Chief executive officer (CEO) compensation is consistently at the forefront of the conversation with respect to the corporate governance landscape. With the introduction of the CEO pay ratio, shareholders and competitors alike have been able to analyze CEO compensation in a whole new light. Additionally, in recent years, shareholder engagement involving many topics, including executive compensation, has played a vital role in how companies mold and shape their specific compensation structure. Companies must learn to walk a fine line between shareholder approval of executive compensation and the ability to retain and attract talent. Going back to 2010, the year Dodd-Frank was put into place, shareholders have actively voiced their opinions on executive compensation matters, and companies, for the most part, have listened.
While the overall numbers of total CEO compensation have continued to climb, the composition of pay, especially equity, has seen a shift toward a more modern approach.
Since the introduction of Say on Pay, less than a quarter of large-cap companies have failed to receive at least 90% shareholder approval. In that same time frame, CEO compensation has continued to increase with each passing year. However, while the overall numbers of total CEO compensation have continued to climb, the composition of pay, especially equity, has seen a shift toward a more modern approach.
For the most recent year, median total compensation for CEOs at Equilar 500 companies—the 500 largest public companies by revenue—leveled off at $11.9 million. While only a 3.5% increase from the year prior, median pay in 2017 was 21.4% more than the median total compensation for CEOs in 2013. Despite the increase at the median this past year, both the 25th and 75th percentile of Equilar 500 total compensation saw a slight decrease from 2016 to 2017 (Graph 1). Narrowing in on CEO compensation by sector provides a closer look at how specific industries pay company heads. For example, the healthcare sector paid its median CEO the highest, at just over $15 million. Conversely, the financial sector exhibited the lowest median CEO pay at $10.2 million—the only sector with a median below $11 million.
“There are a number of factors contributing to the recent rise of CEO pay,” said Patrick Powers, Lead Consultant at Meridian Compensation Partners, who provided commentary for a recent Equilar report, CEO Pay Trends. “First, economic conditions continue to improve in the U.S. and the unemployment rate is at its lowest level in decades. More recently, however, the global economy has also started to take off, particularly in key parts of Europe.”
Powers goes on to add, “Financial performance has been strong. As a result, we’ve seen higher bonus payouts. For example, median bonus payout for the Equilar 500 increased from 108.3% last year to 115.6% this year. The ‘Trump Bump’ and, to a lesser extent, U.S. tax reform have had positive impacts on the stock market, which increases LTI values.”
With shareholder opinion playing an increasingly larger role in the structure of executive pay, companies have become more apt to appease both shareholders and executive talent alike.
With shareholder opinion playing an increasingly larger role in the structure of executive pay, companies have become more apt to appease both shareholders and executive talent alike. As a result, compensation has moved toward a more performance-based composition. Beginning in 2016 and continuing even further in 2017, the Equilar 500 median reported a majority of the long-term incentive (LTI) mix for chief executives was performance-based. Additionally, all sectors, led by the utilities and financial sectors at almost 60% performance-based, utilized performance-contingent awards for a majority of LTI mix. On top of that, nearly 90% of companies in the Equilar 500 granted some sort of performance-contingent award to chief executives in 2017. That is a 20% increase compared to those granting performance long-term incentive awards in 2013. At the same time, option usage has decreased by 16.3%. In fact, 2017 was the only year over the last five years where a majority of companies did not grant long-term incentive options (Graph 2). The technology sector had the most companies grant a performance award with 93% prevalence, yet all sectors in this analysis had at least 82% performance participation.
“Stock options are still common in some industries, but overall continue to decline in prevalence, weighting, and depth and participation within the organization hierarchy,” Powers added. “There are a number of reasons for this. Proxy advisors do not consider options to be a ‘performance-based’ vehicle when evaluating the company’s LTI mix.”
While “performance-based” and “time-based” provide an analysis of the award type, they don’t paint the whole picture. Vehicle type provides extra color and allows for a more in-depth look at LTI awards. For example, at 30% prevalence, companies using the combination of performance awards and restricted stock as vehicles were the most common in 2017, overtaking the option and performance combination from the year before. Furthermore, options as a lone vehicle decreased in prevalence every year in the study, bottoming out at 2.1% in 2017, a 69.1% decrease from 2013. In fact, a larger portion of Equilar 500 companies granted no equity to CEOs than just options in the most recent year.
Regardless of how it’s sliced, CEO compensation has always been a difficult topic to tackle completely. From the early 20th century when it was considered taboo to even speak about and disclose an executive’s salary, to the highly-publicized and scrutinized version of today, the landscape of CEO compensation is ever-changing. Whether that involves performance-based long-term awards or a higher salary for a short-term gain, it’s up to the company to create a mix that attracts and retains the best possible talent available to hold the position. Regardless, shareholders and companies alike must work in congruence in order to find the appropriate pay mix for leadership.
Alex Knowlton is a Senior Research Analyst at Equilar and Managing Editor for Equilar research reports.