Knowledge Center Reports

2014 COO Pay Strategies

November 9, 2014

Chief operating officers (COOs) fill the essential role of managing the company’s day-to-day operations while also communicating critical information to chief executive officers (CEOs). While there is no singularly agreed-upon description of what this role entails across various company types, the effectiveness of a COO is nonetheless vital to the fortunes of many firms. Whether job functions include oversight of production, marketing and sales, or research and development, the necessity to incentivize and compensate the COO appropriately is paramount. For many of the same reasons that CEO pay experienced significant growth from 2009 to 2013, COO compensation also grew robustly over this period. These reasons included broader macroeconomic improvements, a strengthening stock market, increasing levels of responsibility, and more fundamental changes to compensation design. This final explanation is particularly significant as performance-based awards took on a larger role as companies tried to generate more alignment between executive compensation and company performance in the wake of Say on Pay. The following article examines how America’s most influential companies motivate and reward their ranking operations executives.

Key Findings

1. Median compensation in 2013:

   • S&P 500: $4.4 Million (+8.6% YOY)

   • S&P 1500: $2.4 Million (+11.5% YOY)

2. Performance-based awards become more prevalent each year. The share of S&P 1500 companies granting performance awards rose from 37.6% in 2009 to 63.4% in 2013, and the share of S&P 500 companies granting performance awards rose from 45.6% in 2009 to 74.3% in 2013.

3. Equity vehicle mix differs in each index. While the most common equity vehicle mix is a combination of restricted stock and performance stock in the S&P 1500, the most common mix in the S&P 500 is a combination of options, restricted stock, and performance stock.

Executive Summary

COO compensation demonstrated significant growth in 2013 that was on par with the year-over-year growth rate observed by CEOs. The median S&P 500 compensation increased from $4.1 million in 2012 to $4.4 million in 2013. Similarly, the median S&P 1500 compensation increased from $2.2 million in 2012 to $2.4 million in 2013. In the S&P 1500, companies in the basic materials sector had the highest median total compensation at $3.2 million, while companies in the financial sector had the lowest median total compensation at $2.1 million.

Much of the growth in COO compensation can be attributed to the increasing value in both time-vesting and performance-vesting stock awards. Median S&P 1500 stock compensation rose from $769,362 in 2012 to $885,930 in 2013, a 15.1% increase. The increase was even more pronounced within the S&P 500, where stock compensation rose 22.1% from $1,444,635 to $1,764,001. Since 2009, the prevalence of both time-based and performance-based stock awards granted to COOs has been rising steadily, while the number of options granted to COOs has been decreasing.

Methodology

The COOs included in this analysis include all who served in such a position at the end of their company’s applicable fiscal year and for the full preceding year. The period chosen for the majority of graphs and statistics is five years, which encapsulates many of the major developments in executive compensation that were brought on as a result of the financial crisis. The conglomerates sector has been excluded from graphs displaying sector information due the small sample of companies; however, these companies and their COOs were included in all index-level statistics. Though the graphics provided herein display a wide range of statistical information pertaining to COO compensation, they are only a small sampling of available information, and customized data sets are also available for purchase.

Total Compensation

The last year witnessed a growth in COO compensation slightly greater than that observed in recent years, a trend that held across S&P 500, S&P MidCap 400, and S&P SmallCap 600 companies, as shown below. The growth in COO compensation was commensurate with exceedingly strong stock market performance throughout 2012 and particularly in 2013.

• Median compensation among S&P 500 COOs grew 8.6% in 2013, on pace with the 9.5% year-over-year growth mong the index’s CEOs.

• While mid-cap COO compensation experienced a slight decrease at the median in 2012, total compensation was still up 34.0% from 2009 levels.

• COOs of small-cap companies experienced the highest growth of median compensation among the three indices over the last year as well as over the entire five-year period at 15.3% and 42.9%, respectively.

While there seems to be a general consensus that COOs are most prevalent in operations-intensive businesses, the role appears across a wide range of company types, yet every sector also features companies without them. Even the same organizations may sometimes operate with a COO and sometimes without one, as there were numerous cases of companies either adding or eliminating the position from the C-suite between 2009 and 2013. Nonetheless, industry does matter in executive compensation, with some industries simply paying more for COOs than others. Over time, industries often move in and out of leading pay positions relative to other industries, resulting from shifts in macroeconomic conditions, talent and capital migrations, and regulation.

• The operation-intensive basic materials sector had the highest compensation at each of the 25th, median, and 75th percentiles among all sectors.

• In contrast, the financial sector had the lowest median compensation at both the 25th percentile and the median.

Pay Components

The graphs below illustrate the degree to which COO compensation trends over the last five years have been driven by stock awards. Median salary has increased 8.0% over the last two years, while median performance stock awards have increased significantly. Median stock awards have grown due to the increase in performance-based stock compensation. The graphs below show the median value for each pay type, with 2013 values labeled.

• From 2009 to 2013, the median value of performance-based stock compensation in the S&P 1500 increased 42.4% from $453,120 to $645,402, while bonuses increased 35.1% and the median salary value increased just 7.9%.

• Options were the only component that diminished, with the median value falling to $0 in both 2012 and 2013 as more companies moved away from granting the equity vehicle.

In the S&P 500, the same trends play out at higher values, where stock awards tend to play a larger role in compensation packages. Despite declining prevalence among companies in recent years, options still tend to be a more frequently awarded vehicle among S&P 500 companies when compared to the entire S&P 1500.

• In the S&P 500, median performance-based stock compensation increased 13.1% from 2012 to 2013, which was less than 52.0% of the growth the pay component experienced among CEOs.

• The median option award was $340,848 in 2013 despite a 52.4% decrease from 2009 values.

For many reasons, economic sectors differ in how they decide upon various compensation vehicles for their named executives. The following graphs break down COO compensation according to component sectors by the main elements of pay—salary, cash bonus, and equity (as well as ‘other,’ which includes deferred compensation, benefits and perquisites).

• Equity represented over half of the compensation for COOs in terms of average pay mix across the basic materials, healthcare, and technology sectors in the S&P 1500.

• Cash bonuses in the technology sector were the lowest percentages of pay across both indices.

• The only S&P 500 sector in which base salary exceeded 20.0% of the average pay mix was utilities.

• The sector with the highest average pay mix for options was healthcare in both the S&P 1500 and the S&P 500 at 18.3% and 24.3%, respectively.

• The S&P 500 financial sector was the only sector in which the cash bonus exceeded 30.0% of the average pay mix.

Performance Equity and Equity Mix

More companies have incorporated performance equity awards into their compensation programs within the last five years. Larger companies tend to grant all three types of equity vehicles. Out of the three equity vehicles, performance-based awards were the most prevalent. In the S&P 500, the equity vehicles were relatively even in proportion, with performance awards being the more commonly granted equity, followed by time-based stock and then time-based options.

• Time-based stock and performance awards are granted more frequently than time-based options in both the S&P 1500 and S&P 500.

• The share of S&P 1500 companies granting performance awards rose from 37.6% in 2009 to 63.4% in 2013, and the share of S&P 1500 companies granting time-based stock rose from 55.6% in 2009 to 67.7% in 2013.

• The use of time-based options declined since 2009 in both indices, from 50.5% prevalence to 42.2% prevalence within the S&P 1500, and from 65.0% to 57.6% prevalence in the S&P 500.

The following two charts show the mix of equity vehicles (time-based options, time-based stock, and performance-based equity) awarded to COOs from 2009 to 2013. The two most common equity mixes in both years and across both S&P 500 and S&P 1500 companies were the combination of restricted stock and performance-based equity as well as a mixture of all three equity vehicles. The percentage of companies granting no equity to their COOs fell from 2012 to 2013 in both indices. Moreover, it is becoming increasingly common for companies to grant two or more equity types as opposed to just one or none at all.

• There has been a steady shift toward adding performance awards into the equity vehicle mix as companies attempt to create greater alignment between pay and performance.

• The prevalence of the restricted stock and performance stock mix experienced the largest increase within the S&P 1500 over the five-year period, growing from 9.5% in 2009 to 27.3% in 2013.

• The most common mix in the S&P 500, used by a quarter of companies within the index, was a mix all three vehicles, and this was followed closely by the restricted stock and performance stock combination at 24.3% prevalence.

Please contact Amit Batish at abatish@equilar.com for more information. Amit Batish is the Content Manager at Equilar. The contributing author of this article was Tiffany Chen, Research Analyst.