May 2, 2016
Executives receive compensation in several forms, typically consisting of a base salary, an annual bonus, and long-term incentives (LTI)—the latter most often in the form of equity. Salaries and equity that vests over time are “fixed,” meaning the executive should realize the figure with continued company service, while annual bonuses and performance equity are “variable” or “at-risk,” meaning the total amount may vary based on meeting specified performance goals. Company stakeholders have progressively emphasized long-term incentives, claiming those awards drive growth in the long term and align the interests of executives and shareholders.
In a recent study of the S&P 500, Equilar examined performance periods for long-term incentive plans, and found that the most common period over which LTI performance is measured is three years—nearly 71% of all CEO performance awards fell into this range. However, both shorter and longer performance periods are not uncommon, and in fact, one-year performance periods were the second-most popular, defining 18.5% of all CEO performance awards.
Given that one year is considered “long-term” by a significant portion of the S&P 500, Equilar looked at these awards specifically to see how they have developed over time. Though subtle, some interesting trends in equity mix for LTI judged by performance in a single year have developed since the introduction of Say on Pay in 2011. First and foremost, the use of both options and stock in S&P 500 LTI with a single-year performance period declined significantly over the past two years. In 2013, options and stock combined to represent about 31% of LTI—a figure that fell to about 20% in 2015 (with stock accounting for most of that balance).
In the meantime, the decline of options and stock has been balanced by an increase in the use of stock units. Since the implementation of Say on Pay, the use of units among S&P 500 companies as the award vehicle for single-year performance periods increased from 69.9% in 2011 to 79.4% in 2015.
Post Say on Pay, scrutiny from shareholders and proxy advisors on both the amounts and components of LTI pay have propelled stock units higher as the compensation vehicle of choice. The declining use of options in response to Say on Pay has several origins, but is partially because some stakeholders believe options hold the weakest link to company performance, as executives may buy stock in the future at a discount. Options may also focus executives on the nearer-term, thus weakening their link to the creation of long-term shareholder value. The declining use of options and the rise of stock units has also been largely influenced by proxy advisor policies as companies align themselves with practices more likely to precipitate a strong Say on Pay result.
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For more information on Equilar’s research and data analysis, please contact Dan Marcec, Director of Content & Marketing Communications at email@example.com. Heather Kerr, research analyst, contributed to this post.