CEO and Executive Compensation Practices: 2018 Edition

Matteo Tonello is Managing Director at The Conference Board, Inc. This post relates to CEO and Executive Compensation Practices: 2018 Edition, an annual benchmarking report authored by Dr. Tonello with Paul Hodgson of BHJ Partners and James Reda of Arthur J. Gallagher & Co. Related research from the Program on Corporate Governance includes the book Pay without Performance: The Unfulfilled Promise of Executive Compensation, by Lucian Bebchuk and Jesse Fried and The CEO Pay Slice by Lucian Bebchuk, Martijn Cremers and Urs Peyer (discussed on the Forum here).

The Conference Board recently released CEO and Executive Compensation Practices: 2018 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 2018, 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. This year, a new section of the study reviews data from the first year of pay ratio disclosure, which became mandatory for many U.S. public companies in 2018.

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 11 industry groups, using the applicable Global Industry Classification Standard (GICS) codes. In addition, to further highlight differences between small and large companies, findings in the Russell 3000 index are compared with those from the S&P 500 Index. 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.

Contrary to popular belief, CEO pay at larger companies is stable or even declining, while smaller firms are playing catch-up with double-digit raises for their chief executives. Companies with revenues less than $100 million saw increases for their CEOs at more than 20.5 percent, while CEOs in the next bracket up, $100 million to $999 million, had increases of 14.4 percent. However, CEOs in the largest companies ($25-49.9 billion and $50 billion plus) received, respectively, a decrease in pay (-7 percent) and a relatively modest raise (1.4 percent). Among financial services firms, several asset value brackets saw total compensation declines, and there was no real pattern to the changes in contrast to the analysis by revenue. In the lowest asset value bracket (less than $500 million) total compensation fell by more than 8 percent, while in the next bracket up ($500-$999 million) total compensation increased by more than 80 percent.

Companies continue the trend towards granting two or more types of long-term incentive plans (LTIs). All three major LTI vehicles (appreciation awards, time-based awards, and performance-based awards) have increased in prevalence from 2016 to 2017. There has been a slight uptick in appreciation award usage from 2016 to 2017, with prevalence increasing slightly to 46 percent in 2017. Time-based awards exploded in 2017, increasing in prevalence to 74 percent after falling from 66 percent in 2014 to 64 percent in 2016. In the same period, the use of performance-based awards, mostly performance shares, rose from 64 percent in 2014 to 77 percent in 2016, and have again grown in usage in 2017 to 80 percent. This continues the impetus of companies to demonstrate to their investors that longer-term incentives are more focused on strict performance measurement. Stock options have come under fire recently, with many commentators view performance awards that measure achievement over three years as midterm incentives. Stock options vesting over three to five years, and retained beyond that before exercise in many cases, 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.

The pay growth rate for named executive officers (NEOs) outpaces CEOs’. The median Russell 3000 NEO, excluding the CEO, earned $1,486,450 in 2017, resulting in one- and eight-year increases of, respectively, 13.2 percent and 55.7 percent—an annual rate of increase that is almost four percentage points higher than for chief executives. “Median 2017 earnings for an S&P 500 NEO were $3,798,040, still less than a third of what the median CEO of companies in the index took home in the same year, but more than double the earnings for Russell 3000 NEOs,” said Paul Hodgson, partner of governance research firm BHJ Partners and also co-author of the study. “On the other hand, the increase over 2016 pay for S&P 500 NEOs was lower than that for Russell 3000 NEOs both in the short and long-term, 9 percent and 37.3 percent respectively over eight years.”

The number of shareholder-sponsored proposals on executive compensation put to a vote at 2017 AGMs has declined sharply from prior years, in a sign that shareholders are more satisfied with company practices and the increased engagement with directors. In 2017, Russell 3000 companies voted on 30 shareholder proposals on executive compensation, compared to the 45 included in voting ballots in 2016 and 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 introduce clawback policies to recoup incentive pay (seven proposals, or 23.33 percent), link compensation to performance (three proposals, or 10 percent) or limit (or request a shareholder vote on) death benefit payments (“golden coffins”) (two proposals, or 6.67 percent of the total).

The analysis of the newly required pay ratio disclosure displays substantial variation across indexes, business industries and company size groups, suggesting that this information should be interpreted with caution and preferably excluded from peer comparisons. For the first time, in 2018, most U.S. public companies included in the compensation section of their proxy statements the disclosure of the ratio between CEO pay and median employee pay. However, the flexibility allowed by SEC rules in the choice of the methodology for the calculation of pay ratios reduces the comparability of disclosure across different issuers. The review of such disclosure reveals wide variations, with a median for the Russell 3000 of 70:1 (compared to a median of 158:1 in the S&P 500) and a range from 0:1 to 5908:1. In the industry analysis of Russell 3000 companies, the lowest median ratio (40.5:1) is found in the financial sectors, where the generous rewards offered to bankers skews the median-employee compensation used as a denominator in the calculation. However, even in this sector, the range can be broad, with some financial services firms reporting that their CEOs earned as much as 696 times the salary of a median employee in 2017. The segmentation of data confirms that pay disparities are directly correlated to company size: companies with revenue below $100 million, for example, disclosed a median ratio of 15:1, compared to the 249:1 ratio among firms with an annual turnover of $50 billion and over.

Companies have been choosing a less-is-more approach to pay ratio disclosure, forgoing the option of adding a supplemental pay ratio to the proxy statement. Less than 15 percent of Russell 3000 companies chose to provide alternative calculations to supplement the prescribed pay ratio with an additional (often, lower) ratio. In those cases where such supplemental ratio is offered, the most frequent types of adjustment used are the one excluding certain elements of CEO compensation (in most cases, one-time or multi-year equity grants offered in special circumstances) and the one reflecting “add backs” for health and dental benefits. The former type was reported by 5.58 percent of Russell 3000 companies and 7.73 percent of S&P 500 companies, while the latter was reported by 4.58 percent of Russell 3000 companies and 7.48 percent of S&P 500 companies. While there is no clear direct correlation between supplemental pay ratio disclosure and company size, approximately 21 percent of financial companies with asset valued at $100 billion or more did include a supplemental pay ratio in their proxy statement, and it was always to reflect the health-and-benefit add-back. Similarly, 12 percent of companies with annual revenue exceeding $50 billion used the supplemental pay ratio to underscore the impact on the calculation of extraordinary equity grants, compared to 1.74 percent of smaller companies with an annual turnover of less than $100 million. Given the rule on the de minimis exemptions for the determination of the prescribed pay ratio, a very small number of the examined companies chose not to use it and instead disclosed a supplemental pay ratio to highlight the extent to which non-US employees’ pay affects the ratio calculation.

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