Three Trends Shaping the Future of CEO Pay

July 21, 2021

Dan Marcec

2020 may have been an anomaly, but its effects will long outlast the COVID-19 pandemic. Companies now must consider CEO pay not only in relation to the bottom line but also in context with their responsibility to employees and shareholders. These sentiments have been simmering for years but finally bubbled over amidst the events of the past 18 months. 

Caroline Montalbano, a Senior Consultant with Meridian Compensation Partners, and Christina Maguire, Managing Director, Governance Policy and Operations for BNY Mellon, joined Equilar for a recent webinar to discuss the state of CEO pay at the dawn of this new era. Accelerated or altered by COVID-19, critical issues related to compensation planning are collectively shaping a new landscape for CEO pay. This article summarizes three key trends highlighted in that discussion.

Trend #1: The Increased Emphasis on ESG

The challenges with incentivizing ESG outcomes, in contrast to financial goals, are not only that environmental and social initiatives are more difficult to measure and track, but also that they vary widely from organization to organization. Total shareholder return or return on capital invested are straightforward to understand and to measure, and they are widely applicable to almost every company. As ESG has emerged in the CEO pay conversation, boards are focused on working to solidify company priorities and identifying key objectives so they can align pay programs to those commitments.

“We’re focused on guiding that conversation to help companies understand what is most relevant to the commitments they’ve made,” said Montalbano. “We don’t want to see companies pressured into a compensation design without being able to accurately and confidently track it over time.”

Right now, Montalbano said, the most common metrics are focused on the social pillar within ESG, while environmental metrics are mostly confined to capital-intensive industries. A recent Meridian study of 266 S&P 500 companies found that 58% included some sort of ESG metrics in their short-term incentive plan, in comparison to about 5% in the long-term incentive plan. Over time, as companies’ processes mature and their vision for long-term ESG strategy solidifies, they’ll gain more confidence in measuring progress toward those commitments. At that point, weightings in the short-term plans may shift upward, and companies will likely include ESG metrics in long-term incentive plans more commonly as well.

Maguire noted that investors are pushing for ESG commitment and action, but recognize and support the idea that alignment with CEO pay is really about the holistic view of compensation as a driver of the organization.

“We’re not asking for enormous change, we’re asking for an evolution in how you think about both the short term and long term for your employees,” she said. “Compensation plans that are really well thought out are less focused solely on performance metrics like EPS but also on things that are really by and large about your talent pool—like employee turnover, health and safety, or change management.”

Trend #2: The Legacy of COVID-19

One key point hasn’t been emphasized enough outside of the executive compensation world in the broader conversation around CEO pay trends from 2020. At the point the pandemic hit and started to massively affect business operations in the U.S., the first quarter was almost over, and most executive compensation plans had already been established. Committees had approved short-term incentive targets for the 2020 performance year, and most often, annual equity awards had already been delivered to executives.

“By the time we were able to really get a sense of what was coming our way as it relates to the pandemic, companies shifted into response or reaction mode,” said Montalbano.

For most, that resulted in a “wait and see” approach, which worked out well as the economy—on the whole—was resilient. By the end of the year, compensation committees were able to rely on their ability to use discretion to determine a payout that made the most sense for their organization, holistically considering the performance of the company, the impact to the workforce during the year, the impact to the shareholders during the year, and use those inputs to arrive at an outcome. On the whole, this resulted in a slight drop in annual bonus payouts, as the recent Equilar CEO Pay Trends report showed.

The question now is whether the 2020 approach would apply to a future unexpected event. Going forward, many companies will have to reevaluate their strategic goals, but the expectations from stakeholders remain the same. Sophisticated boards who are attuned to aligning key objectives as clearly articulated and measurable parts of the compensation plan will continue to see success.

“We talked to companies in the fall of 2020 about our hope and desire that they were not interested in winning the cost-cutting pandemic race, but actually in winning the recovery post-pandemic,” said Maguire. “That is far and away more valuable to our clients and our portfolios than anything else.”

Trend #3: Shareholder Engagement Is More Important Than Ever

When changes to CEO pay plans do occur, one of the biggest pitfalls companies and boards face is a lack of, or poor, communication to their stakeholders. That starts with investors. In today’s governance landscape, relating changes in a manner that makes sense is a three-step process, said Maguire.

“Engage with your shareholders, aggregate that information, and respond to it,” she advised. “There is an assumption that you can’t be all things to all people, but you can be most things to most people.”

After aggregating that feedback, it’s important to close the loop through proxy disclosures. 

“The one place it shouldn’t show up is in a footnote,” Maguire added.

Montalbano agreed. She said the companies doing shareholder engagement well are communicating the impact of 2020 on their business and the link to pay decisions they’ve made.

“The uncertainty didn’t go away at the beginning of the year,” Montalbano said. “We have seen companies take steps to adjust their 2021 compensation programs and put in proactive disclosures this year.”

In the final analysis, companies should always consider how they’re performing relative to peers and their sector, both in compensation planning and evaluating outcomes. This will pay dividends in the short term and long term if there are strategy changes reflective of a new methodology or structure.

“The beautiful thing about indexed investors is that we’re in a divorceless marriage,” Maguire added. “We’re not going away, and we have the patience to watch you shift your strategy and see the positive results of that.”

Contact

Dan Marcec

Senior Editor at Equilar

Dan Marcec, Senior Editor at Equilar, authored this post. Please contact Amit Batish, Director, Content & Communications, at abatish@equilar.com for more information on Equilar research and data analysis.