Companies may begin stepping away from total shareholder return as main metric to set CEO pay

 

Photo courtesy of Ralph Aichinger on Flickr

Photo courtesy of Ralph Aichinger on Flickr

Rob Swystun, Pristine Advisers

Total shareholder return has emerged as the most popular metric by which to set executive compensation packages, but it might be losing its luster as companies realize it’s not a one-size-fits-all approach.

“It’s not the silver-bullet metric that solves every problem,” Aaron Boyd, director of governance research at compensation-research firm Equilar Inc., stated in a Todd Hennemen article for Workforce magazine.

One of the main shortfalls of using total shareholder return to gauge appropriate compensation according to Greg Arnold, a principal at executive-compensation consulting firm Semler Brossy, is that it tends to reward volatile companies because they more easily rebound from lower performance and then they outperform due to their low starting point.

The trend of using total shareholder return as the base for compensation packages started with the introduction of Say on Pay votes back in 2011, Arnold said.

“Now people are starting to see payouts on them and starting to realize maybe they’re not exactly what they thought they were,” he noted.

Say on Pay largely helped to end what Arnold describes as gross-up payments meant to cover an outgoing CEO’s IRS bill and they also checked absolute compensation growth.

“They’re at the top of everyone’s mind,” he says, “and they drive a lot of the [compensation] plan design elements we’re seeing.”

Those compensation plans have become increasingly similar over the past few years, as Arnold says they’ve become more homogenized due to many companies’ penchant for complying with what the nation’s two major proxy advisors — Institutional Shareholder Services Inc. and Glass Lewis & Co. — consider to be good pay programs.

“Homogenization doesn’t make sense for all companies and all circumstances,” said Arnold. “The challenge for the [compensation] committee is to figure out when to go along with those things that are viewed as ‘best practice’ and when to deviate.”

Deviation may not be in the cards this year, though, as compensation experts expect the current trends to remain strong throughout 2015, continuing to lean toward equity with performance hurdles.

Equilar’s data shows that CEO compensation is tied to equity now more than ever.

“What I think you’re really starting to see now — because a lot of people have moved to performance in equity in the last several years — is a refinement of it,” Boyd said, pointing out that companies have gained a better sense of how to set reasonable targets that still challenge executives using effective metrics that serve investors.

And, at the same time that is happening, discretionary bonuses have fallen out of favor with shareholders.

“Positive discretion is one of those things we don’t see exercised very often,” Boyd said.“And when it is, it’s highly securitized.”

On the Rise

With all that said, though, executive compensation seems to have gone up this past year, although the rise seems to be tied to companies’ performance.

The Association of Executive Search Consultants surveyed 900 members of its candidate database in October and November 2014 and found:

  • 43% of the CEOs received base salary increases in 2014;
  • 56% of other C-suite executives received base salary increases in 2014;
  • Of the CEOs whose compensation grew, almost ¼ of them received raises of 16% or greater.

The association’s senior marketing manager, Julia Salem, said the raises reflect a closer alignment between CEO compensation and company performance, as executive pay has increased along with rising company profits.

On the other side of the coin, four percent of CEOs and two percent of other C-suite executives saw a decrease in their pay, according to the AESC’s BlueSteps Executive Compensation Report.

The AESC’s survey captured data from a wide range of organizations, encompassing organizations with annual revenue from less than $5 million to more than $50 billion. Sixty-eight percent are privately held, 28% are public and 4% are nonprofit. The average CEO compensation in AESC’s survey was $312,494.

Median total compensation for CEOs among Standard & Poor’s 500 firms was $10.1 million in 2013, up from $9.3 million in 2012, according to Equilar.

As companies realize that total shareholder return isn’t a one-size-fits-all proposition, the CEO compensation landscape may undergo a shift in the coming years, but the most likely scenario is that it will continue to go in the only direction it ever seems to go in; up.

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