CEO Pay: A Middle Market Perspective

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CEO Pay: A Middle Market Perspective, presented to the Minneapolis-St. Paul NASPP Chapter on March 27, 2014. …

CEO Pay: A Middle Market Perspective, presented to the Minneapolis-St. Paul NASPP Chapter on March 27, 2014.

Executive compensation has continued to evolve in recent years. Companies are increasingly required to balance the need for competitive pay with the need to respond to increased scrutiny, particularly with regard to the relationship between pay and performance.
To provide some insight and perspective, Buck Consultants has recently completed a study of executive compensation practices and trends in the middle market. In this study, Buck analyzed total direct compensation for Chief Executive Officers in companies listed on the S&P 400 MidCap Index.
In this presentation, we will discuss our findings with regard to both current practices and trends for CEO pay in these Mid-Cap companies. Because long-term incentives typically comprised the largest portion of executive compensation, our study focused on prevalence, mix, usage and design of equity vehicles. Finally, we will look at governance issues, including corporate governance concerns and the degree of alignment between pay and performance.

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  • 1. A Middle Market Perspective Executive Compensation March 27, 2014
  • 2. Agenda • Today, we will: - Take a look back o Perspectives on 2013 o Results of the S&P Mid-Cap Index Study - Take a look forward o 2014 issues and emerging trends 2 MSP NASPP: CEO Pay
  • 3. What did we see in 2013 Simply put…more of the same… “drifting with a purpose” • Pay less while paying more • “Play” for performance • Decisions driven by disclosure • “Optics” continue to be a major feature in plan design • Continued pressure on “problematic” practices • Continued oversight by outside advisors, e.g., ISS, Glass Lewis 3 MSP NASPP: CEO Pay
  • 4. S&P 400 Midcap Index • This study covers CEO’s in 321 non-financial companies within the S&P Midcap 400 Index • This database is updated twice a year, in June and in December • As a result, data can span fiscal years based on filing dates and when the database was last updated 4 MSP NASPP: CEO Pay
  • 5. Industry Breakout 5 MSP NASPP: CEO Pay This Index provides a good cross section of industries Consumer Discretionary 21% Consumer Staples 4% Energy 7% Healthcare 12%Industrials 21% Information Technology 19% Materials 8% Telecommunication Services 1% Utilites 7% Industry Distribution
  • 6. Revenue Breakout 6 MSP NASPP: CEO Pay Also provides a good representation of “Middle Market” Less $1B, 17% $1B- $5B, 67% $5B - $10B, 13% "10B +, 3% Revenue Breakout
  • 7. Target Total Direct Compensation 7 MSP NASPP: CEO Pay • Targeted TDC increased 12% from 2011/2012 to 2012/2013, slightly above the annual 9% movement we saw last year 7 Target Total Direct Compensation = Base Salary + Target Cash Short-Term Incentive + Grant Date Value of Stock Options (as reported by Company) + Grant Date Value of Restricted Shares + Target Value of Performance Share Grants. $2,642,565 $3,123,328 $3,460,775 $4,175,268 $4,547,221 $5,110,040 $5,654,551 $6,042,506 $7,069,947 2010/2011 2011/2012 2012/2013 Target Total Direct Compensation 25th %ile 50th %ile 75th %ile
  • 8. 8 MSP NASPP: CEO Pay Target Total Direct Compensation $6,568,500 $5,531,253 $4,787,403 $4,704,182 $4,614,921 $4,271,669 $3,508,264 $2,817,634 Construction Wholesale/Retail Services Manufacturing Communications Mining Transportation Utilities Last Fiscal Year Target Total Direct Compensation By Industry
  • 9. 9 MSP NASPP: CEO Pay Target Total Direct Compensation -7% 12% 13% 10% 6% 13% 21% 14% Year over Year Change in Target Total Direct Compensation By Industry Median
  • 10. Base Salary 10 MSP NASPP: CEO Pay $634,729 $673,308 $700,000 $806,540 $835,000 $840,000 $969,755 $1,000,000 $1,000,000 2010/2011 2011/2012 2012/2013 CEO Base Salaries 25th %ile 50th %ile 75th %ile CEO base salaries were relatively flat compared to last year, following a 3.5% increase over the prior year
  • 11. Short-Term Incentive Plans (STIP) 11 MSP NASPP: CEO Pay $660,000 $723,000 $678,330 $846,260 $903,455 $900,800 $1,125,000 $1,230,408 $1,209,500 2010/2011 2011/2012 2012/2013 Short-Term Incentive Plan Targets (Excludes Zeroes) 25th %ile 50th %ile 75th %ile Target STIP values were also relatively flat compared to last year, following a 6.8% increase over the prior year
  • 12. 12 MSP NASPP: CEO Pay Short-Term Incentive Plan Payouts Over 90% of the companies with a formal STIP paid out above target in all three years with payouts relatively flat compared to last year, following a 31% increase over the prior year $579,920 $690,000 $705,729 $837,500 $1,100,000 $1,020,044 $1,313,200 $1,605,294 $1,560,080 2010/2011 2011/2012 2012/2013 Short-Term Incentive Plan Payouts (Excludes Zeroes) 25th %ile 50th %ile 75th %ile
  • 13. Paying for Performance – Short Term Year over Year Increase in Total Cash vs. Net Income Growth Alignment 13 MSP NASPP: CEO Pay -43% 6% 43% 3% 4% 4% -50% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50% Bottom Third Middle Third Top Third CEO YoY Total Cash Compensation Change vs YoY Net Income Change % Change in NI % Change in Total Cash The top 1/3 of performers saw the same change in cash as the middle 1/3, which saw nominally more cash than the bottom 1/3
  • 14. 14 MSP NASPP: CEO Pay About 20% utilized some cash payment in the form of a discretionary payment 21% 17% 19% 2010/2011 2011/2012 2012/2013 Prevalence Discretionary Bonus Payments (% of Companies that Awarded a Discretionary Bonus to the CEO) Discretionary Bonus Payments
  • 15. Discretionary Bonus Payments The value of discretionary increases declined by about 12%, following a 15% increase in the prior year 15 MSP NASPP: CEO Pay $212,000 $150,000 $148,350 $430,000 $494,400 $432,800 $750,000 $921,281 $1,000,000 2010/2011 2011/2012 2012/2013 Discretionary Bonus Payments (Excludes Zeroes) 25th %ile 50th %ile 75th %ile
  • 16. 16 MSP NASPP: CEO Pay Pay Mix: Short-Term vs. Long-Term Long-term compensation continues to surpass that of short-term compensation in the CEOs pay mix 16 41% 38% 44% 59% 62% 56% 0% 20% 40% 60% 80% 100% 120% 2010/2011 2011/2012 2012/2013 Pay Mix Short Term Target Comp vs. Long Term Target Comp PAY MIX Long-Term PAY MIX Short-Term
  • 17. 17 MSP NASPP: CEO Pay Long-Term Incentive Grant Values Long-term incentives as a multiple of base salary have increased significantly in year-over-year comparisons 0.00 1.00 2.00 3.00 4.00 5.00 25th Median 75th 1.30 2.40 3.91 1.92 2.90 4.46 2.10 3.14 4.67 Long-Term Incentive Values as Multiple of CEO Base Salary 2010/2011 2011/2012 2012/2013
  • 18. 18 MSP NASPP: CEO Pay Average Equity Grant Makeup – Mix Value Equity grants continue to shift away from stock options, with the heaviest weight now on performance-contingent shares 18 42% 37% 33% 27% 32% 30% 31% 33% 26% 32% 37% 41% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 2009/2010 2010/2011 2011/2012 2012/2013 Average Equity Grant Makeup Performance-Based Restricted Stock Time-Based Restricted Stock Stock Options
  • 19. 19 MSP NASPP: CEO Pay Equity Grant Vesting
  • 20. 20 MSP NASPP: CEO Pay Equity Grant Vesting 20 0% 10% 20% 30% 40% 50% 60% Immediate 1 2 3 4 5+ 1% 3% 4% 56% 25% 12% Vesting for Service-Based Full Value Awards
  • 21. 21 MSP NASPP: CEO Pay Cash-Based Performance Unit Vesting 21 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 LFY LFY-1 LFY-2 Performance Contingent Awards Performance Period 25th Percentile 50th Percentile 75th Percentile
  • 22. Performance Period for Performance Share Plans The most common performance period is 3 years. Companies with shorter performance periods typically vest over 3 years 22 MSP NASPP: CEO Pay
  • 23. 23 MSP NASPP: CEO Pay Prevalence of LTI Vehicles • Fewer companies granting stock options • Performance-Based Restricted Stock remained steady while Time- Based Restricted Stock saw a slight gain • Cash programs declined slightly 57% 51% 62% 14% 6% 60% 56% 56% 14% 7% 60% 59% 50% 8% 9% 0% 10% 20% 30% 40% 50% 60% 70% PBRS TBRS Stock Options Cash None 3-Year Long-Term Incentive Vehicle Utilization LFY-2 Prevalence LFY-1 Prevalence LFY Prevalence
  • 24. 24 MSP NASPP: CEO Pay Value of Long-Term Incentive Plan Targets Date of Grant values for Last Fiscal Year (LFY) LTIP remained relatively steady after an 11% increase in the prior year $1,542,740 $1,921,173 $1,829,954 $2,660,272 $2,950,520 $2,876,446 $3,835,618 $4,218,631 $4,243,434 $- $500,000 $1,000,000 $1,500,000 $2,000,000 $2,500,000 $3,000,000 $3,500,000 $4,000,000 $4,500,000 LFY-2 LFY-1 LFY Long-Term Incentive Plan Grant Values (excludes zeroes) 25th Percentile 50th Percentile 75th Percentile
  • 25. 25 MSP NASPP: CEO Pay Long-Term Incentive Realizable Values? • Companies will continue to refine the “message” in their CD&A disclosure to help explain equity pay practices to shareholders • We are seeing greater use of “realizable pay” disclosures as a clarifying alternative to grant date LTIP values • Demonstrate that the real value of pay opportunities depends on future stock prices and/or achievement of performance goals which may not ultimately be delivered, not accounting/valuation models • Investors believe that this should be a consideration in a pay-for- performance analysis • ISS has generally considered amounts of "realized" equity and performance grants in the qualitative analysis phase of its pay-for- performance analysis 25
  • 26. 26 MSP NASPP: CEO Pay Paying for Performance – Realized Value Overall alignment between 3-Year TSR and 3-Year Average Realized LTI shows greater gap at high end than low end 26 Realized LTI includes gains from exercisable options, value of vested shares, and Cash LTI payments made within each fiscal year (2010-2013) for a sample of 121 companies. $3,954 $5,774 $13,342 $- $2,000 $4,000 $6,000 $8,000 $10,000 $12,000 $14,000 $16,000 Bottom Third Middle Third Top Third Pay and Performance 3-Year Avg Realized LTI vs. 3-Year Total Shareholder Retun 3-Year Avg Realized LTI ($000) 3-Yr TSR 29.4% 3-Yr TSR 12.7%3-Yr TSR -6.4%
  • 27. 27 MSP NASPP: CEO Pay Long-Term Incentive Vehicle Combinations - LFY • A “portfolio” approach is still popular among companies, with no single combination a “benchmark”; TBRS & PBRS combination was the most common at 19% of companies 19% 17% 13% 13% 13% 10% 7% 3% 2% 1% 1% 1% 1% 0.3% 0% 5% 10% 15% 20% 25% TBRS & PBRS Options, TBRS, PBRS PBRS Only Options & TBRS Options & PBRS TBRS Only Options Only Cash, Options, TBRS Cash, PBRS, TBRS Cash & Options Options, TBRS, PBRS, Cash Cash & TBRS Cash, Options, PBRS Cash & PBRS Percent of Companies with Combination LFY Long-Term Incentive Vehicle Combinations
  • 28. 28 MSP NASPP: CEO Pay Performance Metrics 28 Groups like ISS and Glass Lewis prefer different metrics for short and long-term incentives to mitigate unintended risk 0% 20% 40% 60% 80% MBO Share Price Not Disclosed TSR Relative TSR EVA Working Capital Other Ratio Division Performance Cost/ Cost-Ratio Other Return Cash Flow Qualitative Metrics EPS Revenue Profit/Income/Earnings STI - Performance Share Metrics - FY-1 0% 5% 10% 15% 20% MBO Cost/ Cost-Ratio Division Performance Not Disclosed Other Qualitative Metrics Other Ratio Share Price EVA Cash Flow Revenue TSR Return Relative TSR EPS Profit/Income/Earnings LTI - Performance Share Metrics - FY-1
  • 29. • Now, a look forward… 29 MSP NASPP: CEO Pay 29
  • 30. CEO Pay Ratio • Section 953(b) of the Dodd-Frank Act directs the Commission to amend existing rules to require companies to disclose: - The median of the annual total compensation of all employees of the company - The ratio of that median to the annual total compensation of its CEO • Since September announcement, almost 1,000 "unique" letters and 127,000 form letters have been sent to the SEC • Compliance costs for some companies could be "substantial," even though smaller companies exempt and SEC does not spell out a specific methodology for companies to identify a median employee • Consensus thinking: final rules will be adopted this year substantially as proposed, with the pay ratio disclosure required in 2016 proxies 30 MSP NASPP: CEO Pay
  • 31. SEC and Advisory Firms • SEC announced that it will soon review recommendations for possible regulatory action targeting proxy advisory firms • At an earlier roundtable, concerns were raised about whether the firms properly disclose potential conflicts of interest and whether investment advisers too heavily rely on their advice when they vote on behalf of clients • SEC became concerned after the SEC staff issued letters that permit advisers to rely on the advice without the fear of possible enforcement action • SEC will issue recommendations in “near term”; likely to require more disclosures of conflicts, such as whether a proponent of a shareholder proposal or a competing director slate is a client 31 MSP NASPP: CEO Pay
  • 32. Dodd-Frank: Rules not yet Proposed • Disclosure of Pay vs. Performance - Complex disclosure on relationship between executive compensation actually paid and the financial performance of the issuer - Proposal scheduled end of October 2014 • Recovery of Erroneously Awarded Compensation - “Clawbacks”, likely with teeth - Proposal scheduled end of October 2014 • Disclosure regarding Employee and Director Hedging - Disclose whether employees or directors are permitted to hedge equity of the issuer (granted as compensation or otherwise held) - Proposal scheduled end of October 2014 32 MSP NASPP: CEO Pay
  • 33. Hedging and Pledging • Corporate law does not prohibit a director or executive from pledging or hedging stock, but disclosure is required and no loans under SOX • Section 955 of the Dodd-Frank Act requires that companies disclose whether directors or employees are permitted to hedge company securities. No proposed rules have been published by the SEC • ISS 2013 policy updates identified “hedging of company stock and significant pledging of company stock” by directors and/or executives as examples of “failures of risk oversight.” “Significant” is not defined • The ISS warned issuers that this type of failure, “under extraordinary circumstances,” may result in a vote against or a “withhold vote” declaration with respect to “directors individually, committee members, or entire board.” 33 MSP NASPP: CEO Pay
  • 34. Hedging and Pledging • ISS has opted for a substantive, facts-and-circumstances standard • Will consider the following factors “in determining vote recommendations for election of directors of companies who currently have executives or directors with pledged company stock”: - Presence in the company’s proxy statement of an anti-pledging policy that prohibits future pledging activity - Magnitude of aggregate pledged shares in terms of total common shares outstanding or market value or trading volume - Disclosure of progress or lack thereof in reducing the magnitude of aggregate pledged shares over time - Disclosure in the proxy statement that shares subject to stock ownership and holding requirements do not include pledged company stock - Any other relevant factors 34 MSP NASPP: CEO Pay
  • 35. ISS 2014 Policy Updates • The final updates revise ISS proxy voting policies for U.S. listed companies relating to executive compensation and governance: - Board Response to Majority-Supported Shareholder Proposals o Now: case by case basis - The Quantitative Pay-for-Performance Test Impacting ISS’s Evaluation of Say on Pay (“SOP”) Proposals o TSR and CEO pay relative to ISS peer group solely over 3 year period - The Qualitative Pay-for-Performance Assessment Impacting ISS’s Evaluation of SOP Proposals o Quantitative assessment performed where qualitative analysis demonstrates “significant unsatisfactory long-term pay for performance alignment o “Realizable pay” and granted pay compared to S&P 1500 companies 35 MSP NASPP: CEO Pay
  • 36. ISS 2014 Policy Updates • Glass Lewis now uses a pay-for-performance model that benchmarks executive pay and company performance against four peer groups across seven metrics. - Companies can receive a grade of A to F based on quantitative review - Will vote against say on pay and withhold “For” votes for compensation committee members with pattern of failing • Must disclose extent that short-term incentive have been achieved against relevant targets - Must justify any non-disclosure 36 MSP NASPP: CEO Pay
  • 37. ISS Longer Term Policy Changes • Director tenure • Director independence • Shareholder proposals to require independent chair of board • Evaluation of equity plans (US and Canada) 37 MSP NASPP: CEO Pay
  • 38. What To Expect Going Forward No chance for R&R… • Take a proactive approach to shareholder and advisory group concerns – Look for low hanging fruit • Many companies may considered: – Plan design changes – Holding discussions with institutional investors – Supplemental filings • Enhance strategies to improve shareholder support – Assess pay programs from an advisory group perspective – Re-orient your CD&A so that it serves as an advocate for your pay program and your successes as a company (like an MD&A) • Reach out to major shareholders proactively to understand concerns 38 MSP NASPP: CEO Pay
  • 39. What To Expect Going Forward • Also, you can expect executive compensation to continue to go up… 39 MSP NASPP: CEO Pay
  • 40. 40 MSP NASPP: CEO Pay 40 Questions Jim Sillery Principal 952.806.6114 312.315.2815