by sector has remained largely the same over the last six years, notable changes were reported by information technology and health care firms. In the company size analysis, only the largest companies by revenue saw their NEO pay (slightly) reduced in 2016. With six-year increases in median total compensation of 55.1 percent and 71.4 percent, respectively, NEOs in information technology and health care have gone from the bottom of the pay scale by industry to being the recipients of the some of the most generous packages. IT NEOs, for example, overtook their peers in utilities, telecommunication services, and materials, and they almost caught up with those in consumer discretionary. Both industries have seen tremendous growth in the period. In the short term, the highest increases for NEOs were seen in the materials (12.4 percent) and utilities (15.9 percent) sectors.

It is interesting to note that, while the smallest companies by revenue saw NEO pay grow the most over the six-year period under study (a 116.2 percent surge), the smallest companies by asset size reported a 15.6 percent overall decline, with the largest drop seen most recently (-19 percent in 2016, when compared to figures reported in 2015). However, this finding should be interpreted with caution, as it may in fact be caused by a year-over-year change in the composition of the brackets: to be sure, the larger group by asset value—US$500 to US$999 million—saw significant increases in the median total compensation of almost 32 percent. In the analysis by revenue, only the largest company NEOs by revenue saw their pay fall in 2016, though by less than one percentage point.

While increases in base salary for NEOs were similar to those for total compensation, NEOs benefited from much higher bonuses, especially in the S&P 500. The rates of increase in NEO base salary closely mirrored those seen for their total compensation—more specifically, they were 5.1 percent in the Russell 3000 and 3.2 percent in the S&P 500. No significant variation in base salary emerges from the analysis by industry, either over the last year or over the last six years; an exception, however, is represented by health care companies, which reported the highest median of all annual salary raises (8.6 percent). In the analysis by size, changes in base salary also followed a pattern that is very similar to the one described for total compensation.

The rate of change for annual bonuses, on the other hand, was higher than that for total compensation, which would lead to an increase in cash incentives in the overall mix. The pattern by company size was also reversed, as bonuses increased by more for NEOs in the S&P 500 (9.3 percent) compared to those in the Russell 3000 (7.7 percent). The overall value of annual bonuses has changed very little over the last six years, especially in the S&P 500, where it has hovered around US$600,000 for the whole period. For both groups, there was a drop in bonus value in 2015, leading to the more substantial increase to 2016, as bonuses recovered.

The recovery of the financial sectors from the lows of the 2008 financial crisis is evidenced even by the exceptional upward trajectory of the NEO annual bonus. While, in general, bonuses rose across most industry sectors, there are some wide variations reflecting economic fortunes. The most significant increase in annual bonuses over six years for NEOs was in the financials sector, at almost 110 percent. Back in 2010, the beginning of the period, the sector was still affected by the financial crisis, with incentive pay often subject to the temporary regulatory restrictions put in place after the bailouts. In contrast, over the six years, bonuses fell in value in both consumer discretionary and energy, reflecting an economy that has still not recovered full confidence and an energy sector under pressure from both low oil prices and the rising influence of climate change on its long-term strategy.

Incentive Plans (Mid-market sample review)

Performance-based awards now approach 50 percent of the total long-term incentive (LTI) award value at mid-market companies, demonstrating that these companies adopt the LTI trends of the country’s largest companies, but with some lag time. Among the Top 200 US companies by market capitalization, performance-based LTI awards first averaged 50 percent of LTI grant value back in 2012, reflecting at that time a greater desire among large companies for pay-for-performance alignment and rewards with a big potential upside still within the limit of Tax Code Section 162(m) tax-deductibility. That said, the mid-market is catching up, with performance-based awards making up 48 percent of the total LTI grant value in 2016, up from just 39 percent in 2014. Following the trend of large companies, as performance-based awards have increased in the mid-market, both appreciation awards and time-based restricted stock/units have declined (from 26 percent and 35 percent in 2014 to 20 percent and 32 percent in 2016, respectively).

With respect to the choice of compensation vehicles, in designing LTI awards with two or more performance metrics, a number of companies tend to prefer a balanced approach that incentivizes stock appreciation, corporate results, and retention. In 2016, 29 percent of companies used all three types of LTI awards: appreciation awards (which include stock options, SARs [stock appreciation rights], and incentivized stock price increases), performance-based awards (including performance shares, performance restricted stock, performance or premium stock options, and long-term incentive cash—effective vehicles to promote corporate performance targets) and restricted stock (to ensure executive retention). Use of all three LTI award vehicles has nearly doubled since 2014, when only 16 percent of companies structured plans this way.

Aside from the mix, performance-based awards have gained ground in prevalence on both stock appreciation and time-based awards, though many companies continue to grant two or more types of LTI. Since 2014, appreciation awards (stock options and stock appreciation rights) have fallen in prevalence from 53 percent to 45 percent, time-based awards have fallen less steeply from 66 percent to 64 percent, while in the same period the use of performance-based awards, mostly performance shares, rose from 64 percent to 77 percent. This continues the impetus of companies to demonstrate, not so much to proxy advisors, but to their clients and other investors that longer-term incentives are more focused on strict performance measurement.

While stock options have come under fire recently, many commentators view performance awards that measure achievement over three years as midterm incentives. With stock options vesting over three to five years and retained beyond that before exercise in many cases, these are more often viewed as longer term. In addition, with retention clauses being added to many different types of equity awards—restricted stock, in particular—these are also viewed as longer term; and retention is increasingly important in these days of declining CEO tenure.

Almost all performance measures for long-term incentives grew in popularity from 2014 to 2016, with the exception of cash flow. The majority of the companies in the study set LTIs based on income-related measures (63 percent) and/or total shareholder return (56 percent). That said, the gap between these two measures is closing, with income measure use outweighing TSR by only 7 percent in 2016, as compared to 15 percent in 2015. This is further evidence of the “trickle down” effect of LTI program trends from top companies to the mid-market (in 2015, the use of TSR in top company LTI plans surpassed the use of income measures). Capital efficiency measures, where output is divided by capital expenditures to assess the quality of the company’s receivables, and revenue both grew in usage to 30 percent and 24 percent, respectively. Common types of capital efficiency metrics are return on capital employed (ROCE) and return on invested capital (ROIC).

These usage figures all showed increases, from 52, 43, 21 and 17 percent respectively in 2014. Only cash flow showed a decline, from 8 percent to 5 percent over the same period. Increased use of performance metrics overall for LTIs could indicate a growing sophistication in performance measurement for such incentive plans, as companies move away from single metric usage to multiple. For energy and industrial companies, capital efficiency measures are the most common, while for consumer discretionary, health care, IT, materials, and telecommunications, it is all about income. Broken down by industry, the prevalence of both income and TSR becomes clearer. All industries incorporated income-based metrics in 2016, and only telecommunication services companies have LTI that does not include TSR as a metric. Interestingly, TSR is the most prevalent measure for utilities, given the industries’ low risk for a relatively certain margin. Historically, at least, the utilities sector was at one extreme of the risk/reward spectrum. For public policy reasons, their rates are regulated, capping the profits that can be earned. At the same time, the regulators were supposed to give them an adequate return to attract capital, and stocks would typically pay a hefty dividend, which would lead to increased TSR.

In general, STI design trends have been relatively stable over past three years. This stability extends to types of performance measures, complexity of performance measures (as indicated by number of performance measures), and the pay-for-performance curves. However, there have been some slight movements in the data, which are as follows:

  • Increase in the use of capital efficiency measures; prevalence of 25 percent in 2016 following 20 percent in each of 2014 and 2015.
  • Shifting of the pay-for-performance curve to have a tighter performance threshold, particularly for EPS, which shows an increase in the prevalence of performance threshold of 90 percent of target increasing from 31 percent in 2014 to 43 percent in 2016. A similar increase is shown for capital efficiency..
  • Shift in payout range from beginning at zero percent to a threshold of 50 percent. The most prevalent payout range shifted from zero percent to 200 percent in both 2014 and 2015 to 50 percent to 200 percent in 2016. This is a recognition of achieving a minimum performance threshold versus beginning to payout on achieving a minimum goal.

In addition to the above changes, the use of income as a measure saw a small decline, revenue stayed around the same, and cash flow, after a bump up to 19 percent in 2015, returned to 16 percent, the same figure as in 2014. Unusually, total shareholder return (TSR) usage increased from 1 percent to 2 percent. Income and/or revenue dominates in most industries, while capital efficiency metrics are most popular in financial companies, which also use measure outside the top five metrics. Cash flow is common in Industrial companies, as are discretionary financial measures.

The weighted average of performance measures used for STIs is just over two, although when non-financial measures are included, this rises to over three. For LTIs, the equivalent weighted average figures are less than two, though increasing over prior years Despite the growing use of multiple performance measures in STIs—the weighted average grew to 2.22 from 2.18 between 2014 and 2016—over a third of companies continue to use a single measure if non-financial measures are excluded. If these measures are included, only a fifth of companies use a single measure. One, two, or three measures are the most common, or modal, practice, at 35 percent, 27 percent and 28 percent, respectively. Very few companies use more, again, unless non-financial measures are included, when there is a general shift upward, with more than 10 percent using four, five and six or more each.

Single metric LTIs have fallen from 54 percent of companies in 2014 to 38 percent in 2016, and, in contrast, the proportion using two metrics has risen from 38 percent in 2014 to just over half in 2016. While no companies use four or more, a tenth use three, up from 8 percent in 2014.

As noted above, in their short-term incentive plans, companies set tighter performance ranges for EPS and revenue measures than for capital efficiency and income measures; and, in 2016, the wider range for the latter two measures was extended further at the maximum The most prevalent threshold seen in the short-term incentive plans examined for the purposes of the study is 90 percent or greater of target performance. The most prevalent maximum is 110 percent or lower. However, significant variation can be found in the spread between threshold and maximum, depending on the financial measure being used and whether the performance goal is expressed as a “level” or a percentage change. For example, when expressed as a level, the range for an EPS goal is most often set in a much narrower band than, say, a capital efficiency measure like ROIC or a percent change goal for revenue.

Nearly 70 percent of EPS measures were found to have a threshold value of 90 percent of target or higher and 54 percent of maximum EPS values are 110 percent of target or lower. Conversely, capital efficiency measures had 50 percent of threshold goals equal to 90 percent or more of target, while only 31 percent had caps of 110 percent of target or lower and 63 percent had maxima set at 111 to 120 percent. For revenue growth, two-thirds set thresholds at 90 percent or higher but a third at 79 to 70 percent, while half had maxima set at 110 percent or less and half at 131 to 150 percent. In general, practice continues to converge on a payout threshold of 50 percent of target and a maximum of 200 percent of target.

Most weightings for LTI performance targets are set at 50 percent—reflecting the most common choice of two metrics—but there has been a general lowering of thresholds needed for payout as a percentage of target The most typical weight for a LTI target, be it EPS, capital efficiency, revenue or TSR, is between 40 and 50 percent. However, more than a third and almost a fifth of companies, respectively, base 100 percent of LTI performance on EPS or TSR alone. There has been a general drift toward lower threshold performance as a percentage of target performance, especially for income and capital efficiency measures, at less than 70 percent. EPS thresholds have shifted from 90 to 99 percent of target to 80 to 89 percent, possibly reflecting uncertain economic times and the difficulty of predicting future long-term performance.

On the other hand, there has been a small shift away from lower-quartile performance as the threshold for relative performance measures—perhaps it is easier to predict, or require, better performance against peers than predict an absolute level of achievement—toward threshold payouts from the 26th to 34th percentile range, and a corresponding shift to 50th percentile target performance and upper-quartile performance for maximum payouts. As with STIs, the most common payout range for LTIs based on an absolute measure is between 50 to 100 percent of target. A substantial minority, however, over a quarter, set threshold payouts of zero. The maxima are generally set at 200 percent (just over half) or 150 percent of target (around a quarter).

LTI performance thresholds, at least for absolute measures, look to be getting more challenging, while maximum payouts, in some cases, are getting more generous In 2016, there was also a marked shift upward in threshold performance as a percent of target when using absolute performance measures. In 2014 and 2015, at the 25th percentile, threshold performance as a percent of target was set at 60 percent and 50 percent respectively, but, in 2016, 52 percent was now the median. There was little change in threshold payout as percent of target, except at the maximum, where it increased from 75 percent in 2014 and 2015 to 100 percent in 2016. The median maximum performance as percent of payout has stayed constant at around 125 percent, similarly the median maximum payout is 200 percent of target. In at least one company, maximum payout of an LTI increased to 600 percent of target in 2016, from a prior maximum of 300 percent, giving a much higher potential payout should maximum performance be reached.

For relative performance measures, while percentile rankings for threshold performance changed little, again, the maximum payout for such performance increased from 50 percent of target in both 2014 and 2015 to 80 percent in 2016. Target and maximum percentile rankings have changed little over the period studied, with a median of the 50th percentile for target performance and a median of maximum performance at the 75th percentile, leading consistently to a 200 percent payout of target.

Executive compensation design and oversight practices by the board

While an annual say-on-pay vote appears to be the standard, more than half of smaller manufacturing and nonfinancial services firms (under US$100 million of annual revenue) opt for less frequency. Across industries, more than 75 percent of companies currently hold annual say-on-pay voting, with the highest rate found in financial services (89.3 percent). Slightly less than 21 percent of companies in the nonfinancial services industry group and 9.8 percent of manufacturing companies have opted for a policy where executive compensation is submitted to a say-on-pay vote every three years. However, this choice was favored by more than half (53.8 percent) of the sample of manufacturing and nonfinancial companies in the smallest size group (under US$100 million of annual revenue). Similarly, there is a moderate direct correlation between company size and the annual frequency of say-on-pay votes. Across industries and size groups, very few companies chose to hold a say-on-pay vote every two years.

When designing new executive compensation policies, large financial companies set equity retention periods and go beyond regulatory requirements with contractual clawback provisions. Approximately 50 percent of companies across the manufacturing industry reported that they only adopted the type of clawback policy mandated by the Sarbanes-Oxley Act. The number is slightly lower for nonfinancial services companies (41.9 percent) and lower for financial services companies (35.1 percent), a sign of the marked response of financial institutions to the call for a stronger correlation between pay and performance. Of financial services companies, 36.8 percent indicated that they also introduced a clawback policy of the type mandated by the Dodd-Frank Act but not yet regulated by the SEC (proposed rules were issued for public comments in July 2015). With respect to manufacturing and nonfinancial services companies, the revenue analysis shows a clear direct correlation between the introduction of clawback policies of the Dodd-Frank type and the size of the company. In particular, this type of provision is used in employment agreements with executives by 51.7 percent of companies with annual revenue in the US$10 billion to US$19.9 billion range, compared to 14.8 percent of those with less than US$100 million in revenue. Disgorgement related to excessive risk taking and provisions to clawback compensation in cases of performance evaluation errors are more popular in certain size groups of financial companies. For example, in the largest group (US$100 billion or greater in asset value), they are used by 35.7 percent (excessive risk taking) and by 14.3 percent of companies (performance evaluation errors), respectively.

Similarly, 43.9 percent of financial services companies include retention requirements in their equity-based compensation policy for top executives, compared to only 15.9 percent in manufacturing and 20.2 percent in nonfinancial services. On equity retention, the company-size analysis shows correlation with asset value and great disparity between small and large organizations. In particular, 64.3 percent in the group of companies with asset values equal to or greater than US$100 billion use contractual provisions on mandatory retention, compared to 33.3 percent of the companies with asset value of less than US$5 billion.

Large companies are more likely to enforce anti-gross-up policies. Across industries, between approximately 33 percent and 45 percent of companies report adopting an anti-gross-up policy to curb payments to executives on tax charges tied to severance and perquisites received from the company. The percentage increases with corporate size (as measured both by annual revenue and asset value), with significant variation between the smallest and largest groups. As much as 78.6 percent of companies with US$20 billion or greater in annual revenue adopt the policy, compared to a meager 7.4 percent of those with less than US$100 million in revenue. Anti-gross-ups are more consistently used across size groups of the financial services sector, where the rate of adoption increases from 33.3 percent for companies with less than US$5 billion in asset value to 50 percent of those with assets of US$100 billion and over.

Compensation benchmarking disclosure is more prevalent among larger companies, with industry and company size the most frequently used criteria for identifying the peer-comparison group. More than 78 percent of companies disclosed the names of individual companies composing the peer group used for executive compensation benchmarking purposes. Generally, the larger the company size, the higher the percentage of companies providing this type of disclosure. The compensation committee is most frequently charged with the responsibility of determining the compensation peer group. However, between approximately 32 percent and 43 percent of companies across industries also revealed some level of direct involvement of senior management. The median number of companies included in the compensation peer group ranges from 14 to 17, depending on the industry, and from 12 to 19, depending on the size of the company. Industry and company size are the most frequently used features to identify the organizations that should be included in the compensation peer group. Earnings performance is also cited as a criterion by 31.9 percent of financial services companies. Across industries and company-size groups, annual base salary is the aspect of senior executive compensation that is most commonly tied to the analysis of the compensation peer group. However, 17.8 percent of financial services companies and 22.7 percent of manufacturing companies use compensation peer benchmarking to determine annual equity-based incentives, and 9.8 percent of nonfinancial companies use this method for cash-based bonuses contingent upon performance.

Compensation consultant fees tend to be lower than the amount for which disclosure is required. Across industry and size groups, a large majority of companies did not disclose the aggregate fee paid for compensation-related services or for additional consulting services, since the fee amount was lower than the US$120,000 threshold for which securities laws mandate disclosure. When disclosed, the highest median fee for compensation-related services was reported in the manufacturing group (US$132,000). Manufacturing companies also display the highest median disclosed fee for additional services unrelated to compensation (US$20,000 at the median). However, average figures for compensation related to such additional services can be as high as US$1,004,268 (as reported in financial services).

Say-on-pay and other shareholder activity on executive compensation

The number of shareholder-sponsored proposals on executive compensation put to a vote at 2017 AGMs has continued to decline, as institutional investors pursue alternative avenues for engagement with companies on these matters. In 2017, Russell 3000 companies voted on 35 shareholder proposals on executive compensation, compared to the 39 included in voting ballots in 2016 and the 132 in 2010. Following the regulatory introduction of the say-on-pay vote, companies have been more prone to proactively seek the support of investors on these matters. In turn, investors have limited their submissions on executive pay to more specific and narrowly formulated requests to limit (or request a shareholder vote on) death benefit payments (“golden coffins”) (seven proposals, or 19.44 percent of the total), introduce clawback policies to recoup incentive pay (five proposals, or 13.89 percent), or adopt equity-retention requirements (one voted proposal, or 2.78 percent). In the same voting period of 2016, there were six voted proposals restricting severance agreements (“golden parachutes”), but none of this type went to a vote this year. The more frequent proponents of resolutions in this field were multiemployer investment funds affiliated with labor unions, such as the American Federation of Labor and Congress of Industrial Organizations (AFL-CIO), which was responsible for two of the proposals on golden coffins; however, several of the proposals of this type were submitted by individual gadfly investors, such as John Chevedden and Cornish Hitchcock. Support levels remain limited, another indication that the debate on compensation issues occurs outside of and before the annual general meeting of shareholders.

Say-on-pay analysis confirms a significant turnover in failed votes, while the number of companies that passed but received less than a 70 percent support level increased from last year and 2015. In the Russell 3000, only 28 of the executive compensation plans put to a say-on-pay vote in the first half of 2017 failed to receive the support of a majority of shareholders. In 2016 and 2015, the numbers were 29 and 52, respectively. However, six companies that reported failed votes in 2017 had also missed a majority support level in 2017: Senior Housing Properties Trust, FMC Corp, Bed Bath & Beyond Inc., Nabors Industries Limited, Tutor Perini Corp, and Atlas Air Worldwide Holdings. (There were only two of these cases last year, in the comparison of the 2016–2015 list.) Tutor Perini Corporation is the only company in the Russell 3000 that has failed all seven years of say-on-pay advisory votes. Nabors Industries Ltd. had four consecutive failed votes as of 2014, received 65.3 percent of for votes at its 2015 annual general meeting (AGM), and then failed the advisory vote again in 2016 (with a mere 36 percent of votes cast in favor of the compensation plan proposed by management) and in 2017 (where the percentage of favorable votes cast increased only slightly, to 43.73).

The analysis continues to highlight a significant year-over-year turnover in failed votes and, aside from the cases indicated above, all companies that failed their say-on-pay votes in 2017 had successful votes in 2016—in most cases, by wide margins. This finding underscores the importance of proactive engagement with institutional investors on these matters to assure that the pay policy continues to be aligned with the long-term business strategy of the organization.

Another 118 companies in the Russell 3000 (or 6.1 percent of the 1,948 companies that held their AGM in the first six months of 2017) reported passing say-on-pay with less than 70 percent of votes cast, the level at which proxy advisory firms may scrutinize more closely their compensation plans and evaluate issuing a future negative recommendation. The number is higher than the one registered last year (105 proposals) and in 2015 (90 proposals), but down significantly from the 141 companies with votes under 70 percent during the same period in 2014. The 2017 list includes prominent names like retailers Abercrombie & Fitch and CVS Health, the hospitality group Wynn Resort, and energy giants ExxonMobil and Halliburton. Moreover, 24 of the companies below the 70 percent support threshold in 2017 were also below that level in 2016.


1Judit Torok, U.S. Salary Increase Budgets for 2018, The Conference Board, 2017 (forthcoming).(go back)

Both comments and trackbacks are currently closed.

One Comment

  1. Irena
    Posted Friday, October 6, 2017 at 10:32 am | Permalink

    Amazing report and the numbers are just fascinating! It makes me think how tough the decision of assigning a new CEO can be, because the mistake could cost tens of millions, like that fail with Marissa Myer and Yahoo.

  • Subscribe or Follow

  • Supported By:

  • Program on Corporate Governance Advisory Board

  • Programs Faculty & Senior Fellows