CEO Stock Incentives Increasingly Tied to Stock Ownership and Retention

Dan Leon is a senior associate and LaToya Scott is an associate at Willis Towers Watson. This post is based on a Willis Towers Watson memorandum by Mr. Leon, Ms. Scott, Robert Newbury, and Erik Nelson. 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 Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay, by Jesse Fried (discussed on the Forum here).

New findings confirm what we’ve long known: many companies are adding retention requirements to prevent executives from quickly selling equity earned through long-term incentives (LTI) post-vesting.

Willis Towers Watson’s Global Executive Compensation Analysis Team reviewed ownership guidelines and retention policies in effect during 2010, 2015, and 2019 among the S&P 500 and found that the number of companies with retention requirements has jumped from 35% in 2010 to 64% in 2019, approximately an 83% increase. This dramatic growth suggests that stock retention requirements could become as nearly universal as ownership guidelines.

The trend tracks companies’ practice of using stock ownership guidelines to require executives to own a specific amount of company shares to better align the interests of investors and executives. The most recent driver of this practice occurred in September 2019 when the Council of Institutional Investors (CII) suggested that ownership guidelines and retention policies should be included as part of an executive compensation program focused on building long-term (at least five years) shareholder value. Previously, in 2015, Institutional Shareholder Services (ISS) began to formally account for these policies while evaluating and scoring a company’s equity compensation plan.

The growth of ownership guidelines and retention requirements

Figure 1 illustrates the growing prevalence of the S&P 500 to implement both retention requirements and ownership guidelines, with roughly one-third using both compared with 63% in 2019. Those using only ownership guidelines dropped significantly to 33% in 2019, from 50% in 2010.

Figure 1. Prevalence of S&P 500 ownership guidelines and retention requirements

Figure 1. 2019, 2015, & 2010 S&P 500: Prevalence of ownership guidelines and retention requirements

Source: Willis Towers Watson’s Global Executive Compensation Analysis Team

Stock ownership guidelines among the S&P 500

Overwhelmingly, the ownership target under these guidelines is typically structured as a multiple of an executive’s base salary (91% in 2019). Other methods applied in 2019 included a fixed number of shares (3%), the lesser of a salary multiple or fixed share amount (4%), and other designs (2%) including an absolute dollar value, lesser of a dollar value or number of shares, or, in one instance, a multiple of equity awards granted over the prior seven years.

The multiple of base salary for CEO ownership guidelines has edged up from 5x salary to the new norm of 6x salary (Figure 2). In 2010, 63% of S&P 500 companies were using 5x salary and only 10% had a multiple of 6x salary. This gap was closed in 2015 with 38% of companies using 5x salary and 42% using 6x salary. The use of 6x salary took a clear lead in 2019, making up 54% of the S&P 500, with 24% still using 5x salary.

A decent-sized portion of S&P 500 companies also apply multiples above the prevailing practice of 6x salary for their CEO, scaling up from 10% in 2010 to 17% in 2019. Nearly all multiples above 6x salary for CEOs ranged from 7x to 10x salary in 2019 (94%). Multiples of 7x and 10x salary each made up 35% of these companies, 24% used 8x salary and the remaining 6% had a multiple above 10x salary for the CEO.

Figure 2. Multiples of salary for CEO ownership guidelines among the S&P 500

Figure 2. 2019, 2015, & 2010 S&P 500: Multiple of salary for CEO ownership guidelines

Source: Willis Towers Watson’s Global Executive Compensation Analysis Team

Stock ownership guidelines often require executives to reach their ownership target within a certain number of years. This compliance period applies for new executives joining the company, executives who are promoted, or for all covered executives upon establishing new or updated ownership guidelines. Although the majority of companies included a compliance period of five years in 2019 (73%), many companies (18%) decided to forgo a compliance period altogether, opting instead for a retention policy restricting executives from selling shares until they have achieved their ownership target.

S&P 500 stock retention requirements

There are two strong cases that can be made for stock retention requirements. They preserve the long-term focus that was the very reason for a company LTI program and can also strengthen equity awards by encouraging strategies which buoy results well beyond the vesting date. These benefits weren’t lost on S&P 500 companies. As shown in Figure 3, retention requirements among the S&P 500 leapt from 2010 to 2015, increasing by 54.2%. Growth continued in 2019, increasing 18.5% over 2015.

Figure 3. S&P 500 prevalence of stock retention requirements

Figure 3. 2019, 2015, & 2010 S&P 500: Prevalence of stock retention requirements

Source: Willis Towers Watson’s Global Executive Compensation Analysis Team

The majority (52%) of S&P 500 companies in 2019 (Figure 4) used stock retention policies that prohibit executives from selling equity until they have met their ownership guideline target. And 6% used both (i) a policy tied to ownership guideline achievement plus (ii) a stand-alone policy in which executives must hold shares for a certain timeframe after vesting regardless of their compliance status under the ownership guidelines. Another 6% of companies included only a stand-alone retention requirement, and the remaining 36% did not have any type of retention policies.

Figure 4. S&P 500 stock retention requirement designs

Figure 4. 2019 & 2015 S&P 500: Stock retention requirement designs

2020 outlook for ownership guidelines and retention policies

Executive compensation programs in the new decade will strive to augment companies’ long-term value, so the prevalence of ownership guidelines and retention requirements will grow and policy designs will become more robust. Companies using ownership guidelines of 5x salary for their CEO should pay attention to the trend towards 6x salary or higher as they may find themselves well behind the majority of their peers. Those without retention requirements may want to consider incorporating these policies into their existing ownership guidelines or adding a stand-alone retention policy. And companies with retention requirements should continue to evaluate whether the requirements keep up with growing investor demands for greater long-term equity retention from executives.

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