Competition in the executive labor market is intense.
Companies are commonly experiencing attrition at 50% to 100% above recent years,
while rapid escalation in new-hire packages for ongoing compensation and
buyouts of forfeited equity values is real-time and not yet fully reflected in
competitive pay data.
Making matters worse for established companies, the battle
is being fought on two fronts. They are competing against their direct peers on
the one hand and on the other hand against well-funded, developing and
growth-stage companies—including IPOs that are offering enticing upside
opportunities in a supportive equity market. Winning this war for executive
talent requires companies to understand the following trends in compensation.
Unvested equity is the primary retention vehicle used by
established public companies. This supports their rationale for granting a
large portion of long-term incentives in the form of restricted stock, and
making long-term incentive grants annually with overlapping, multi-year vesting
schedules. Companies often track these unvested amounts as “walk-away” values
and make supplemental grants when they are insufficient to provide a meaningful
There are valid reasons for granting restricted stock and
making annual long-term incentive grants with overlapping vesting related to
providing a tax-effective ownership interest, mitigating compensation-related
risk and rewarding the underlying growth in shareholder value reflected in the
underlying shares and dividend rights. But “golden handcuffs” are an
Common and accepted practice now is to buy out unvested
equity values in executive recruiting packages with make-whole payments and
grants that emulate the amounts, form and timing of whatever was forfeited from
the prior employer. Furthermore, this is not just for CEOs. There are many
examples of recent buyouts well into eight figures for CFOs and other proxy
officers, as well. The effect is that unvested equity no longer has real
employment-related risk for executives. They are likely to receive the value if
they stay employed in their current jobs and vest, or leave for new positions
and receive a make-whole.
Companies need to review their executive pay strategies for
competitive advantage in today’s market. The following are practical ideas to
consider alongside other human capital initiatives related to development,
training, engagement, selection, diversity, succession planning, etc.,
recognizing that pay is just one element of a broader set of considerations:
1. Structure effective packages for new hires and promotions.
Our experience suggests that companies often overpay outside hires to attract
the candidate, and underpay internal promotions because the increases are large
enough that it is not necessary to come all the way up to the market median. It
also is common to focus on the individual packages rather than on broader
internal pay relationships and equitability. All of this needs to be avoided.
For outside hires, three principles should be followed:
Set ongoing target pay at a level and mix
consistent with existing company practice for others to maintain internal
Buy out forfeited compensation with the
objective of making candidates no better or worse off than if they had stayed
with their prior employer (i.e., make them whole).
Provide additional one-time inducement only if
necessary to make the deal. For key roles, a general rule of thumb for
reasonability is 3–5x salary, or 1x regular annual long-term incentive grant
value for senior executive lateral moves. Where the position being offered is
at a higher level or in a bigger, more complex organization with higher ongoing
pay, this is often inducement enough.
For internal promotions, start with target annual incentive
and long-term grant values at or close to median, and leave room for growth in
salary. Here, the rule of thumb is that the promoted executive should be at
median overall in two to three years with satisfactory performance, recognizing
that upward market movement is likely in the interim.
2. Leverage long-term incentives to increase real pay
delivery for outperformance. A strong business strategy that provides
opportunity for compelling real, earned pay from equity is one of today’s keys
to attracting and retaining talent. This is apparent from the growing prevalence
of executives leaving secure, long-term employers for startups and IPOs. They
see the potential upside leverage as more than offsetting the potential
Companies need to review the structure of their long-term
incentives in response, especially where there is heavy reliance on restricted
stock and performance shares designed to regularly payout in the target range.
Such reviews should recognize that there are two ways to enhance potential pay
delivery for high performance without increasing the grant value. The first is
structuring performance shares with higher maximum payout opportunities than
the standard 200% of target shares, with steeper performance curves for
outperforming and underperforming against financial (i.e., non-market-based) metrics.
The second is setting high-risk goals for relative and/or absolute total
shareholder return (i.e., market-based) metrics. This shifts the GAAP valuation
of shares/units being granted from face value to Monte Carlo value. Under the
Monte Model, the higher the performance risk, the lower the grant value per
share and the more shares that can be granted and subsequently earned at a
multiple for above-target performance.
3. Use selective, performance-based special awards.
One-time special awards are made for various reasons including support for
critical strategic initiatives, recognition and retention of high performers
and new-hire inducement.
Below the proxy-officer level, primary considerations are
precedent, internal, equitability and cost. However, an additional
consideration for proxy officers is Say on Pay risk, recognizing that there is
required disclosure to an audience that includes large investment funds and the
proxy advisors who are generally opposed to rewards outside the “regular” program.
For example, Vanguard amended its voting policy with a negative provision on
special awards in 2019. BlackRock took similar action in 2021, warning of
increased scrutiny of special awards going forward.
Several recent Say on Pay failures have occurred in years
when CEOs and other proxy officers received special awards, although this was
not always the case. Meridian research shows that in addition to avoiding
excessive amounts and having significant vesting/earnout periods, successful
companies have used performance-based award structures designed to clearly
deliver on-top pay for on-top performance.
The disclosed rationale is also
important and should go beyond simple retention because the commonality of
buyouts is well understood.
4. Differentiate high-performing businesses and
individuals. The bias seems to be toward treating everyone the same,
especially proxy officers, among whom differences are disclosed to be seen
publicly and interpreted. This underscores the importance of designing pay
structures to provide and encourage differentiation.
An example of a simple and effective provision for companies
that have typical 0%–200% of target annual incentive funding is to allow
individual awards for outstanding performers up to 250% of target within the
funded pool. Another is for companies that use executive salary ranges to raise
the maximums for high performers who do not have immediate or foreseeable
advancement potential. It is also increasingly common to recognize business
and/or individual performance in annual long-term incentive grant values.
Nuance in compensation program design and
messaging should not be overlooked.
5. Refine peer groups. Where executive talent-market
competition extends to growth companies and successful recent IPOs, these
companies should be in the peer groups, if not to directly benchmark executive
pay levels, then at least to know their pay practices. For example, it is
common sense that established financial services companies should be looking at
fintech, and Big Pharma should be looking at drug discovery companies. The fact
that there may be exceptions to the standard revenue-size and market-cap
thresholds in peer-group selection criteria should not be the determining
6. Put teeth in restrictive covenants. Finally, there
is an important set of considerations unrelated to direct pay. Current
hypercompetitive labor markets warrant a review of post-employment restrictive
covenants. For executives who leave voluntarily without “cause” or for “good reason,” this should include the use of
noncompete provisions in states where enforceable, as well as confidentiality,
nonsolicitation and mutual nondisparagement provisions.
Executives who qualify
for retirement under equity grants that accelerate or continue vesting should
be included as well. Business strategy and corporate culture are undoubtedly the
key factors in successfully competing for executive talent. Meanwhile,
compensation is a major support element, especially for retaining and
recruiting high performers when market demand is strong. Nuance in compensation
program design and messaging should not be overlooked.
1 See Meridian publication by Donald Kalfen and
George Paulin, “Special Awards to Senior Executives” at meridiancp.com/insights/perspectives-on-one-time-special-executive-awards.