Executives are compensated strategically to encourage them to drive results. The majority of executive pay is typically linked to performance measures as a way of aligning executive and company incentives. Therefore, if a company does not meet the goals and expectations set by the board and executive teams, the executives receive a smaller portion of their potential pay. If a company performs better than anticipated, executives may also receive a payout exceeding the target level set by the company.
With so many moving parts, pay packages should be tailored to the individual executive, position and company. Therefore, it is important to understand how the different components of an executive pay package interact and affect overall compensation. Compensation packages for executives are generally split between cash components and equity, which includes stock, units and options. Executive pay is often structured in a way that rewards both individual and company performance, in order to encourage executives to create shareholder value.
The summary compensation table (SCT) is a table disclosed in the executive compensation portion of a company’s proxy statement. Regulated and required by the Securities and Exchange Commission (SEC), it shows the breakdown of the total compensation for each named executive officer (NEO) at the company, who are typically the five highest-paid employees at a given company. The table includes base salary, bonus, stock and option awards valued in full on the date they were granted, non-equity incentive plan compensation (i.e. plan-based cash bonus), pension and deferred earnings, and all other compensation, which includes the value of perquisites and benefits. The SCT is a critical reference point for shareholders to examine when determining how to vote on company Say on Pay proposals.
Realized pay is the total pay an executive actually receives during a full fiscal year. Realized pay comprises base salary, bonuses, any stock or options that vested only during the fiscal year, and the value of “all other compensation.”
According to the Center On Executive Compensation, realized pay is the best way to gauge pay and performance. However, it is not easily calculated to compare with other companies, so it is difficult for companies and shareholders alike to assess what peer companies are paying their executives without in-depth research resources.
Realizable pay is an aggregate approach to total compensation over a period of time. It is made up of future vesting stock and options as well as base salary and bonuses. Realizable pay may be calculated using information found in a company’s proxy statement, and therefore companies are able to measure the realizable pay of peers in a more straightforward manner than realized pay, thus making it a good barometer for pay for performance. Though it is easily calculated, realizable pay may not disclose the correct pay amount because of its use of future payouts and not what is actually received.
Cash: The cash component of executive compensation is normally stated as an annual base salary and bonus. The salary for the Chief Executive Officer (CEO) of a company may depend on several factors, including company size, industry, tenure and experience. Base salaries are guaranteed to an executive, as it is not tied to performance objectives.
Stock: Stock refers to shares of a company that are awarded to an employee. Shares can be granted without restrictions, with time-based restrictions, or with performance-based restrictions, in which specific performance metrics and goals are met. Performance includes metrics such as financial goals, like increasing Total Shareholder Return (TSR) for investors. Other metrics include company performance, such as increasing market share, or individual performance.
Units: Units are essentially a promise for executives to receive stock, or the equivalent value in cash, after the end of either a performance period or a time vesting schedule. By granting units instead of stock directly, companies can minimize the administrative costs of granting actual shares. Sometimes, executives can decide whether to exchange their units either for company shares or their equivalent cash value.
Options: A stock option, or simply option, gives an employee the right to purchase a share of company stock at a pre-determined price for a certain period of time. The pre-determined price at which the options may be purchased, commonly called the exercise or strike price, is generally the price of the company’s stock on the date the options are granted. Therefore, if the company performs well, the stock price will increase over the exercise price, giving the options value. For an executive, this is a reward for their role in the company’s success. Usually, options cannot be exercised for some time, giving executives another incentive to stay longer at a company.
An annual incentive plan (AIP) is a short-term, yearly bonus plan designed to provide incentives to an employee of a company. Generally connected to performance measurements and granted in cash, an AIP has a target payout and usually can be increased or decreased depending on whether or not the performance conditions are met within the specific fiscal year. A long-term incentive plan (LTIP) is a multi-year incentive plan created with the dual purpose of incentivizing employee retention and to reward performance, most often awarded in equity compensation (i.e. stock or options). Similar to an AIP, LTIPs are awarded with a target value, and payouts may be higher or lower depending on how the individual performs in relation to the target goals.
Pay for performance in connection with executive compensation is the philosophy that pay should be tied to one or more performance metrics pertaining to the company. This practice provides incentives for an executive to perform at the highest levels in order to receive payment. There are many different measures used by companies to weigh an executive’s performance, though the most popular in the United States is total shareholder return.
Since the implementation of Say on Pay in 2011 as part of the Dodd-Frank act, investors have called on their portfolio companies to provide evidence of a more direct link between pay and performance, as opposed to providing compensation based solely on tenure and service. This mandatory, though non-binding, shareholder advisory vote on executive compensation has opened up dialogue between boards and shareholders on ways to better align company strategy and performance with creating shareholder value.
In 2022, the SEC finalized Pay Versus Performance rules requiring companies to disclose information about the relationship between executive compensation actually paid to top executives and the financial performance of the company. The requirements include a table in which companies must disclose 5 years of pay information for the CEO and all other NEOs, along with 5 years of performance information. All companies subject to the requirements must include TSR and Net Income performance information, along with at least one additional company-selected metric, determined by the company to be the metric that most directly impacts executive compensation. The rules serve to standardize the pay for performance alignment information many companies were already disclosing, further underlining the importance of the pay for performance philosophy in corporate governance.
Total shareholder return (TSR) is the total return of a stock to an investor in a specific company. It is the internal rate of return of all cash flows to an investor during the holding period of a specific investment. Essentially a measure of the company’s value, TSR is used as a key metric for performance objectives in an executive compensation. Because it is easily measured and compared to peer group companies, TSR provides the ability to gauge compensation comparatively to competitors and is seen as the best indicator of pay for performance comparisons between companies. TSR is also one of the required performance metrics companies must disclose under SEC Pay Versus Performance rules, along with net income.
Executive Retention: Companies that undergo frequent transitions on the executive team may struggle, as many shake-ups may lead to a loss in a central idea or strategy. Therefore, a main goal of executive compensation is to promote executive retention in order to ensure consistency in leadership and, subsequently, philosophies and goals. Executive compensation is a balance. It must be rewarding enough to attract and retain top talent, but must be reasonable enough that shareholders do not have an issue with the amount. For this reason, directors form Compensation Committees to oversee the organization’s executive compensation.
Long-Term Incentives: Executive compensation must properly set short- and long-term incentives which reward executives for the achievement of company strategic objectives that will maximize shareholder value. Generally, long-term incentive periods run between three and five years, with the executive not receiving any pay from the incentive component until the end of the performance period.
Pay for Performance: The concept of aligning executive compensation with company performance. Most executive pay packages are crafted so that the majority of the executive’s compensation is dependent on the company achieving specific financial goals and/or strategic objectives with previously defined metrics. If a company fails to meet the financial or strategic goals, the executive would not receive the part of their compensation that was dependent on meeting those criteria. Therefore, their compensation would be less than anticipated. On the other hand, if the company exceeds the objectives, the executive may receive higher compensation. In general, if pay and performance are not aligned at a company (i.e. pay is on the rise and performance is on the decline), then the company may come under scrutiny from its shareholders.
Report of material events (e.g. a new NEO or director, voting results, acquisition, bankruptcy).10K
The annual statement of the Company, released at the end of the year. The 10-K looks backwards and serves as a summary of financial performance in the previous year.
An alternative approach to pay out an annual bonus—discretionary bonus is a ‘one-time’ bonus that falls outside an annual pay cycle. Annual bonuses are planned out by the compensation committee, with specific metrics in which the executives will be evaluated. Typically, bonus targets are measured as a percentage of an executive’s base salary.
An option valuation equation. Accounts for volatility, underlying stock price, expected life, strike price, risk-free interest rate and dividends.Black-Scholes FAS 123(R)
Financial Accounting Standard Board’s recommended model for option valuation using the Black-Scholes Methodology.Board of Directors
Top governing group of a company. The Board of Directors does not manage daily operations but represents shareholders’ interests, votes on key issues and offers strategic guidelines.Bond Yield
The amount of return an investor realizes on a bond.Burn Rate/Run Rate
Measures how quickly a startup is ‘burning’ through issuable shares approved by investors, allowing companies and shareholders to know how long before the company needs to request more shares to be approved.
An SEC-required disclosure of the ratio between the company’s annual compensation to the CEO and to its median full-time employee. Under the SEC rule, pay may be determined any way that reasonably reflects the annual compensation of employees, but must be consistently applied for the purposes of comparison, and is referred to as the CACM, or Consistently Applied Compensation Measure.Compensation, Discussion & Analysis (CD&A)
An SEC-required section of a company’s annual proxy statement. In this section, a company lays out their compensation philosophy, and explains to shareholders why they decided to structure their compensation plans in a certain way.Cliff Vesting
Vesting schedule in which entire award vests at one time.Compensation Benchmarking
The process of comparing a Company’s pay practices to peer companies, the purpose of which is to set pay levels at competitive rates. This process strikes a balance between retaining and attracting the best talent available while making sure that shareholders do not view pay packages as excessive.Compensation Consultant
Experts in the design and implementation of compensation plans, with the goal of creating the proper incentives for employee behavior. Compensation consultants also advise companies on trends in the area of compensation and on the current rates of pay for given job categories. Consultants often use Equilar’s compensation data to make their recommendations. The key difference between a compensation consultant and Equilar is that Equilar is data agnostic and does not make recommendations to issuers.Corporate Issuers
Companies that issue stock that trades on an exchange.
Annual filing filed with SEC containing corporate strategy and forward-looking information. The Compensation, Discussion & Analysis outlines the decision-making process and justification for executive compensation programs. The Summary Compensation Table outlines the pay of the Top 5 executives in detail.Dilution
The process of issuing more shares that reduce the voting power of shares already outstanding.Dividend
Giving a portion of a company’s earnings back to shareholders—typically cash payment, can be reinvested into position.Dow Jones Industrial Average (DJIA)
Dow Jones Industrial Average. Tracks 30 large ‘blue-chip’ companies in the NASDAQ or NYSE.
Electronic Data Gathering Assessment/Analytics & Retrieval – the SEC’s public database.Equilar Market Peers
Equilar’s algorithmic Peer Group Generator based on the strength of connections in proxy disclosed peer groups. Equilar’s Market Peer methodology is used to create a 15-company peer group used by investors to evaluate pay and performance.Equilar TrueView (ETV)
A blend of both proxy data and survey data. Proxy data only covers NEOs. Survey data covers the Top 25 highest-paid employees. Combining both data sets provides a more accurate picture of the compensation landscape.Executive Compensation
The financial compensation and other non-financial awards (e.g. perquisites) received by an executive for his/her service to the organization. Typical components of an executive pay package include cash salary, bonuses or annual short-term incentives paid in cash, long-term incentives in the form of cash or restricted stock/units, restricted stock/units or option awards with time-based vesting provisions, and the value of benefits and perquisites. In most cases, the majority of executive pay is linked to company performance measures as a way of aligning executive and company incentives.
Insider trade reports. Any board member, officer of the Company or shareholder owning 10% or more of the company must disclose a Form 4 when they buy or sell stock. These transactions are made public to avoid insider trading issues.
Vesting schedule in which award incrementally vests over the term of an award.Grant
An incentive award given to an executive as compensation. The grant can be paid out in cash or equity (stock, options).Grant Date Fair Value
The value of the award at grant date (on the day it is awarded). Awards typically vest after the grant date, so an executive may have shares granted that he/she cannot actually buy or sell until they vest.
Incentive plans (could be cash, stock, options) tied to multi-year job performance that is evaluated using predetermined metrics. The typical length of a long-term award cycle from grant date to vesting is three to five years. Long-term incentives are traditionally considered a retention vehicle for executives since they require the executive to remain in place and performing for their full award to become vested.
An interest-bearing account at a bank or credit union—not to be confused with a money market mutual fund.
CEO, CFO and the next three highest-paid executives, as disclosed in the Company’s proxy. Typically referred to as the Top 5.Nasdaq Composite
Stock market index of the common stocks and similar securities listed on the NASDAQ stock exchange. Along with the Dow Jones Average and S&P 500, it is one of the three most followed indices in U.S. stock markets.New York Stock Exchange (NYSE)
The world's largest stock exchange by market capitalization of its listed companies at $25 trillion as of 2020.
An option giving the holder, usually an officer or employee, the right to buy stock of the issuing corporation at a certain price within a certain period.
Pay for performance in executive compensation is the philosophy that pay is or should be tied to one or more company performance metrics. This practice provides incentives for an executive to perform against pre-determined goals in order to receive a full payout under the compensation program. In a pay for performance assessment, both compensation and performance can be defined in various ways.
Pay for performance is an important factor in Say on Pay voting determinations by investment funds, and in Say on Pay recommendations issued by proxy advisory firms. For this reason, company proxy statements often include a discussion of pay for performance alignment in the CD&A section or related compensation disclosure.Pay Versus Performance (SEC)
In 2022, the SEC adopted Pay Versus Performance rules requiring U.S. public companies to disclose a new table and supporting narrative, providing information about the relationship between company financial performance and compensation to the CEO and other Named Executive Officers (NEOs).
The required pay component is referred to by the SEC as Compensation Actually Paid, and is based on modifications to the compensation figures reported in the SCT, including requiring the fair value of equity awards granted be annually updated until vesting, and deduction of change in actuarial present value of all defined benefit and actuarial pension plans, and addition of service cost plus prior service costs.
The performance component includes multiple metrics for which performance must be disclosed. The SEC requires the inclusion of TSR and net income for all companies subject to the rule, plus one or more performance metrics determined by the company to be the most important they use to tie pay to company outcomes (Company-Selected Measure).
The rules require that 5 years of compensation and performance history be included in the new table, Companies are also required to explain the relationship between their total shareholder return (TSR) performance and the TSR performance of a chosen peer group on a market cap-weighted basis.Peer Group
A group of comparator companies used for various forms of benchmarking, including compensation, TSR, financial metrics, etc.Proxy Advisory Firm
Provides analysis and voting guidance to shareholders. Major proxy advisors include ISS and Glass Lewis. Shareholders find value in their services as they calculate pay for performance and compensation alignment to inform their proxy voting and engagement processes.
Realizable pay is an aggregate approach to total compensation over a period of time. It is made up of future vesting stock and options as well as base salary and bonuses. Realizable pay may be calculated using information found in a company’s proxy statement, and therefore companies are able to measure the realizable pay of peers in a more straightforward manner than realized pay.
Realized pay is the total pay an executive actually receives during a full fiscal year. Realized pay comprises base salary, bonuses, any stock or options that vested only during the fiscal year, and the value of “all other compensation.”Relative TSR
Total Shareholder Return calculated on a relative basis to a peer group. Another common performance metric.Russell 3000
An index that tracks the performance of the 3,000 largest-traded U.S. stocks which represent about 98% of all U.S-incorporated equity securities (on a market cap share basis).
Advisory voting practice allowing shareholders to express opinion on pay packages granted to executives. Say on Pay originated as a result of the post-2008 Financial Crisis Dodd-Frank bill. The results are non-binding, so the Company is not required to follow the recommendation.SEC Filings
A financial statement or other formal document submitted to the U.S. Securities and Exchange Commission (SEC). Public companies, certain insiders and broker-dealers are required to make regular SEC filings. Investors and financial professionals rely on these filings for information about companies they are evaluating for investment purposes. Many, but not all, SEC filings are available online through the SEC’s EDGAR database.Section 16 Officer
Anyone who owns 10% or more of a company, or is considered a director or officer of the issuer.Stock
An ownership stake in a publicly-traded companySurvey Data Multipler
Companies (including Equilar) survey companies for information on total compensation of their Top 25 paid executives, resulting in anonymized findings to comply with DOJ regulations.S&P 500
The Standard & Poor’s 500, often abbreviated as the S&P 500, is an American stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ.
Total Shareholder Return calculated on a relative basis to a peer group. Another common performance metric.
The time at which an executive takes ownership of the award/grant. Typically an executive is granted equity that vests over several years, so he/she receives the value of the equity award in increments.
The highest-ranking person in a company or other institution, ultimately responsible for making managerial decisions.Chief Financial Officer (CFO)
A senior executive with responsibility for the financial affairs of a corporation.Chief Human Resources Officer (CHRO)/Chief People Officer
A corporate officer who oversees all aspects of human resource management and industrial relations policies, practices and operations for an organization. CHROs may also be involved in board member selection and orientation, executive compensation, and succession planning.Compensation Analyst
Compensation analysts use metrics and models to understand current compensation trends and predict future trends. They also prepare data for compensation leaders and ultimately the compensation committee.Compensation Committee
The Committee consisting of “Independent” Directors is appointed by the Board of Directors and is responsible to the Board (and ultimately to the shareholders) for determining and approving the executive compensation package.Compensation Consultant
Experts in the design and implementation of compensation plans, with the goal of creating the proper incentives for employee behavior. They also advise companies on trends in the area of compensation and on the current rates of pay for given job categories. Consultants often use Equilar’s compensation data to make their recommendations. The key difference between a compensation consultant and Equilar is that Equilar is data agnostic and doesn’t make recommendations to issuers.Compensation Manager
Plans, develops and implements new and revised compensation programs, policies and procedures to be responsive to the company’s goals and competitive practices.
The General Counsel/chief legal officer is an expert and leader who helps the company minimize its legal risks by advising the company’s other officers and board members on any major legal and regulatory issues the company confronts, such as litigation risks.
Primarily responsible for developing and analyzing various employee stock plans for their organization.
A vice president responsible for human resource information systems or human resource management systems (HRMS). The role serves as an intersection of human resources and information technology through HR software. This allows HR activities and processes to occur electronically.