Equilar offers more evidence that say on pay has had a direct effect on executive compensation practices at publicly traded companies.
There is more evidence that say on pay has had a direct effect on executive compensation practices at publicly traded companies. Since say on pay was implemented three years ago, corporate boards have become much more aware that the compensation policies they choose for their key executives must measure up to the expectations of investors and proxy advisory firms. That awareness has translated into granting fewer options as equity compensation and using more restricted stock grants when companies look to reward their key executives. In fact, the trends show companies moving away from options and using more results- based shares to draw a stronger alignment between pay and performance.
According to the ‘2013 equity trends report’ from executive compensation and corporate governance research firm Equilar, the percentage of S&P 1500 companies using options grants decreased for the fifth year in a row, falling from 78.5 percent in 2007 to 65.2 percent in 2012. Over the same period, however, the use of restricted stock among S&P 1500 companies increased from 80.1 percent of firms to 92.8 percent. That represents the highest use of restricted stock ever.
‘One of the effects of say on pay has been higher engagement levels between shareholders and companies,’ notes Aaron Boyd, director of governance research at Equilar. ‘As companies are reaching out and discussing pay, explaining their philosophy directly to shareholders and then having a conversation about it, in a number of cases we’ve seen companies make adjustments to their pay plans.’
The adjustment companies have made most frequently has been to decrease the use of options and increase the use of time-based restricted stock and performance-based restricted stock in their compensation plans to ensure executives receive pay for performance.
‘A vehicle like performance-based shares requires an executive not only to stick around for a few years, but also to hit certain performance metrics in order to have their stock awards granted,’ Boyd explains. ‘Some people felt that, with options, all you had to do was stick around for a few years and if the stock price went up, you would receive value for that. A lot of shareholders want to see a stronger correlation between performance and pay.’
Crashing the party
Shareholders want to see this stronger alignment between pay and performance primarily because they saw their portfolios decimated by the stock market crash brought on by the 2008 financial crisis and the recession that followed. The view of options soured in the minds of many when they saw executives profiting from exercising options even as their companies were suffering major losses. ‘There was some debate over whether options were encouraging excessive risk-taking by basically having no downside to a stock price fall and encouraging executives to shoot for big gains by taking more risk,’ Boyd explains.
The Equilar research also shows that say on pay has helped produce another trend: companies have been diversifying their use of equity vehicles within their compensation plans. More companies are using a combination of options, time-based restricted stock and performance- based restricted stock to create a stronger alignment between pay and performance. Boyd says companies are using all three ‘to deliver value to their executives in a number of equity vehicles and not just focusing on one.’
He adds that over the last several years, he has seen firms using multiple equity vehicles with greater frequency and regularity than they have in the past. The reason? ‘To diversify the ways in which compensation is being delivered to their executives in order to hopefully mitigate the risk of somebody finding a loophole or going ‘all-in’ on one vehicle to maximize a payout while neglecting another area of importance for the company,’ says Boyd.
Taking the long view
One area of importance for companies is retaining executive talent, and the Equilar report shows firms are using performance-based equity primarily as a long-term incentive for executives. Approximately 66 percent of all performance-based equity vehicles granted in 2012 were given in the form of long-term incentive plan stock, long-term equity units or long-term options. Using long- term performance-based vehicles provides a better incentive for executives to make decisions that promote the long-term growth of the company. It can also provide higher rewards for those executives who remain with the company longer and continue to meet positive revenue and profit targets.
With the trends showing clear movement toward more performance-based equity in compensation plans, the results over time should yield stronger alignment between pay and performance at more companies because, instead of waiting for shares to vest, executives will have to meet performance metrics in order to cash in their awards. That has been one of the goals of proxy advisory firms ISS and Glass Lewis, which have insisted on better pay-for-performance alignment when handing out positive recommendations for say-on-pay votes. Requiring a certain level of performance to receive an equity award payment is also something many shareholders have been insisting on before they will cast a positive say-on-pay vote.
Boyd suggests other things will come out of these compensation trends as well. ‘This is part of a larger process of companies trying to find a way to ensure their executives are focused on short-term performance, but doing so without it being at the expense of long- term growth,’ he says. By placing the right incentives in the executive’s compensation plans, companies are making sure there is always an eye on long-term growth and that when it comes to business decision making, ‘the things executives are doing are sound and will lead to sustainable growth for both the company and the shareholders,’ he adds.
