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Article | Executive Pay Matters

Small-cap companies jump on the CEO performance award bandwagon, new study finds 

Executive Compensation
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By Michael Bowie | November 21, 2019

Here’s a first from our new study: S&P 1500 performance awards are 50% of the average long-term incentive (LTI) program mix.

Performance continues to drive CEO pay, and increasingly LTI performance awards, Willis Towers Watson’s just released study, “CEO Pay at S&P 1500 Companies: 2019,” found. In fact, performance-based awards now make up 50% of all LTI granted to CEOs across all S&P 1500 companies.

The build has been gradual. Over the past decade, performance awards became the primary LTI component for CEOs at the largest U.S. companies, replacing time-vesting awards such as stock options and restricted stock. Now, evidence suggests smaller companies are following suit, using performance awards as the primary LTI vehicle.

Small-cap companies experienced the most pronounced shift in granting CEO performance awards, increasing from 61% in 2017 to 67% in 2018, while S&P 500 and S&P 400 companies held steady in 2018 at 88% and 79%, respectively. This growing trend in the S&P 1500 reflects investors’ determination to align pay with financial performance and growth and to take a long-term view about delivering value to stakeholders that include investors and employees.

These findings were identified by Willis Towers Watson’s Global Executive Compensation Analysis Team (GECAT) in its annual review of S&P 1500 CEO pay. Other key findings highlighting an increased emphasis on pay for performance include:

  • Target pay levels: Target total pay increased 5.5% at the median for S&P 1500 CEOs in 2018. However, total pay potential for CEOs across each index (S&P 500, S&P 400, S&P 600) grew at a slightly slower rate than the previous year. Performance-based pay delivered through annual bonus payouts and LTI comprised 81% of 2018 target pay for CEOs in the S&P 1500.
  • Salary adjustments: S&P 1500 CEOs received a median salary increase of 2.7% in 2018, about half the rate of increase of overall target pay levels. Forty percent of CEOs did not receive salary increases in the past year, and just over one-quarter haven’t received salary adjustments over the three years reviewed. Annual bonus payouts: Strong company performance drove an average annual bonus payout of 114% of target in 2018, up from 111% in 2017, with 64% of payouts at or above target.
  • LTI realized: The value of LTI earned — the combination of time-vesting awards vesting, stock options exercised and performance plan payouts — grew 13% at the median in 2018, but at a much lower rate than the previous year when the median earned grew 33%.
  • Performance-award payouts: Looking specifically at performance awards, the average payout was 110% of target based on the underlying shares or units granted for performance periods completed in 2018. Strong market performance over the recently completed performance cycle led to substantial value gains because of stock price growth. Consequently, the average realized value from payouts for awards completed during 2018 was 157% of target.

The quest to optimize pay for performance

The Willis Towers Watson study shows that compensation for U.S. CEOs is largely and increasingly comprised of performance-based pay, primarily annual cash bonuses and long-term, equity-based awards whose payout is earned based on a long-term performance measurement, usually over 3 to 5 years. Consequently, year-over-year changes in CEO pay are largely the function of payouts based on variable performance outcomes.

Our review of realizable pay relative to target pay among the S&P 1500 suggests that for most companies, pay is directionally aligned with performance. As shown in Figure 1, CEOs at companies in the top third of performers, as measured by total shareholder return (TSR), are on pace to realize 131% of the target direct compensation (TDC) granted over the past three years. Alternatively, those CEOs at companies in the bottom third of performers would earn 73% of their three-year target pay.

Median 3-year realizable pay versus TSR performance
Median3-year realizable pay versus TSR performance*

The road ahead

Performance is increasingly driving CEO pay, making it important for companies to focus their efforts on incentive programs and whether metrics used are appropriate and goals set are rigorous relative to the opportunities provided. Further, companies should be diligent in understanding pay outcomes and payout scenarios to ensure they’re maximizing the return of their incentive dollars.

Companies must strive to set meaningful and strategically appropriate performance goals within their incentive programs and calibrate them to ensure earned payouts are justified given the mechanics of the program and the underlying performance driving the achieved payout. As external constituents continue to monitor the rigor of established metrics, companies should properly communicate the rationale for incentive program metrics and how required performance levels for payout are set, particularly when required performance shifts considerably or reductions in required performance yield greater payouts.

For more details on the survey findings, please download our deck.

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CEO Pay at S&P 1500 Companies: 2019 PDF 1.8 MB
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