In January 2018, gender pay equity took a national stage as news outlets reported on the dramatic disparity in pay between actress, Michelle Williams, and her male co-star, Mark Wahlberg. Ms. Williams received only $1,000 for re-shooting scenes for the film All the Money in the World, while Mr. Wahlberg received $1.5M, meaning that a male employee made 1500x his female counterpart. While the pay disparity in corporate America may not be as stark, and the employees not as famous, this example is illustrative of the type of pay inequity that has become a topic of discussion across industries. This CAPintel summarizes the current state of the conversation around gender pay equity to provide context to executives and directors as they begin to have these discussions at their organizations.

Key Takeaways

  • Several institutional investors have specifically pushed gender pay equity into the limelight by engaging companies and requesting that they disclose their gender pay statistics
  • CAP’s research finds that female representation among top 5 Named Executive Officers (NEOs) is limited; less than 50% of the companies in our sample had a female among the NEO group
  • Among companies with female NEOs, non-CEO female pay was 87% of their non-CEO male counterparts at median
  • 7% of companies had a female CEO. Among this small sample, median total compensation was 23% higher than median total compensation for male CEOs
  • Mandatory gender pay gap disclosure went live in the U.K. in 2018 and the data supports unequal representation of women in higher paying roles
  • While disclosure is not required in the U.S., momentum is building among both institutional investors and state legislatures to act to prevent pay inequity
  • In CAP’s view, the focus on gender pay equity is not an isolated event, but part of a larger movement toward establishing greater equality and diversity in work environments

Background

Gender pay equity is a topic being discussed in the news and across corporate America. In the U.S., the pay of working women is 80% of the pay earned by males, according to the Institute for Women’s Policy Research. Boards of directors and chief executive officers have become increasingly focused on promoting equality and diversity initiatives as institutional investors have incorporated board diversity and other Environment, Social and Governance (ESG) issues into their proxy voting guidelines. Several institutional investors have specifically pushed gender pay equity into the limelight by engaging companies and requesting that they disclose their gender pay statistics. Individual states and cities in the U.S. are taking steps to prevent future pay inequity.

Outside the U.S., several countries, including the U.K., Nordic countries, Germany and Australia, have adopted laws requiring organizations to disclose, or in some of the more aggressive cases eliminate, their gender pay gaps. These laws highlight that companies around the world need to be thinking about the pay disparities that exist within their organizations and try to understand the underlying issues that cause these disparities.

Gender Pay Equity in the U.S.

In recent years several institutional shareholders have helped bring gender pay equity to the forefront by pressuring large public companies to voluntarily disclose statistics regarding the gap between wages for men and women. One institutional investor, Arjuna Capital, has effectively targeted companies through gender pay equity-related shareholder proposals since 2016. While none of these shareholder proposals received majority support, 21 companies have disclosed or committed to disclose gender pay gap information. Among the companies that have disclosed to date, many of which are from the financial services and technology industries, the disclosures generally reveal a wage gap of 0-1% for men and women in comparable roles and locations.

These reports seem to indicate that these companies have done a lot of work to close the gap in wages for men and women in the same job function; however, these voluntary disclosures do not include information about the number of men and women in each comparable pay band. As a result, it is unclear how successful companies have been in addressing the structural issue of inequitable representation of men and women in leadership roles and other high paying jobs, a factor viewed as contributing to overall gender pay inequity.

To date, it is not clear how major institutional investors and proxy advisory firms will use this information. In their 2018 policy updates, Institutional Shareholder Services (ISS) introduced guidelines on how they will assess shareholder proposals related to gender pay equity. Considerations include:

  1. The company’s current policies and disclosure related to both its diversity and inclusion policies and practices, its compensation philosophy and fair and equitable compensation practices,
  2. Whether the company has been the subject of recent controversy or litigation related to gender pay gap issues; and
  3. Whether the company’s reporting regarding gender pay gap policies or initiatives is lagging its peers.

U.S. Public Company Gender Pay Equity among Named Executive Officers (NEOs)

To get a sense of the current state of gender equality with respect to both pay and representation in leadership among U.S. public companies, CAP analyzed the compensation of top executives at 150 companies with revenues greater than $19B, as disclosed in the Summary Compensation Table in 2017/18 proxy statements. Among our sample, we found that:

  • 7% of companies had a female CEO. Among this small sample, median total compensation was 23% higher than median total compensation for male CEOs
  • 53% of our sample had a male-only NEO group
  • Among the remaining 47% of companies, non-CEO female NEOs made 87% of their non-CEO male NEO counterparts at median. CAP arrived at this finding by calculating the ratio between average female non-CEO NEO pay and average male non-CEO NEO pay for each company with at least one female NEO, excluding those where the only female NEO was the CEO.

The NEO pay gap directionally aligns with the average median pay gap reported in the news. CAP’s analysis did not control for other circumstances that inform pay levels (e.g., job function, tenure, individual performance, etc.); however, these findings provide further support that the disparity in pay between men and women is, in many cases, attributable (at least in part) to the lack of female representation in top leadership positions at many organizations.

Gender Pay Equity in the U.K.

In February 2017, the U.K. government adopted rules requiring “relevant employers” with more than 250 U.K. employees to publish gender pay gap data for those employees located in the U.K. by April 4, 2018. The rule requires approximately 9,000 employers in both the private and public sectors to disclose the following:

  • Mean and median gender pay equity gap in hourly pay
  • Mean and median bonus gender pay gap
  • Proportion of males and females receiving a bonus payment
  • Proportion of males and females in each pay quartile

On April 5, the day after the filing deadline, the Financial Times reported that the average reported median pay gap between men and women was approximately 10%. We have seen that this gap varies by company and industry. For example, several large financial services companies have reported median pay gaps that are notably larger than average.

Unlike the voluntary disclosures in the U.S., U.K. companies do not have any flexibility in calculating these statistics because the rules are very prescriptive. Where U.S. disclosures have shown the pay gap between male and female employees in substantially similar roles, U.K. disclosures are required to disclose statistics for all U.K. employees regardless of role. While the reporting coming out of the U.K. does not tell us if men and women are receiving the same pay for the same work, it does tell us that men are, overall, earning more than women, indicating that there are more men in higher paying roles than women.

To address this point, many companies try to explain the “why” behind their reported figures. These explanations tend to support the notion that a greater proportion of male employees are in higher paying roles than their female counterparts. Specific rationales include:

  • More men are in senior roles
  • Fewer men are in part-time roles that tend to pay less
  • More men are bonus eligible

Some organizations went further and disclosed how they plan to address the disparity including diversity targets that they plan to achieve in the next 5 to 10 years.

Anti-discrimination Laws in the U.S.

While U.S. regulators have not adopted gender pay equity disclosure requirements, several states and cities have passed, or have proposed, legislation aimed at preventing future pay inequity. These laws generally aim to accomplish this goal by prohibiting employers from inquiring about a prospective employee’s salary history among other provisions.

For example, in Massachusetts, the Act to Establish Equal Pay includes the following requirements:

  1. Employers may not inquire about salary/benefits history before extending an offer;
  2. Employers may not prohibit employees from talking to co-workers about wages/benefits;
  3. Employers must pay women based on competitive market rates and not salary history.

Laws in most other states and cities contain similar provisions to the Massachusetts law. One recent outlier is New Jersey’s Equal Pay Act, which passed the legislature on April 10, 2018 and is considered among the most rigorous. The law requires equal pay for “substantially similar work” and allows employees to seek up to six years of backpay for discriminatory pay practices.

Conclusion

In CAP’s view, the focus on gender pay equity is not an isolated incident, but part of a larger movement toward establishing greater equality and diversity in work environments. Research supports that organizations with greater gender diversity are stronger financial performers. While many organizations have initiatives to promote and achieve a better gender balance, accountability and tone from the top is important to achieving those goals.

While the U.S. may not have prescriptive national legislation in the near term, we expect that institutional shareholders will continue to push for companies to voluntarily disclose diversity statistics, including gender pay gaps. It will be important for companies to be able to assess the state of their gender pay gap, and to diagnose the underlying issues that cause any identified disparity in pay between male and female employees. We view the current spotlight on gender pay gaps as the first step towards addressing equality in pay as well as the more structural issue of representation across all levels in the organization.

Beginning with fiscal years ending on or after December 31, 2017, companies are required to disclose the ratio that compares the compensation of the CEO to the compensation of the median employee (pay ratio). This disclosure was part of the Dodd-Frank Wall Street Reform and Consumer Protection Act signed into law in 2010.

Compensation Advisory Partners LLC (CAP) researched early pay ratio disclosures. As of March 9, 2018, we obtained pay ratios from 150 companies with a median revenue of $2.1B from a cross-section of industries.

Pay Ratio

The median pay ratio disclosed by these companies is 87x. The lowest ratio is 1x (Apollo Global Management, Dorchester Minerals and The Carlyle Group) and the highest ratio is 1465x (Fresh Del Monte Produce Inc.).

Summary Statistics

Median Employee Pay

Median CEO Pay

Pay Ratio

75th percentile

$88,612

$10.5M

172x

Median

$58,256

$5.6M

87x

25th percentile

$43,966

$2.5M

36x

As expected, the pay ratio correlates with company size, with larger companies disclosing higher ratios. CEO pay varies greatly depending on the size and complexity of the organization. Employee pay has less variability since it reflects the job function and does not vary significantly based on the size of the organization. The median ratio in our sample of 150 companies ranges from 20x for companies with revenue less than $500M to 218x for companies with revenue greater than $15B.

20x 54x 84x 157x 183x 218x <$500M $500M-$1B $1B-$5B $5B-$10B $10B-$15B >$15B Median Pay Ratio by Revenue Size

Few companies, 15, disclose a supplemental pay ratio with only a handful of companies (three) disclosing more than one additional ratio. These companies with supplemental ratios are typically adjusting the CEO’s pay which may exclude anomalies such as a one-time special bonus or equity award. Interestingly, three companies disclosed a higher supplemental pay ratio likely to provide context for a large year over year increase in the 2019 proxy statement.

Location of Disclosure

Nearly 70% of companies disclose the pay ratio after the Potential Payments upon Termination or Change in Control section of the proxy statement. Approximately 25% of companies disclose the pay ratio just before or after the Summary Compensation Table and a small minority, 5%, disclose it in the Compensation Discussion and Analysis (CD&A).

Pay ratio is typically not disclosed in the CD&A, signaling to shareholders that the pay ratio is not used to determine CEO pay levels. Additionally, around 25% of companies include language in the disclosure that the ratio should not be used to compare pay levels to other companies within the industry, region of the country or revenue size.

Measurement Date

The SEC’s final rules give companies the flexibility to use any date within the last quarter of the fiscal year to identify the median employee. Companies most commonly used the last day of the fiscal year or a date within the last month of Q4. It is also common for companies to use a day within the first month of Q4 to identify the median employee.

Measurement Month

Prevalence

Measurement Date

Prevalence

First Month of Q4

29%

Last day of Q4

44%

Second Month of Q4

8%

First day of Q4

17%

Third Month of Q4

57%

Other

33%

Not Disclosed

6%

Not Disclosed

6%

Exclusions from Median Employee Determination

Approximately one-third of companies excluded a portion of their workforce when determining the median employee. The most common rationale is the de minimis exemption (approximately 55%) whereby a company can exclude up to 5% of its non-U.S. employee workforce. Companies also commonly cited an acquisition or corporate not responsible for setting pay (e.g., independent contractors) as rationales for excluding certain employee groups.

Conclusion

As more companies continue to file their proxy statements in the coming weeks, we will likely see larger pay ratios, particularly as companies with a significant part-time workforce begin to disclose their ratios. We do not anticipate an increasing trend in the number of companies filing supplemental pay ratios though it will be interesting to see the rationale for those that do. We expect to continue to see companies placing the pay ratio outside of the CD&A with most disclosing it after the Potential Payments upon Termination or Change in Control section.

Compensation Advisory Partners (CAP) reviewed executive compensation pay levels and trends at 50 companies (Early Filers) that filed their most recent proxy statement between November 2017 and January 2018 (fiscal year ends from July 2017 to October 2017; 35 companies have September 30 fiscal year ends). Industry sectors reviewed include: Consumer Discretionary, Consumer Staples, Financials, Health Care, Industrials, Information Technology and Materials. Among these 50 companies, median Revenue was $7.5B, median Market Capitalization (based on each company’s fiscal year-end) was $13.0B and 1-year Total Shareholder Return, or TSR (based on each company’s fiscal year-end) was 19.3%.

Overall Findings

Performance: 2017 performance (based on Revenue growth, EBIT growth, EPS growth and 1-year TSR) was strong. Revenue and EBIT grew by approximately 6%, EPS was up 4% and TSR was up nearly 20% vs. prior year.

CEO Pay: Median CEO pay increased slightly by 3.3% mainly driven by actual annual incentive payouts. The grant date value of long-term incentives (LTI) was generally flat.

Annual Incentive Payout: Overall, the median 2017 annual incentive payout was 115% of target, reflective of strong financial performance.

2017 Performance

CAP reviewed Revenue growth, EBIT growth, EPS growth and TSR performance for the Early Filer and the S&P 500 companies. Overall, 2017 median performance for Early Filers was strong. Revenue and EBIT grew approximately 6%, EPS grew around 4% and TSR was up nearly 20%. TSR among the Early Filers showed double-digit growth for the second year in a row; this growth is due to strong financial performance as well as market expectations around tax reform in light of the current political climate.

Financial Metric (1)

2016 Median 1-year Performance

2017 Median 1-year Performance

S&P 500

Early Filers

S&P 500

Early Filers

Revenue Growth

2.1%

2.0%

6.3%

5.7%

EBIT Growth

2.2%

7.6%

6.6%

6.0%

EPS Growth

4.2%

5.2%

9.9%

3.9%

TSR

3.3%

18.4%

17.0%

19.3%

(1) TSR and Financial performance for the S&P 500 is as of September 30, 2016 and September 30, 2017. Financial performance and TSR for Early Filers is as of each company’s fiscal year end.

CEO Total Direct Compensation

Among Early Filers with CEOs in their role for at least two years (n=39), median total direct compensation increased 3.3%. This increase was mainly due to higher actual annual incentive payouts in 2017; the grant-date value of LTI was generally flat year over year. Actual annual incentive payout was up nearly 4% reflective of strong financial performance while LTI, the largest component of CEO pay, was up only 1%. Median base salary for CEOs in our sample was unchanged from 2016.

3.3% 0.6% 6.2% 3.8% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 1-Year Median Change in CEO Compensation Actual Annual Incentive Actual Total Cash Grant-Date LTI Value Total Comp

Annual Incentive Plan Payout

The median actual annual incentive payout in 2017 was 115% of target, higher than the median payout in 2016 of 106% of target. In fact, the 25th percentile bonus payout in 2017 was at target, noticeably higher than last year (86% of target).

Summary Statistics

Annual Incentive Payout as a % of Target

2015

2016

2017

75th Percentile

134%

141%

147%

Median

106%

106%

115%

25th Percentile

97%

86%

100%

Performance for companies with at or above target annual incentive payouts was substantially stronger than that of companies with below target payouts. Companies with payouts at or above target had strong EPS (10.9%) and TSR (23.2%) growth and solid Revenue (6.3%) and EBIT (7.2%) growth. Performance for companies with below target payouts was flat or declining from prior year.

Financial Metric (1)

2016 Median 1-year Performance

2017 Median 1-year Performance

Below target payout (n=21)

At/above target payout (n=29)

Below target payout (n=12)

At/above target payout (n=38)

Revenue Growth

(0.7%)

3.0%

2.1%

6.3%

EBIT Growth

(2.8%)

15.9%

1.0%

7.2%

EPS Growth

(3.9%)

16.9%

(4.3%)

10.9%

TSR

16.9%

19.6%

(3.9%)

23.2%

(1) Financial performance and TSR is as of each company’s fiscal year end.

76% of companies in 2017 provided a payout at or above target which is considerably higher than 2016 and 2015 (58% and 62%, respectively). In 2017, significantly more companies provided a payout between 100 – 150% of target than below target. This distribution is more evenly split in prior years. The distribution of payouts in 2017 aligns with stronger overall performance than 2016 and 2015.

8% 10% 8% 30% 32% 16% 42% 38% 54% 20% 20% 22% 2015 2016 2017 Annual Incentive Payout as a Percentage of Target < 50% 50% - 100% 100% - 150% > 150%

Incentive Plan Design

Among Early Filers, 75% of companies use 2 – 3 financial metrics in the annual incentive plan and nearly 83% use 1 – 2 measures in the LTI plan.  Metrics in the annual incentive plan typically focus on growth and profitability, while LTI plans are more likely to reward executives based on profits, return measures or stock price performance. A growing number of companies are beginning to use non-financial strategic goals, primarily diversity and inclusion and creating a more engaged workforce, in the annual incentive plan design. With the recent amendment to 162(m) due to the Tax Cuts and Jobs Act, we anticipate more companies will use strategic measures and individual objectives to reward executives in the future.

As performance-based compensation continues to be championed by both shareholders and proxy advisory firms, the use of performance-based LTI continues to be very prevalent. Performance plan usage remains high, at 90% of Early Filers. Option use declined among the Early Filers (54% down from 62%) and shifted to use of restricted stock.

86% 66% 62% 54% 30% 16% 90% 76% 54% 52% 34% 14% Perf Awards Time-basedRS/RSU Stock Options 2 Vehicles 3 Vehicles 1 Vehicle LTI Prevalence 2016 2017 Vehicle Prevalence Vehicle Mix

TSR continues to be the most prevalent LTI metric, with approximately 60% of companies using a performance-based plan with this metric. Of the companies that use TSR, 25% use it as a modifier, 50% use it as a stand-alone metric in conjunction with a financial measure and 25% use it as the sole measure. The prevalence of TSR as the sole measure has decreased somewhat over the last several years as companies use a balanced approach to reward executives for long-term financial and stock price results. We anticipate its usage as a sole measure to plateau or continue to decline particularly given ISS’ recent shift towards the use of other financial measures in its quantitative pay for performance assessment (ISS and Glass Lewis Policy for the 2018 Proxy Season).

Governance Practices

Over the last decade, many companies adopted good governance practices. Increased scrutiny from shareholders and proxy advisory firms has quickened the pace with which companies incorporated clawback, or recoupment, policies as well as hedging and pledging policies. It is no surprise that more than 90% of companies in our sample have a clawback policy in place. 85% of companies also have implemented hedging and pledging policies for their executives.

Nearly all companies (96%) in our sample have stock ownership guidelines in place; these guidelines encourage executives to hold a meaningful equity stake and align with shareholder interests. The guideline is most commonly expressed as a multiple of salary, with a median CEO multiple of 5x base salary and other NEOs with a multiple of 3x base salary. About one-third of companies also require executives to hold stock (typically 50 – 100% of net shares received) until stock ownership guidelines are met. It is less common for companies to require executives to hold shares for a period of time (e.g., 1 year) in lieu of stock ownership guidelines. Good governance practices continue to be a focus of shareholders, and companies are routinely implementing and updating policies as appropriate in the current regulatory environment.

Conclusion

2017 was a year of strong financial performance for the Early Filers, which resulted in above target annual incentive payouts for approximately 75% of companies. CEO actual total cash compensation increased by 6%, and when combined with generally flat LTI award values, total pay increased by 3%.

2018 will be the first performance year after the passage of tax reform. We do not expect companies to unwind their use of performance-based pay and good governance practices, yet we foresee greater use of individual and strategic performance measures, along with increased use of discretionary pay decisions, in moderation.


For questions or more information, please contact:

Lauren Peek Principal
lauren.peek@capartners.com 212-921-9374

Joanna Czyzewski Associate
joanna.czyzwski@capartners.com 646-486-9746

Melissa Burek Partner
melissa.burek@capartners.com 212-921-9354

On a panel of leading executive compensation experts, Margaret Engel discusses some of the top executive compensation issues and trends including: the current public mistrust of executive compensation programs, the importance and the rigorous process of target goal setting, the challenges that many companies face with long-term performance awards, and the likely increase in the use of performance-based stock options in the future.

Compensation Advisory Partners (CAP) examined 2016 executive pay and company performance at 33 companies across five segments of the financial services industry: Wall Street Banks, Trust Banks, Regional Banks, Investment Banks, and Asset Managers.

2016 was an uneven year for the banking and capital markets space. Among our sample covering five industry segments, median Total Shareholder Return (TSR) for the year (+23%) was more than double that of the S&P 500 excluding financial companies (+11%). However, operating earnings were up only modestly (+2%), at median, as most of the increases in stock price came near the end of the year and appear to have been related to changes in investor sentiment following the election results. Median total CEO pay was flat year-over-year, aligning it more closely with operating earnings than TSR.

Compensation Advisory Partners (CAP) reviewed executive compensation pay levels and trends at 50 companies (Early Filers) that filed their most recent proxy statement between November 2016 and January 2017 (fiscal year ends from July 2016 to October 2016; 35 companies have September 30 fiscal year ends). Industry sectors reviewed include: Consumer Discretionary, Consumer Staples, Financials, Health Care, Industrials, Information Technology and Materials. Among these 50 companies, median Revenue was $6.1B, median Market Capitalization (based on each company’s fiscal year-end) was $9.0B and 1-year Total Shareholder Return, or TSR (based on each company’s fiscal year-end) was 18.4%.

Overall Findings

  • Performance: 2016 performance (based on Revenue growth, Pre-tax Income growth, EPS growth and 1-year TSR) was generally flat year over year.
  • CEO Pay: Median CEO pay was up 5.5% from 2015 due to increases in annual incentive payout and the grant date value of long-term incentives (LTI).
  • Annual Incentive Payout: Overall, median 2016 annual incentive payout was 104% of target which was consistent with 2015 results.
  • Annual Incentive Plan Design: Profit-based growth, Revenue growth and Cash Flow growth are the most common measures used in the annual incentive plan. Companies typically use 2 – 4 metrics to ensure executives are focused on overall company performance.
  • Long-Term Incentive Design: Performance-based awards are the most prevalent LTI vehicle although stock options and time-based restricted stock are also commonly used but to a lesser extent. Most companies use relative TSR as an LTI metric although we expect its use to plateau as proxy advisory firms like ISS begin to use financial performance in their pay-for-performance assessment.

2016 Performance

2016 was a year marked with global political uncertainty partly due to the Brexit vote in June, the U.S. presidential election in November and the continued unrest in the Middle East. Despite these challenges, 2016 financial performance was generally flat (+/- 3%) for the second year in a row. However, 2016 TSR performance was much stronger than 2015 performance despite market uncertainty. CAP reviewed Revenue growth, Pre-tax Income growth, EPS growth and TSR performance for the Early Filers and the S&P 500.

Financial Metric (1) 2015 Median 1-year Performance 2016 Median 1-year Performance
S&P 500 Early Filers S&P 500 Early Filers
Revenue Growth 2.3% 2.2% 2.1% 2.2%
Pre-Tax Income Growth 1.8% 1.5% 2.2% -2.8%
EPS Growth 5.0% 3.1% 4.2% 2.4%
TSR 3.4% 0.4% 14.9% 18.4%

(1) TSR and Financial performance for the S&P 500 is as of September 30, 2015 and September 30, 2016. Financial performance and TSR for Early Filers is as of each company’s fiscal year end.

CEO Total Direct Compensation

CEO actual total direct compensation increased modestly (5.5%) among Early Filers with CEOs in their role for at least two years (n=42) driven by increases in annual incentive payouts and the grant-date value of LTI awards. Annual incentive payouts, at median, were nearly 6% higher over prior year. Although year over year financial performance was relatively flat, companies typically adjust incentive plan metrics to exclude factors that may be outside an executive’s control (e.g., currency fluctuation) which can result in higher incentive plan achievement compared to GAAP performance. Median base salaries for CEOs in our sample were unchanged from prior year.

Annual Incentive Plan Payout

Actual annual incentive payouts in 2016 were around target, reflective of the relatively flat 2016 financial performance. Payout in 2016 was 104% of target at median which is similar to median payout in 2015 (102% of target). Median annual incentive payouts for 2016 and 2015 were lower than 2014 (110% of target); however, 2014 was a year of strong financial performance which resulted in above target annual incentive payouts.

Summary Statistics Annual Incentive Payout as a % of Target
2014 2015 2016
75th Percentile 125% 133% 137%
Median 110% 102% 104%
25th Percentile 92% 82% 82%

As would be expected, performance for companies with at or above target annual incentive payouts was stronger than that of companies with below target payout. Most noticeably, however, is that median Profit growth for companies with at or above target annual incentive payouts was significantly stronger than similar growth for companies with below target payouts; median Revenue growth was only modestly stronger for companies with at or above target payout. Median 1-year TSR performance for both groups was very strong in 2016. These results are directionally similar to 2015 performance with the exception of TSR which, for both above and below target payouts, was stronger in 2016 than 2015.

Financial Metric (1) 2015 Median 1-year Performance 2016 Median 1-year Performance (2)
Below target payout (n=23) At/above target payout (n=27) Below target payout (n=23) At/above target payout (n=26)
Revenue Growth -3.6% 7.5% -0.7% 3.5%
Pre-Tax Income Growth -4.1% 8.8% -13.2% 20.5%
EPS Growth -2.6% 12.2% -8.7% 16.3%
TSR -13.4% 14.8% 16.9% 20.0%

(1) Financial performance and TSR is as of each company’s fiscal year end.
(2) Excludes 1 company that eliminated its annual incentive program beginning in 2016.

Approximately 55% of companies provided a payout at or above target in 2016 which is consistent with 2015. Additionally, the distribution of payouts in 2016 is similar to that of the prior year which is consistent with generally flat year over year performance.

Incentive Plan Design

Annual Incentive Plan Design

Across all companies reviewed, Profit growth (typically EPS or Operating Income), Revenue growth, and Cash Flow growth were the most commonly used metrics in the annual incentive plan design. Typically, companies place more emphasis on profits with most allocating at least 50% of the total award on profit-based metrics.

Most companies use 2 – 4 metrics in the annual incentive plan design which allows companies to balance an executive’s focus on the many aspects that define its success. This approach also provides some risk mitigation so that executives are not concentrating on a single metric potentially at the expense of other meaningful financial measures. A minority of companies (8) in our sample use only 1 metric in the annual incentive plan, with most of these companies using a profit-based metric.

Long-Term Incentive Plan Design

Among early filers, performance-based awards are the most prevalent long-term incentive vehicle provided to executives as companies continue to ensure executive pay is aligned with longer term company and stock price performance. However, companies in our sample do continue to provide stock options and time-based restricted stock awards, although these vehicles reflect a smaller portion of total LTI (28% for stock options and 20% for time-based restricted stock). Most companies reviewed deliver equity in the form of 2 – 3 vehicles which helps to balance the link with longer term performance.

For companies that grant performance-based awards, the most common metrics are TSR, profit-based growth and return measures (e.g., ROE, ROA and ROIC). 67% of companies use TSR, 57% use a profit-based metric (with EPS used most often) and 31% use a return measure. Similar to annual incentive metrics, companies use multiple metrics (typically 2 – 3 metrics) in performance-based awards. Among the 12 companies that use only 1 metric, 50% use company financial performance (typically a profit-based metric) while 50% rely solely on relative TSR. However, TSR is most commonly used with other metrics or as an award modifier. Over the last several years, more companies have been incorporating relative TSR as a long-term measure to address multiple issues including: setting credible long-term goals, using measures that can be understood by participants and aligning with proxy advisory firms’ pay-for-performance assessments. We would expect that the use of TSR will plateau particularly as firms, like ISS, begin to use financial performance measures in their pay-for-performance assessments.

Conclusion

2016 performance, overall, was generally flat year over year which resulted in annual incentive payouts that were around target for the second year in a row and modest pay increases, through incentives, for the CEO. 2017 will likely be a year of uncertainty as political outcomes from 2016 (e.g., Brexit and the U.S. presidential election) may impact international trade deals, U.S. federal regulations and consumer confidence which could impact economic performance. We would expect many companies to take a wait and see approach before making wholesale changes to their annual or long-term incentive plan design.

 

Lauren Peek is a Principal at Compensation Advisory Partners. Joanna Czyzewski is an Associate at Compensation Advisory Partners.

 

The CAP 100 Company Research consists of 100 companies from 9 industries, selected to provide a broad representation of market practice among large U.S. public companies. In this report, CAP reviewed Pay Strategies, Annual Incentives, Long-Term Incentives, Perquisites, and Shareholder Friendly Provisions of these companies in order to gauge general market practices and trends.

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