The SEC completed its implementation of additional proxy disclosure required by the Dodd-Frank Wall Street Reform and Consumer Protection Act by issuing final rules for disclosure of the relationship between executive “Compensation Actually Paid” and company financial performance. The new disclosure was required for fiscal years ending on or after December 16, 2022, so it typically appeared for the first time in proxy statements issued in 2023.

Compensation Advisory Partners analyzed disclosures made by 100 prominent companies to understand the relationship between CEO compensation and performance over a three-year period. The results of the study indicate that total shareholder return is an important driver, but other factors play a role as well.

Companies are now required to provide a table that compares pay reported in the Summary Compensation Table for the CEO and the average of other Named Executive Officers to Compensation Actually Paid to these executives as well as to three performance metrics: Total Shareholder Return (TSR), Net Income, and a Company Selected Measure that represents the most important metric used to link company performance and Compensation Actually Paid. In 2023 proxy statements, most companies were required to provide three years of data, which will extend to four years in 2024 and five years in 2025.

Compensation Actually Paid differs from pay reported in the Summary Compensation Table in several respects. The key difference involves the treatment of equity. In the Summary Compensation Table, equity is valued at the date of grant and only equity granted in that particular year is reported. In contrast, for Compensation Actually Paid, outstanding unvested equity which normally includes grants made over a three- to five-year period is re-valued each year at the earlier of the date of vesting or the fiscal year end. In the initial year of an equity grant, the entire grant is re-valued at year end (or the date of vesting, if earlier) and included in Compensation Actually Paid. In subsequent years, only the incremental change in value is included to avoid double-counting. As a result, Compensation Actually Paid can be a negative number when stock price declines.

The SEC’s decision to require companies to report TSR alongside Compensation Actually Paid was important. Obviously, TSR is a critical performance metric for investors. TSR also has the advantage of being one of the few metrics that is directly comparable between companies, regardless of industry or size.

Key Take Aways

CAP Analysis: TSR as a Determinant of Compensation Actually Paid

CAP analyzed the relationship between three-year cumulative Compensation Actually Paid to CEOs and three-year TSR in a sample of 100 large companies. We expected to find a strong correlation between Compensation Actually Paid and TSR over the three-year period, since equity is almost always the largest component of CEO compensation and equity values depend directly on TSR.

Overall, we found that TSR performance explained 77% of CEO compensation. Although these findings indicate that performance is highly correlated with Compensation Actually Paid, once we eliminated a single outlier, the correlation was weak. To our surprise, TSR performance then explained only 18% of the variation in CEO compensation for the 99-company sample. Revenue explained 19% of the variation for this sample. We conclude that factors other than TSR performance – for example, industry pay practices, the initial size of CEO packages using the Summary Compensation Table methodology, cash compensation levels and industry TSR performance, collectively explain the majority of the variation observed in Compensation Actually Paid.

We reviewed the sample and removed 13 outliers, which we defined as companies with more than a 50% differential in the percentile ranking of Compensation Actually Paid and relative TSR performance. In the chart shown below, the outliers are indicated by a red x. A glance at the chart shows that these companies either had very high or low levels of Compensation Actually Paid compared to TSR performance.

This refinement significantly improved the correlation between Compensation Actually Paid to CEOs and relative TSR performance. Correlation improved to 41% from 18%. The significance of revenue actually fell to 14% from 19%. While factors other than TSR clearly are responsible for much of the variation observed in CEO compensation from company to company and across industries, TSR performance still has a substantial influence on executive compensation.

We also performed a multiple regression analysis to understand the relationship between Compensation Actually Paid, TSR and company revenue size. The correlation improved to 35% for the full sample excluding the single outlier when both variables were taken into account. Excluding the additional 13 outliers defined above, the correlation improves to 50%. This finding should give investors comfort that in most cases the system is working reasonably well.

CAP Analysis: Relative Pay and Performance Rankings

In addition to regression analyses, we prepared a more traditional examination of pay and performance by determining the percentile position of both Compensation Actually Paid and TSR for each company in our sample

On a positive note, two-thirds of our sample of 100 companies reasonably aligned pay and performance – delivering relatively low CEO Compensation Actually Paid for lower TSR performance or relatively high Compensation Actually Paid for higher TSR performance. We note that only 17 out of 100 companies in the sample fall into the upper left-hand quadrant. This means that relative to other companies these companies pay more and have weak relative TSR performance, resulting in a misalignment between CEO pay and TSR performance. In our view, this outcome supports the process board compensation committees use to set CEO compensation. A majority of companies are paying higher levels of Compensation Actually Paid for strong TSR performance or lower levels for weak TSR performance, or simply paying conservatively relative to other S&P 500 companies even though TSR performance is strong.

CAP Analysis: The Relationship between Compensation Actually Paid and TSR by Industry

We drilled down and examined the relationships between CEO Compensation Actually Paid and TSR performance in six different industry groups within the original 100-company sample. The results are summarized below with scatter plots for each of these industry groups provided in the Appendix.

We found large disparities between industries in the extent to which CEO Compensation Actually Paid correlated to TSR performance. The Energy and Health Care industries demonstrated the highest correlations. In each, TSR performance explained approximately 50% of the variation in CEO Compensation Actually Paid. Conversely, Industrials and Utilities firms exhibited effectively no correlation between TSR and CEO Compensation Actually Paid.

Interestingly, companies in the Energy and Healthcare industries also reported among the highest levels of CEO Compensation Actually Paid, on average. In contrast, Utilities companies paid the lowest on average. The average company in the Materials sample paid about equal to the average reported by the entire 100-company sample.

Note that the initial disclosure period of 2020 – 2022 corresponded with the Covid-19 pandemic and a period of rising energy prices. Given the macro forces, it stands to reason that Healthcare and Energy would benefit. Conversely, other industries were certainly impacted negatively by supply chain disruptions and government shutdowns, particularly in 2020 and 2021.

Industry Correlation

CAP Analysis: CEOs with the Highest Compensation Actually Paid

We identified 15 CEOs among our 100-company sample whose three-year cumulative Compensation Actually Paid exceeded $100 million. Moderna’s CEO topped the list with an eye-popping Compensation Actually Paid of almost $957 million, accompanied by an equally eye-popping TSR of $918 earned in three years on an initial investment of $100.

CAP Analysis: Ratio of Compensation Actually Paid to Summary Compensation Table Total Compensation

As a rule, most CEOs did well in terms of compensation over the past three years, although a significant portion of these amounts remain unvested and at risk. For a majority of our sample, Compensation Actually Paid exceeded the Summary Compensation Table methodology by 20% or more over the three-year period. Fully 73% of CEO had Compensation Actually Paid that equaled or exceeded amounts reported in the Summary Compensation Table. Only 5% accumulated less than 80% of the amounts granted over three years.

Appendix: Pay and Performance Relationships by Industry

For questions or more information, please contact CAP’s team:

Margaret Engel
Founding Partner
[email protected]
914-325-1943

Louisa Heywood
Associate
[email protected]
646-568-1160

Rebecca Friday
Analyst
[email protected]
646-486-9741