KEY TAKEAWAYS

• The use of performance-based long-term incentives (“LTI”) continues to be the prevailing practice, constituting more than 50% of the typical LTI program for Named Executive Officers (“NEO”)
• Companies have been re-examining the mix of components in their LTI program and actively increasing performance-based awards, while de-emphasizing stock options and time-based restricted stock
• While used to a lesser extent, stock options and time-based restricted stock continue to be part of the LTI program for many NEOs
• The most prevalent metrics used in performance-based LTI plans are return measures, such as ROI, Total Shareholder Return (“TSR”) and Earnings Per Share (“EPS”)
• Many companies have decided that the use of a two-pronged approach of measuring performance results against both internal goals and relative to the external market is a best practice

TRENDS IN LONG-TERM INCENTIVE PLAN DESIGN

51% of companies in our study made changes to the LTI plan design in 2013 or for 2014. Companies continue to reduce the emphasis on time-based restricted stock and stock options and deliver a greater portion of LTI compensation in the form of performance-based equity or cash awards. Among companies that changed their LTI mix, most companies reduced the emphasis on stock options (71%) and/or increased the emphasis on performance-based LTI (67%). 33% of companies that changed the LTI mix reduced the emphasis on time-based restricted stock.

This continued shift towards performance-based LTI compensation reflects an effort by companies to respond to shareholder feedback and align executives’ pay with performance. Target Corporation, for example, responded to a number of shareholder comments calling for a greater link between pay and performance. In 2013, Target eliminated the use of stock options (which represented 75% of total LTI in 2012) in favor of a 100% performance-based LTI program.

The overarching priority for many companies is to use LTI vehicles that best align with their business strategy and unique shareholder value proposition. For example, Aetna, Inc. replaced performance-based market share units (“MSUs”) with time-based stock appreciation rights (“SARs”) in 2014. Aetna disclosed that the longer term nature (10 years) of SARs “…supports the Company’s long-term strategic focus to drive change in the healthcare industry and to create long-term shareholder value.” Another example is Pfizer, Inc. which grants 5- and 7-year Total Shareholder Return Units (“TSRUs”). Pfizer discloses that the value executives realize from TSRUs “…is consistent with the value received by Pfizer’s shareholders.”

The table below outlines the reported changes among companies in our study:

Note: Percentages add to greater than 100% due to multiple changes by certain companies.

PREVALENCE OF LONG-TERM INCENTIVE VEHICLES

Over the past three years, the prevalence of stock options has declined slightly and the use of time-based restricted stock has been relatively flat. Companies tend to grant these vehicles as a supplement to performance-based LTI.

Below is the breakdown of the percentage of companies granting each LTI vehicle to NEOs from 2011-2013:

Note: Percentages add to greater than 100% because most companies grant a variety of vehicles.

Companies continue to use multiple vehicles to deliver LTI to executives. 51% of companies in our study deliver LTI in the form of two vehicles, 29% use three vehicles and 20% use only one vehicle. Among the companies that deliver LTI compensation through one vehicle, 60% grant only performance-based LTI.

LONG-TERM AWARD MIX

The average LTI mix in 2013 is generally consistent with 2012. Performance-based LTI continues to represent more than half of the LTI mix (approximately 55% of total LTI) while stock options represent approximately 25% and time-based restricted stock represents 20%.

The chart below depicts the average LTI mix for NEOs as disclosed in the CD&A:

PERFORMANCE-BASED LTI METRICS

Companies routinely reassess their LTI plan design, including the performance metrics used, to ensure that the design reflects the company’s business strategy and objectives to attract, incentivize and retain executives. Among performance-based LTI plans, the use of a return measure increased to 49% in 2013 (up from 41% in 2011) indicating that companies are trying to encourage operational efficiency, along with profitability and growth. Among the companies that use return measures, 47% use ROI or ROIC, 37% use ROE and 16% use ROA. TSR and EPS are also prevalent long-term incentive metrics, used by 42% and 36% of companies, respectively. In our study, most companies with performance-based LTI plans use two metrics.

Companies are also more likely to use LTI metrics that reflect key measures of success in their industry. The Automotive industry frequently uses Cash Flow as a metric, focusing executives on liquidity to manage the significant cash requirements associated with the industry. In the Pharmaceutical and Technology industries, where the success of a company’s pipeline and current product offerings is reflected in their stock price, TSR is used more frequently as a metric.

Overall, 49% of companies in our study measure performance relative to the external market (typically using TSR) and 89% measure performance against pre-established goals (typically internal financial metrics). Although the use of relative TSR has increased slightly since 2011, the use of absolute internal financial metrics is most prevalent. Approximately 92% of companies that use TSR, measure performance relative to a defined comparator group (54% use a defined peer group, 40% use a broader industry index and 6% use both) while nearly 95% of companies measure financial performance against pre-established goals based on the business plan.

In recent years, companies have moved away from using only absolute or relative performance measures and instead frequently use a two-pronged approach. In 2013, 37% of companies used both absolute and relative performance measures compared with 24% in 2011. The use of both absolute and relative performance measures allows companies to evaluate performance from a balanced perspective, considering both internal and external results.

The chart below displays the prevalence of LTI metrics for performance-based awards in 2011-2013:

CONCLUSIONS

The role played by performance-based LTI within LTI programs continues to grow. Performance-based LTI constitutes 54% of total LTI, on average, for NEOs. As performance-based LTI grows, the use of stock options and time-based restricted stock has been declining; however, these vehicles often have a role in a well-designed LTI program since stock option value depends on longer-term stock price appreciation and time-based restricted stock serves as an excellent retention vehicle.

The most commonly used metrics are return measures, such as ROI, as well as TSR and EPS. These metrics demonstrate that companies are attempting to use LTI to incentivize operational efficiency, profitability and growth. While most companies evaluate financial performance against internal goals, a growing number of companies have adopted a two-pronged approach to long-term performance measurement. These companies use internal financial goals and also incorporate a relative goal (typically TSR) to measure company performance in the context of the external market.

While most companies have already implemented changes that provide for a stronger link between executive pay and company performance, we expect to see companies continue to refine their performance-based LTI plans to support their business strategy. Additionally, we expect that setting meaningful long-term financial goals will continue to be a challenge for many companies leading some to incorporate relative performance metrics in the LTI program.

HIGHLIGHTS

• Companies rarely make wholesale changes to plans, but frequently revisit the performance metrics used
• Most companies use multiple measures to ensure the plan provides balance and aligns with overall business strategy
• Overall, 2013 annual incentive payouts were higher than in 2012 indicating stronger performance

CHANGES IN ANNUAL INCENTIVE PLAN DESIGN

Overall, 34% of companies in CAP’s study changed their annual incentive plan design in 2013 or 2014. The most common changes were to the performance metrics used to fund awards (47% of the companies making a change) or to the weightings applicable to performance metrics (32%). Another frequent change was to increase the target award opportunities offered to Named Executive Officers; reductions in target awards were made much less frequently. These changes, as well as other modifications shown in the chart on the right, illustrate that companies continue to review and enhance the pay-for-performance relationship through changes to the annual incentive program.

Note: Due to multiple changes, does not add up to 100%.

Change in Performance Metrics

Among the companies that changed the annual incentive performance metrics, about one-half of companies modified plan metrics while maintaining the current number of metrics to better align pay with performance:

• Ten (10) companies kept the same number of metrics but replaced a metric in the incentive plan
• Four (4) companies reduced the number of metrics, and
• Two (2) companies added metrics to the current plan.

Several companies indicated that their rationale for changing annual incentive metrics was, in large part, to have a more holistic view of overall company performance and to better align incentives with their business strategy:

• AFLAC Inc: Added Operating Return On Equity (OROE) as a performance metric for senior vice presidents and above; this metric allows shareholders to evaluate AFLAC’s financial achievements relative to other organizations in terms of how effectively capital is used to generate earnings
• Danaher Corp: Added Return On Investment Capital (ROIC) in order to help validate the efficiency of earnings and complement the cash flow metric
• United Technologies Corp: Changed the earnings metric from EPS to Net Income since Net Income is not impacted by share repurchases
• Bristol-Myers Squibb: Replaced Adjusted Net Cash Flow from Operations with a metric for pipeline performance that consists of regulatory submissions and approvals and is a better indication of long-term growth potential.

Change in Target Bonus Opportunity

In 2013, median target bonus opportunities for CEOs increased (by 9 percentage points), while the opportunities for CFOs decreased (by 3 percentage points). Most notably, target bonus opportunity for CEOs in the Automotive, Insurance, and Retail industries increased by 10 percentage points year over year. However, the Technology industry experienced a significant decrease (21 percentage points) due to an increase in the base salary for Cisco’s CEO (from $375,000 to $1,100,000) and a decrease in the target opportunity for the new CEO at Intel (from 462.7% of base salary to 239.2%).

Median target bonus opportunity for CFOs in the Automotive industry experienced a decrease of 5 percentage points in 2013 largely due to the promotion of a new CFO at Goodyear (target opportunity decreased from 91% to 63% of base salary). Conversely, target bonus opportunity for CFOs in the Insurance industry increased (8 percentage points) in 2013; all other industries saw little movement to the target bonus opportunity.

Note: Financial Services industry is excluded since most companies in our study do not disclose target bonus opportunities for the Named Executive Officers.

ANNUAL INCENTIVE PLAN DESIGN / PRACTICES

Award Leverage

Disclosure of the payout range (i.e., both threshold and maximum payout as a percentage of target) is a limited practice as most companies reviewed did not disclose a threshold level of performance required to receive a bonus payment. For the 37 companies that disclose a threshold bonus, 50% of target is the most common payout percentage. However, 20 companies disclose a minimum bonus payout of less than 50% of target; a majority of these companies provide a payout based on multiple plan metrics.

Approximately 75% of companies disclose the maximum bonus opportunity. A majority (60%) have a maximum bonus opportunity of 200% of target bonus. Ten (10) companies have a maximum bonus of 250% of target or higher. A majority of these companies are in the Consumer Goods, Pharmaceutical, and Technology industries.

Annual Incentive Plan Metrics

EPS, Revenue, Cash Flow and Operating Income are the most prevalent metrics used in annual incentive plans. Although EPS is the most common metric overall, it is the most common metric for only two industries (Financial Services and Healthcare). Revenue, the second most common metric, is the most prevalent in four industries (Consumer Goods, Pharmaceutical, Retail and Technology). Our findings suggest that EPS is used more broadly across industries while Revenue tends to be used in consumer-driven industries.

Most companies (approximately 70%) use more than one performance metric in the annual incentive plan. 25% of companies disclose using two (2) metrics in their annual incentive programs, 25% use three (3) metrics, and 21% of companies use four (4) or more metrics. Approximately 62% of these companies use a profit-based metric in combination with Revenue and/or Cash Flow.

The chart below shows the three (3) most metrics by industry in 2013:

Note: Percentages reflect the prevalence of companies disclosing the metric.

2013 Actual Bonus Payout

Nearly all companies (98%) in our research awarded bonuses to their Named Executive Officers for 2013 performance. Overall, the median CEO bonus was 121% of target compared to 112% in 2012, indicating that 2013 performance was generally stronger than 2012. Most industries exceeded target bonus payouts by 11 – 65 percentage points. However, two industries (Retail and Technology) fell short of expectations by 22 and 12 percentage points, respectively.

Use of deferral mechanisms in the annual incentive plan is a limited practice and is more common in the Financial Services industry given regulations from the Federal Reserve. However, a few companies across industries also have a deferral policy in place. Companies typically defer annual incentive payment in the form of restricted stock/units.

Use of Discretion

Approximately 50% of companies in our research disclose the use of discretion in the annual incentive plan. Among these companies, approximately 40% allow only for downward adjustments of the final payout. Approximately 55% allow for both upward and downward adjustments by funding bonuses for Name Executive Officers at maximum based on a financial metric (this is unrelated to the final award allocation which may have additional performance requirements) to ensure compliance with Section162(m) of the Internal Revenue Code. This approach provides the Committee with the most flexibility in determining the bonus payout.

Conclusion

Given significant changes to the annual incentive plan design in recent years, companies rarely made wholesale changes to the overall plan design in 2013 or for 2014. Among the companies that made changes, most were focusing on refining the incentive metrics to ensure a more complete view of company performance and alignment with the overall business strategy. Despite these changes to the incentive metrics, EPS, Revenue, Cash Flow and Operating Income continue to be most common. While we would not expect to see extensive changes to the incentive plan design in the future, we anticipate that companies will continue to refine their metrics and the metric weightings as they continue to ensure executive pay is aligned with performance.

Partner Susan Schroeder and Principal Bonnie Schindler are interviewed on their 2014 survey of non-profit and government incentive pay practices.

Partner Susan Schroeder and Principal Bonnie Schindler are interviewed on their 2014 survey private company incentive pay practices.

The increases that CAP observed in 2013 are much higher than seen last year. In 2012, our study showed almost no change in CEO compensation (-0.3% at median) and a very modest increase in CFO total direct compensation (1.4% at median).

Our findings indicate that the rate of increase in total direct compensation levels for both CEOs and CFOs accelerated in 2012-2013 compared to flat pay increases in 2011-2012. This increase suggests that the economic recovery is having an impact. The higher increase in 2013 among CEOs was driven by larger increases in actual bonuses paid for 2013 and slight increases in long-term incentives (LTI). The slower rate of growth in CFO compensation may signal a leveling off of CFO pay increases – which has been increasing at a faster rate than CEO pay since 2010. On an absolute basis, CFO total direct compensation continues to total approximately one-third of CEO total direct compensation.

Methodology

Our findings are based on a sample of 92 public companies. Similar to prior years, the study analyzes executive pay data disclosed by companies with revenues ranging from $1 to $130 billion, and median 2013 revenues of $8 billion. Only companies with the same CEO and CFO incumbents in the past three years are included allowing us to measure year-over-year changes for individual incumbents. In the past, we excluded financial services firms from the study, since this industry’s compensation practices were evolving in the years after the financial crisis. This year we expanded our sample to include financial services companies in our analysis, because we believe that compensation in the financial services industry has stabilized over the last couple of years.

Study Results

Salaries

In 2013, approximately 73% of CFOs received salary increases compared to 85% in 2012. The median increase was 3.3% and the 75th percentile increase was 6.3%. In comparison, only 54% of CEOs received salary increases and the increases were smaller — 1.4% at median and 4.9% at the 75th percentile. The number of CEOs receiving a salary increase was similar to 2012. Less frequent and lower salary increases among CEOs may be explained by companies’ hesitancy to increase salaries beyond $1M.

2013 Salary Increases

Actual Pay Levels

Our findings indicate that the rate of increase in total direct compensation levels for both CEOs and CFOs accelerated in 2012-2013 compared to flat pay increases in 2011-2012, supported by stronger performance in 2013. During 2012-2013, actual total direct compensation (salary plus actual annual incentive plus the grant date value of long-term incentives) for CEOs and CFOs increased by 5.2% and 3.2%, respectively. This year is the first year since 2010 that we see higher median increases in actual total direct compensation for the CEO versus the CFO. In addition to salary increases of 1-3%, annual bonuses were 4-5% higher at median and long-term incentives increased about 3% at median for both CEOs and CFOs.

Absolute CFO total direct compensation levels, on average, continue to be approximately 30% of CEO total direct compensation levels.

Since this was the first year financial services companies were included, we tested the results without financial services companies and found that the median increase in total direct compensation between the two data sets for CEOs and CFOs was within a 1% difference. However, total cash compensation yielded greater differences. For CFOs of non-financial services companies the median increase in total cash compensation was 1.9% vs. 4.6% median increase of the total sample. For CEOs the median increases were 3.1% vs. 4.2%, respectively. This is due to higher bonus payouts at financial services institutions in 2013.

2013 Median Salary Increase by Industry

2013 Median Actual Total Direct Compensation Increase by Industry

Our study breaks out 2013 CEO and CFO pay by industry classification (Financials, Consumer Staples, Consumer Discretionary, Healthcare, Utilities, Materials, Information Technology, Energy, Industrials, and Telecommunication Services). When looking at median increases in salary for both CEOs and CFOs, they tend to be in the range of 0-3%. Median salary increases over 3% occurred in the Materials and Information Technology industries for CFOs and in Industrials for both CEO and CFO. When looking at actual total direct compensation there is greater volatility in increases, which is primarily driven by industry and company performance.

Target Pay Mix

In terms of target compensation levels, the overall pay mix remained largely unchanged from 2011 to 2013. We continue to observe a greater emphasis on at-risk pay for CEOs than for CFOs.

Long-Term Incentive (LTI) Vehicle Prevalence and Mix

LTI vehicle prevalence and mix trends have been fairly consistent over the past few years. The use of at least two long-term incentive vehicles continues to be the majority practice for CEOs and CFOs. The role of stock options has been decreasing slowly in the overall mix with companies delivering about 30% of LTI using this vehicle. On average, performance-based LTI continues to comprise approximately 50% of LTI for CEOs and CFOs. Data continues to show that about 80% of CFOs and CEOs receive some form of performance-based awards as part of their LTI program.

Conclusion

Given the improved economy and strong stock market it is not surprising that CEO and CFO pay levels increased in 2013. The fact that CEO pay increased at a faster rate than CFOs for the first time in four years, implies that Compensation Committees are recognizing CEO performance as overall company performance improves. In the future, we expect continued pay-for-performance alignment with CEOs experiencing a greater impact on compensation for good and bad performance.

Underlying the Fed’s input to financial institutions is a legitimate concern about the potential for incentives to encourage excessive risk taking. The Fed has stated that: “risk-taking incentives provided by incentive compensation arrangements in the financial services industry were a contributing factor to the financial crisis that began in 2007” and “Before the crisis, large banking organizations did not pay adequate attention to risk when designing and operating their incentive compensation systems.” Agree or disagree with these points, over the past several years compensation-related risk management processes have vastly improved.

In this CAPflash, we provide an overview of how compensation practices have evolved following the Fed’s guidance, what (in our view) the Fed has got “right” and where they may have gone too far, and what we expect to see from banks and regulators in the near future.

Where We Are Now

The Final Guidance was principles-based, leaving leeway for implementation to consider differences among the institutions subject to this new level of oversight. For example, companies with significant differences in their businesses, such as select investment banks, custody banks, regional banks, and credit card companies were all subject to the same guidance. In its October 2011 publication, the Federal Reserve noted, “The interagency guidance helps to avoid the potential hazards or unintended consequences that would be associated with rigid, one-size-fits-all supervisory limits or formulas.” In our experience, banks devoted considerable time and resources to demonstrate substantial conformance with the new requirements, but went about responding and demonstrating conformance to regulators in different ways.

The Interagency Guidance was founded on three key principles:

1. Balance between risks and results. Incentive compensation arrangements should balance risk and financial results in a manner that does not encourage employees to expose their organizations to imprudent risks;
2. Processes and controls that reinforce balance. A banking organization’s risk-management processes and internal controls should reinforce and support the development and maintenance of balanced incentive compensation arrangements; and
3. Effective corporate governance. Banking organizations should have strong and effective corporate governance to help ensure sound incentive compensation practices, including active and effective oversight by the board of directors.

Improved Risk Management

In our experience, companies have come a long way in addressing all three key principles. Most banks have greatly strengthened their risk management processes and ensured that the risk function has a defined role in reviewing compensation design, as well as performance outcomes and their impact on compensation payments. Where the risk function seldom had any role in the incentive compensation process in the past, they are now integrated into the process. Similarly, great strides have been made to ensure that Compensation Committees are informed about risk-taking within the organization and how incentive compensation designs across the company address risk. Many banks have also formed internal committees responsible for maintaining controls and risk oversight of incentive compensation plans across their organizations.

Prescribing Plan Design

The Fed and other agencies have become more prescriptive in their “guidance” to banks, at times almost to the point of allowing for limited leeway in compensation practices. The table below provides a summary of the methods for linking compensation and risk outcomes described in the Final Guidance, and select examples of how current compensation design practices have evolved based on input from regulators.

In our view, the area where the Federal Reserve has had the most positive impact on incentive compensation design is in requiring deferrals to be subject to performance adjustment, before and after grant, based on risk outcomes (generally not the case before the guidance). Other changes encouraged by the Fed (e.g., eliminating/reducing stock options, reducing upside incentive plan leverage to 125%-150% of target, reducing the use of relative measures, etc.) seem to be less well founded in the principles of risk balancing and more arbitrary. It is difficult to identify the role that these incentive design features played in the financial crisis and it seems to us that Fed input on these areas is based more on theoretical objections than any empirical data supporting the hypothesis that these incentive design features encouraged excessive risk-taking among executives at financial institutions.

Future Concerns and Expectations

U.S. regulators should be commended for maintaining a largely hands off approach thus far with respect to pay levels, focusing primarily on incentive compensation design and control features. This approach provides a strong focus on risk balancing of incentive compensation, while recognizing the need for the industry to maintain competitive compensation programs. In contrast, in the European Union, CRD-IV places caps on the level of incentive pay that may be delivered (as a ratio of fixed pay). This type of regulation severely limits the ability to implement a pay-for-performance compensation design and, in response, has led many companies to increase fixed pay. As a result, CRD-IV has potentially harmed shareholders by weakening the pay-for-performance relationship. Thankfully, to-date, the Fed has avoided this kind of heavy-handed approach in addressing compensation in U.S. financial institutions.

Still, we may have unanticipated consequences in the U.S. Many shareholders and shareholder advisory groups prefer formulaic performance-based incentive arrangements to discretionary incentives, as they fear that discretion will be used for the benefit of management. However, because regulators have discouraged formulaic, performance-based upside in incentive compensation plans, many financial institutions have moved to more discretionary incentive arrangements to allow for greater flexibility to compensate executives. Another potential response to the Fed’s input is that, over time, financial institutions may increase pay levels to address concerns that executive talent will depart for other industries (e.g., hedge funds, private equity, asset management) where there are no restrictions on incentive design.

Going forward, we expect regulators to provide more guidance on monitoring and validation processes and results. Many companies developed approaches to retrospectively review risk outcomes and the corresponding impact on compensation decisions, but communicating these processes and results for all covered employees to regulators is still, generally, in early stages. Regarding incentive plan upside leverage, regulators have started to state more and more directly a belief that 125% is most appropriate, but many banks have held their ground at 150%. Some of the banks that moved to 125% may start to re-evaluate their program and consider moving back to 150% to remain competitive.

As companies and Committees try to “live with” the restrictions of the guidance, we expect to see a continued move away from formal targets and increased use of discretion, increases in pay levels to recognize decreased incentive plan upside leverage, and challenges in applying risk adjustments and clawbacks.

Conclusion

Incentive compensation processes and designs among financial institutions have changed a great deal over the past four years, to a large degree driven by regulatory input. If we look back at the principles (Final Guidance), most banks have come a long way in addressing them. At this point, we hope that regulators can step back and consider how much progress has been made and consider taking a pause to begin to evaluate what changes were necessary and effective and what changes may have been excessive.

Appendix – Summary Market Data

[company-by-company data available upon request]

Methodology

CAP reviewed 2012, 2013, and 2014 proxy statements and the most recent equity award agreements of the 23 large publicly-traded banks1 that were included as part of the Federal Reserve’s horizontal review of incentive compensation. Our analysis looked for year-over-year changes in compensation structure, annual and long-term incentive design, performance-based vesting, recoupment policies and stock ownership guidelines/retention requirements.

Select summary data is shown below. Findings have been divided into two data sets, large complex banking organizations (LCBOs) and other large banks with assets exceeds $50 billion. LCBOs are one year ahead of the other large banks in terms of their interaction with the Fed, and the related implications on compensation program design.

Long-term Incentive Mix, 2012-2014

Long-term Incentive Absolute vs. Relative Performance Metrics, 2012-2014

Long-term Performance Plan Maximum Upside Leverage, 2012-2014

Stock Ownership Requirements

Some companies differentiate stock retention requirements for the CEO versus Other NEOs. Therefore in some instances the prevalence shown is greater than 100 percent.

Research assistance was provided by: Myron Lising, Roman Beleuta, Michael Biagi, Michael Bonner, Rachael Holland, and Jasmine Yanes.

Among the 44 company sample, median revenue was $11B, median market capitalization was $23B and median 12 month Total Shareholder Return (TSR) was 27% at the end of February 2014.

What We Found

The early findings and trends from these filers generally showed a continuation of trends from the 2013 proxy season. Early in 2014 companies:

• Received high levels of shareholder Say on Pay support
• Awarded CEO bonuses that were slightly higher as a percent of target compared to prior year earned bonuses, and
• Shifted more of the long-term incentive “LTI” program to performance based vehicles and decreased the emphasis on stock options

Say On Pay (SOP) Vote Results

In 2014, all Early Filers that released SOP results to-date (n=38) received majority shareholder support and 87% of companies received greater than 90% support. Among these companies there has been a steady uptick in the level of support at the 25th percentile over the last four years.

CAP Comment: SOP levels in early 2014 to-date continue to be strong. We expect similar SOP support levels for calendar year-end companies as we approach the 2014 annual meeting dates.

CHANGES IN SHORT AND LONG-TERM COMPENSATION

Base Salary

Among Early Filers, 46% of companies disclosed an increase to the CEO’s base salary in 2013 and the overall average base salary increase was 2.7%.2 CEOs in the Industrials industry received the largest average base salary increase (8.7%) followed by Consumer Staples (3.9%).

CAP Comment: The average executive base salary increase among the Early Filers is consistent with projected merit increases in the broader market where we are generally seeing 3.0% increases for 2014.

Short-term Incentive Payouts

Bonus payouts as a percent of target for the Early Filers increased slightly at the median. The median CEO bonus payout for 2013 was 100% of target compared to 97% in 2012. In general, there was a slight shift upwards in the bonus payouts when compared to the prior year. This is in-line with overall expectations as companies’ earnings and income also had modest growth year-over-year.

51% of Early Filers paid above target in 2013, compared to 46% in 2012. Of the companies that paid above target, median year-over-year increases in revenue, earnings and income growth were in the 10-20% range, compared to 5% for all Early Filers companies.

CAP Comment: Year-over-year financial performance results are aligned with CEO bonus payouts for the Early Filers. Companies are putting more time and effort into the goal setting process to ensure an appropriate pay and performance alignment; investors and proxy advisory firms increasingly focus on the performance goals and rigor of the incentive plan targets.

Long-term Incentive Mix

Over the last two years, the portion of the LTI mix delivered in a performance-based vehicle has increased in the general market. Early Filers showed a continuing, consistent shift, placing more emphasis on performance-based LTI and less emphasis on stock options; the weighting on time based restricted stock remained flat.

Approximately 85% of the Early Filers use two or three vehicles to deliver their long-term incentives.

CAP Comment: A general trend over the last couple of years has been a de-emphasis on stock options as part of the LTI program and an increase on the portion of performance based LTI. ISS is supporting this shift as they do not consider options to be performance-based.

Disclosed changes to compensation programs and polices

Companies continue to modify their compensation programs as they reassess program features in light of business/strategic changes and/or evolving shareholder and proxy advisory groups’ hot buttons. 36 of the 44 companies (82%) we researched disclosed making a change to their compensation programs or policies. The most prevalent change among the Early Filers was a modification to the company’s benchmarking peer group. Peer group changes are typically a result of companies trying to better align the peer group median size with that of their own company.

Note: Percentages add up to greater than 100% due to multiple responses

CAP Comment: Modifications to a company’s peer group is common as Compensation Committees and management review appropriate peers for benchmarking on an annual or biennial basis. Given that ISS and Glass Lewis consider a company’s peer group when conducting their analyses, it is another reason that assessing the appropriateness of peer companies is a valuable exercise.

Similar to last year, companies continue to modify their clawback policy as a sign of good corporate governance. Companies are not universally waiting for final Dodd-Frank regulations before making adjustments to their policy. The uptick in the disclosure of hedging/pledging policies also continued, and overall, 86% of Early Filers disclose having both. Lastly, 14% of Early Filers voluntarily disclosed a supplemental table, graph or discussion of realized/realizable pay. In-line with CAP’s recent research on this topic and disclosure in 2013 proxies, these companies tend to compare realized/realizable pay with target or Summary Compensation Table pay values, as well as alignment with TSR.

Conclusions

While the Early Filers research is a sneak preview into the upcoming proxy season, we expect to see directionally consistent trends with these changes and practices indicated from our research. Companies are continuing to demonstrate good corporate governance and policies / programs that enhance company performance and pay linkages. Since there have not been significant changes in proxy advisory firm policies or expanded Dodd- Frank legislation, we do not expect to see significant program overhaul in the current proxy season. Companies with low SOP support will likely disclose more significant program modification.