Current Trends in Executive Compensation Based on the 2024 Proxy Season

Introduction

Pay Governance LLC provides counsel and advice to the Board of Directors’ Compensation Committees of more than 450 prominent publicly-traded and private companies. In addition to providing executive compensation and technical advice, we are frequently requested to provide our insights and advice regarding compensation and industry trends and regulatory developments. Our ongoing client work, internal research and attendance at Compensation Committee meetings during the 2023 year and 2024 proxy season give us a comprehensive view of the prevailing issues and compensation strategies that Compensation Committees are considering.

The purpose of this discussion paper is to summarize the key executive compensation takeaways from the 2023 year and highlight the prominent issues and news being discussed in 2024 Committee meetings.

Performance & Pay Environment Entering 2024

Shareholders experienced solid gains in 2023, with TSR increasing by 11.6% and 7.73% for the average S&P 500 and Russell 3000 company, respectively. These TSR results were aligned with top-line growth approximating 5% at the typical company for each group. These companies also maintained strong returns on assets and capital from prior year results. EPS growth slightly outpaced the growth in revenue as results reflected historical norms following the swings of the past two years following the pandemic.

These results were generally incorporated in the pay outcomes reported by companies in their most recent proxies:

• Actual bonus paid for 2023 at the typical company was slightly above target opportunity, which demonstrated another year of good performance. However, that payout level was down from the payouts in the prior two years, which were significantly above target and approached 150% of target on average in 2021 as companies rebounded from the pandemic and its economic uncertainties may have influenced goal setting.
• Long-term incentive cycles ending in 2023 marked the first full post-pandemic cycles for most companies and payouts for the typical plan were in the range of 125% to 150% of target. Coupled with the stock price gains that many of these companies earned over the period, the actual value realized from payouts approximated 175% of the underlying target value.
• Changes in target pay opportunities for 2023 for the typical CEO generally continued those witnessed in 2022: modest increases in salaries (≈3-4%), no change in target bonus opportunities (percent of salary) and target long-term incentive values up by mid to high-single digits. Overall, total target pay opportunities increased by roughly 7.5% for the typical CEO.

Based on first quarter meetings with our clients’ Compensation Committees, we do not anticipate target pay opportunities for 2024 to deviate too much from the results experienced in the past couple of years.

ISS Voting Policies Influencing SOP Votes in 2024

Based on our review of ISS commentary, their policy changes and research reports, we identified several factors that would influence ISS’s SOP recommendations this year:

• Scrutiny of Adjustments: ISS’s 2024 Proxy Season Preview reiterated its intent to increase its scrutiny of incentive adjustments, particularly if they “are unusual or substantially increase payouts” and especially for companies receiving a “medium” or “high” concern on their quantitative pay-for-performance tests.
• GAAP to Non-GAAP Reconciliations: ISS expects companies to provide a reconciliation between results for incentive metrics and GAAP financials when results between the two are meaningfully different. Providing a bridge between GAAP and non-GAAP results (even as an appendix) is considered a best practice by ISS.  Glass Lewis also has expressed a preference for companies to disclose a similar reconciliation between results used for incentives and those reported in the company’s GAAP financial statements.
• Goal Rigor: ISS believes companies have been setting unchallenging goals based on their research showing most Russell 3000 companies have consistently paid above-target bonuses over the past several years. As a result, ISS is paying particular attention to year-over-year changes in performance targets and resulting payout factors this proxy season (e.g., goals set below prior year levels that pay above 100% of target)
• SEC’s Pay versus Performance (PvP) Disclosures: While the SEC-mandated PvP table went unmentioned in ISS’s 2024 policy updates, conversations with ISS indicate they could use PvP disclosures to reinforce the findings of their own quantitative pay-for-performance tests although it only has been reported in a few instances to date. Glass Lewis has also indicated the possibility of taking a similar approach.
• SOP History: Although not part of ISS’s formal policies, ISS will examine a company’s SOP history when recommending whether compensation committee members should be re-elected to the board, resembling an approach used by ISS before SOP was adopted.

Year-to-Date SOP Voting Results for 2024

As of May 31, nearly 70% of the S&P 500 and 50% of the Russell 3000 have reported their SOP results for 2024.  ISS continues to support the overwhelming number of those proposals, roughly 92% of proposals filed to date. This level of support is a meaningful uptick from last year’s results (90.5% for the S&P 500 and 88% for the Russell 3000) and generally would be the highest in the past decade for both groups if it is sustained for the rest of the year.

While the lack of ISS’s support does not mean automatic failure, it does make the difference between overwhelming (nearly 95%) and “weak” support (roughly 65%). Both ISS and Glass Lewis define “weak” support as being below 80%, with the expectation such companies will conduct extensive shareholder outreach, appropriately respond to investor feedback and provide thorough disclosure of the process as well as views heard. Only 3 S&P 500 and 11 Russell 3000 companies have failed SOP to date, averaging around 37% support.  These failure rates are <1% of proposals voted, which would be a marked decline, if maintained, from the 2-3% failure rate of the past six years.

Takeaways from ISS “Against” Recommendations

In our experience, companies generally are aware of ISS’s policies, seem responsive to some (but not all) of its feedback and have reduced potential irritants in their programs as appropriate.  This may explain, in part, the improvement in overall SOP results noted in the prior paragraph.

Among companies receiving an “against” SOP vote recommendation from ISS, about one-half had a “high” overall concern rating, with one-quarter rated as “medium” and the rest as “low”.  Normally, companies receiving an “low” concern receive ISS’s support 95% of the time, suggesting companies that don’t have problematic pay practices that draw ISS’s ire. Looking at ISS’s quantitative pay-for-performance tests, nearly one-half of companies receiving an “against” from ISS this year scored a “high” concern on its Relative Degree of Alignment test (RDA: ranking of CEO’s pay vs. ISS’s selected peer groups in comparison to the company’s TSR vs. ISS’s peers).  In contrast, roughly 75% of the group were rated a “low” concern on ISS’s Multiple of Medium (MOM) and Pay-TSR Alignment (PTA) tests. This is consistent with our experience and may be influenced by the companies ISS selects for peer comparisons in the RDA test, which may differ significantly with the group used by the company to set CEO pay.

Not surprisingly, pay and performance related issues were the most common criticism of these companies in ISS’s qualitative assessment of their programs, including those rated a low concern on the RDA test. Among companies not receiving support but rated a “low” or “medium” concern, ISS’s pay-performance issues related to the structure of their regular pay program or special, one-time grants:

• Applying discretion or emphasizing subjective goals in their bonus plans.
• Setting annual bonus goals lower than prior year’s results and paying out above target.
• Overlapping metrics in the company’s annual bonus and long-term incentive plans.
• Using a one-year performance period for long-term incentives, reducing the plan’s long-term focus.
• Delivering LTI mostly or entirely in the form of time-based awards.
• Adjusting goals to outstanding long-term performance cycles or using discretion to pay at target.
• Awarding sizeable one-time, special awards that are largely time-based.

These criticisms also were common for companies rated a “high” concern as well as issues with the CEO’s maximum bonus opportunity, failure to cap long-term incentive payouts at target for negative TSR and relative metrics that do not target out performance (> 50th percentile). In addition, ISS was particularly critical of the quality of the proxy disclosure of these companies, exacerbating the difficulties ISS likely had in understanding the company’s rationale for their pay program or the Committee’s actions.

Key Legislative, Regulatory and Technical Developments

There were several important developments in these areas in the first half of the year that have captured the attention of companies and lead discussions with our clients’ Committee.

• Delaware Court’s Rejection of Elon Musk’s Pay Package.  While not a legislative or regulatory development, no compensation development probably received as much attention as the Delaware Court’s voiding (January 30) of the pay package Elon Musk received in 2018. The award was a performance-based stock option grant with 12 tranches of options each equal to 1% of Tesla’s common shares outstanding. The award was tied to increasing Tesla’s market cap from $50 billion to $100 billion (first tranche of options) to $650 billion (last) and growing either revenue or adjusted EBITDA to $175 billion (vs. $12 billion for the year prior to the grant) or $14 billion (basically break-even in 2017), respectively.

In voiding the package, the court indicated that Telsa failed to prove the grant was “entirely fair: and cited the: lack of independence of Tesla’s directors; flawed process used to develop the package (Mr. Musk proposed the package; Board had little or no pushback); incomplete disclosures used by shareholders to approve the package (directors’ personal ties to Mr. Musk; discussion of the process); failure to benchmark the magnitude of the proposed pay; and rigor of some of the goals.

The ruling sends a clear warning to those few companies that have awarded or are considering awarding extraordinarily large pay packages to their top executives. More importantly, it has led our clients to confirm: the independence of their Committees/Boards beyond what’s required by the SEC; their processes used for developing, governing, administering executive pay proposals, especially those for the CEO; any pay-performance linkages associated with their incentive plans, especially special or one-time awards; and understanding the market position of the pay outcomes associated with those plans.

• Clawbacks. The SEC did not issue any changes or additional guidance regarding their clawback listing requirements.  However, Glass Lewis and BlackRock issued policies which go beyond the SEC’s requirement to recoup performance-based compensation only in the event of a financial restatement.  Glass Lewis believes such policies also should be applied in cases of “material misconduct, a material reputational  failure, material risk management failure or a material operational failure” and regardless of whether the employee is terminated (with or without cause).  ISS wants time-vesting equity to be included in any clawback situation.

Similarly, BlackRock’s view is clawbacks should cover “deceptive business practices” (executive behavior that causes material financial harm to shareholders, material reputational risk to the company or resulted in a criminal investigation).  A few of our clients have revised their policies to consider these actions, but the most are taking a “wait and see” approach.

• Federal Trade Commission’s (FTC) Ban on Non-Competes. In April, the FTC issued a ruling banning non-compete arrangements nationwide for both public and private organizations. Under the rule, existing non-competes for “senior executives” are allowed to remain in place, but such agreements for all other workers were immediately deemed unenforceable. “Senior executives” are defined as individuals earning more than $151,164 in direct pay (excluding benefits) and have “policy making authority” (like the definition for Section 16 officers). Once the rule becomes final (120 days after their publication in the Federal Register on May 8 or Nov 3), any new non-competes will be disallowed.  Companies will still be able to use other restrictive covenants (e.g., non-solicitation of customers or employees, non-disparagement, non-disclosure of confidential information or trade secrets).  Business groups such as the U.S. Chamber of Commerce and Business Roundtable have promised litigation, and it is far from certain the ban will be established case law.
• Interagency Rules for Incentive Compensation for Financial Institutions.  In early May, several agencies overseeing U.S. financial markets (Federal Deposit Insurance Corporation, Officer of the Comptroller of the Currency, National Credit Union Administration and the Federal Housing Finance Agency) re-proposed rules for incentive-based compensation arrangements mandated by Dodd-Frank and initially proposed in 2016.  Interestingly, the Federal Reserve Board and SEC have not acted to join the proposal as of June 1.

Rules apply to all financial institutions with consolidated assets over $1 billion and vary by asset size (Level 1: $250 billion & more; Level 2: $50 billion to $250 billion and Level 3: $1 billion to $50 billion). All covered institutes would need to prohibit incentive plans with features encouraging excessive risk-taking, develop plans which balance risk and reward, establish effective risk management governance and require appropriate Board/Committee oversight, recordkeeping and disclosures.  Level 1 and 2 institutes would be subject to enhanced requirements including mandatory deferrals of short and long-term incentives, caps on upside (maximum) incentive potential and clawbacks with a seven-year look-back period.

The proposals are far from being enacted as compliance would not be required until 540 days following their being entered into the Federal Register, although the agencies are seeking to shorten it to 365 days. More to come in this area, but financial institutes have been down this road once before without any action taken.

Closing

These updates provide a view into some of the notable discussions and topics within Compensation Committee meetings. With the slow but steady growth in early 2024 and uncertain economic outlook, we expect discussions on executive pay strategies will continue to maintain strong motivational incentives. Companies incorporate both internal business and company expectations with external pressures and developments.