Performance-related boost to CEO pay


CEO pay in the U.S. has continued to rise on the back of strong corporate results and shareholder returns, with performance-related elements making up a growing proportion of total remuneration.

Total direct compensation (salary, bonus and long-term incentives) rose 8.9 per cent in the past year, according to the Mercer Human Resource Consulting 2006 CEO Compensation Survey, taking the median a median remuneration for a CEO to $8.2 million.

The survey, based on the latest proxy filings of 350 large public companies, found that corporate net income increased by 14.4 per cent over the same period, up from 13 per cent in 2005, and total shareholder return was 15.1 per cent, more than double the 6.8 per cent return in 2005.

Meanwhile, the drive for responsible executive pay and new proxy rules mean that companies have been forced to disclose the value of compensation, benefits and perquisites.

What this has shown is that performance-based incentives now make up some 15 per cent of total compensation, with over half of the CEOs receiving performance shares in 2006 while the numbers receiving stock option that are not linked to performance declined slightly.

CEO base salary increased to a median $995,000 after having been at $975,000 for two years while total cash compensation - salary and annual bonus - rose to $2.6 million, slightly higher than the $2.4 million reported in 2005.

Yet similar restraint was not so evident in the sums awarded to CEOs in their pension plans. Here, the reported median increase was approximately $1.0 million.

"We have been predicting the rise of performance-based equity awards for several years," said Diane Doubleday, global leader of Mercer's executive remuneration business.

"At the heart of shareholders' expectations for pay aligned with performance is the structure of long-term equity programs, specifically programs that vest or pay out based on performance.

As of 2006, the accounting rules that facilitate using performance-based equity were in effect for almost all companies. As a result, we now see a significant increase in performance shares and performance-contingent restricted stock.

"In addition, the new disclosure rules include previously unknown information about performance goals and targets," she added.

But as Mercer's Peter Chingos pointed out, an increase in performance-related payments is not necessarily in itself a major step forward unless the performance targets are suitably transparent and onerous.

"Target-setting will be the next area of focus, as companies are forced to define how performance is being measured and rewarded," he said.

"The increased disclosure and need for analysis is also likely to cause many companies to simplify their programs. The process of preparing the Compensation Discussion and Analysis (CD&A) caused some companies to make changes and will probably prompt more to simplify and clarify the performance criteria in their compensation programs."

In the UK, analysis of similar performance-related incentives has revealed that CEOs still receive payouts even when they fail to perform.

In 2003, the average UK FTSE corporation began to pay their directors performance-related incentives even when they delivered just one third of the profits growth the markets expected.

Moreover, market historian David Schwartz found in 2004 that there was actually an inverse relationship between pay and profitability in UK public companies– the more the boss got paid, the worse the company tended to perform.

Little wonder, then, that the Mercer report argues that U.S. investors continue to be unhappy with what they perceive as slow progress on reining in CEO pay.

Several institutional investors have focused their efforts on having a greater influence on compensation. This year there are more than 60 proposals for a "say on pay" - a proposal to put executive compensation to a non-binding vote by shareholders.

In addition, shareholders have put forward more specific proposals to limit severance and require pay to be more tightly linked to performance.

And many also believe that – just as in the UK – pay disclosures are now so lengthy and confusing that shareholders' objectives have not been achieved, leading Mercer to predict that further refinement of the disclosure rules will take place before next year's proxy season.