Comp Committees appear to have gotten the message when it comes to executive pay for performance. As discussed in this article in the WSJ, executive compensation “is increasingly linked to performance,” but investors are now asking whether the bar for performance targets is set too low to be effective. Are companies just paying lip service to the concept?
The WSJ analysis showed that median pay for CEOs of companies in the S&P 500 reached “a post-recession high,” and that about 60% of that pay was derived from equity awards, “most of which [were] tied to performance targets.” While performance bonuses are familiar elements of pay, tying equity awards to performance metrics—such as EPS, operating profit, total shareholder return or specific operating goals—is a relatively recent phenomenon.
But has the prevalence of performance metrics had the effect (whether or not intended) of lifting executive compensation? According to the article, based on ISS data, for about two-thirds of CEOs of companies in the S&P 500, overall pay “over the past three years proved higher than initial targets….That is typically because performance triggers raised the number of shares CEOs received, or stock gains lifted the value of the original grant. On average, compensation was 16% higher than the target.” In addition, for 2016, about half of the CEOs of the S&P 500 received cash incentives above the performance target payout levels, averaging 46% higher, while only 150 of these companies were paid bonuses below target. Examples cited in the article included using the same earnings growth target year after year—notwithstanding forecasts from analysts suggesting much higher earnings growth—paving the way for executives to consistently exceed the target and earn the maximum, and making up the difference with other components of compensation when one component of pay fell short because targets were not met.
And sometimes, the WSJ contends, pay may be exceeding performance targets because those targets are set at levels that are, shall we say, not exactly challenging. According to the head of analytics at ISS, in some cases, “’the company is setting goals they think the CEO is going to clear….It’s a tip-off to investors.’” The article reports that, based on a 2016 analysis, ISS concluded that about 186 of the Fortune 500 expected that the equity awards granted to their CEOs would pay out above target, 122 at target and 150 below target.
The head of corporate governance for a major institutional investor expressed his concern that, sometimes, the bar is set “too low, allowing CEOs to earn ‘premium payouts in the absence of compelling performance relative to the market.’’’ In selecting metrics and setting targets, comp committees “must juggle a range of factors,” taking into account the preferences of investors and proxy advisers, as well as the recommendations of consultants.’’ However, he said, “‘[i]t has to be the right measure and the right achievement level.”’