The landscape for CEO pay has evolved significantly over the last several years. Trends and changes in overall compensation for chief executives can predict and ensure that pay for those in the C-suite is fair and a reflection of a corporation’s success. More than ever, shareholders are keeping a careful eye on CEO pay, particularly in accordance to performance over a longer time horizon. The underlying assumption for shareholders is that those making big bucks should also be the leaders in delivering big results.
Compensation for chief executives is on the rise. A recent Equilar report featuring commentary from Meridian Compensation Partners analyzed the various trends in CEO pay and how corporations construct pay packages. The study examined companies across the Equilar 500—a sample of the largest U.S. public companies by revenue.
“Not only has the value of compensation risen, but the rate at which it is increasing appears to be trending upward as well.” – Christopher Power, Senior Consultant at Meridian Compensation Partners
Despite Say on Pay having been put into practice in 2011, investors have passed large CEO compensation packages regularly. CEO pay also continues to rise. From 2017 to 2018, CEO pay increased 8%—a jump from the 5.6% increase between 2016 and 2017. This put median CEO compensation for 2018 at $12.1 million (Figure 1).
The U.S. economy is growing. It is expanding at a steady pace, making most firms able to grow profitably. Although it is a factor, CEOs are not earning more just because the economy is growing. Performance-based awards have taken a lead in CEO compensation packages. With performance-based awards, as a company performs better, investors receive better returns, and CEOs attain better pay. With better economic conditions, chief executives are enticed to take incentive payouts.
After the passing of the Tax Cuts and Jobs Act, in which the performance- based compensation expense under Section 162(m) of the Internal Revenue Code was eliminated, increases in base salary have been minor. Between 2014 and 2018, median base salary in the Equilar 500 only increased by $91,500 or an average of $22,880 per year (Figure 2). On the other hand, performance-based rewards have been on the rise.
Since 2018, 87.8% of Equilar 500 CEOs received performance-based awards. Although growth for this pay component has slowed, from a 16.8% jump from 2014 to 2016, to only 2.6% growth from 2016 to 2018, it still exceeded both time-based stock and option grants. Tesla’s Elon Musk was awarded a total pay package of almost $2.3 billion in 2018, which may be a reflection of shareholders valuing the long-term value creation that a CEO provides over how much they take home.
Overall, CEO compensation rose in every sector in 2018, except for consumer goods. For the fifth year in a row, the healthcare sector had the highest median pay at $16.3 million. In the utilities sector, 2018 saw the lowest median pay with $9.7 million. Consumer goods saw a 0.9% decrease in compensation with $9.9 million (Figure 3).
Moreover, because CEO pay is becoming more heavily reliant on performance rather than tenure, time-based incentives have overall lagged behind performance-based incentives in CEO compensation packages between 2014 and 2018 (Figure 4). This may also be a reflection on how shareholders prefer to see a CEO drive results and profit rather than perceived loyalty by staying with the company for several years.
Investors aim to align pay with performance over a longer horizon. CalPERS—the largest pension fund in the United States—announced earlier in 2019 that it would begin assessing the executive pay plans of the companies it invests in under a new custom five-year quantitative analysis that compares total CEO realizable pay and total stock performance relative to a company’s peers. The new framework, which utilizes a five-year time horizon, provides insight on how investors are evaluating pay for performance with a longer-term view and the potential impact on Say on Pay voting results.
According to Simiso Nzima, Investment Director of Global Equity at CalPERS, among the various compensation goals for CalPERS is to “ensure that the design and practice of compensation at portfolio companies appropriately incentivizes management and employees to generate long-term sustainable returns in alignment with the interests of long-term investors.”
Investors are also seeking more than just shareholder returns. In recent years, a greater emphasis has been placed on environmental, social and governance related risks. Investors now expect companies to mitigate any potential risks that may come from these factors, as well as meeting strategic corporate goals. Similarly, non-financial goals such as leadership development or diversity initiatives may also be at the forefront of shareholders’ minds. As a result, investors may push for a CEO compensation plan that encourages executives to drive success in accordance with these standards.
Due to an increasing prevalence in performance-based awards, the better a CEO can drive and achieve strategic goals, the more they can expect in compensation.
Apart from shareholder expectations, Christopher Power, Senior Consultant at Meridian Compensation Partners, sheds some light on the trends. Power explains, “The low unemployment levels in the U.S. are creating a seller’s market for talent, which has led to a steady increase in pay levels across most organizations, including the CEO role.” This means that because top talent is already in a good position, they can leverage a higher compensation program from other organizations hoping to snag a top performer, including CEOs. As a result, compensation committees are building pay packages that aim to retain their top talent and keep them motivated.
Power continues, asserting that as the U.S. and global economies continue to grow, CEOs will have an easier time meeting targets and therefore will receive larger and larger incentive payouts. And, the stakeholders are content with this. Power explains, “Companies have continued to craft their message about the pay ratio, so that all stakeholders are informed about the overall pay programs, rather than what the CEO receives in compensation.” As long as stakeholders are well aware of this, they will continue to suitably reward CEOs for performance.
Ultimately, it appears as though compensation for chief executives will continue to rise. Due to an increasing prevalence in performance-based awards, the better a CEO can drive and achieve strategic goals, the more they can expect in compensation. Although shareholders have been demanding more from CEOs, such as diversity initiatives and complying with environmental, social and governance principles, the growing U.S. and global economies have made profits easier to come by. In corporate governance, watching a CEO’s pay is a means for investors to ensure that the chief executive is acting in compliance with the corporation’s goals and parameters. Therefore, as long as CEOs are able to meet shareholder expectations, pay trends in the C-suite are expected to continue.
Daniella Gama-Diaz is Associate Editor of C-Suite.