Executive Compensation: Long Term Incentive Trends

Background.  We have discussed in recent years evolving trends in “total compensation”, especially in long term incentives (which typically are in the form of stock-based compensation.)  Changes have come slowly.  However, several significant events occurred during 2011—insider trading controversies, a downgrade in the U.S. credit rating, and mandatory Say on Pay voting for most U.S. public company shareholders—which seem to have accelerated the pace. While some of these events were unexpected, companies had been preparing for Say on Pay (and the Dodd-Frank Act) well in advance, and the threat of failing caused many companies to address vulnerabilities in the design of their compensation programs for the 2011 proxy season. As a result, the landscape of executive compensation saw more change this year in long-term incentive usage than in any recent year since 2007.

Setting the Table(s).  The Securities and Exchange Commission (SEC) initiated change at the end of 2006 by overhauling proxy disclosure rules, requiring public companies to provide more detailed information (both narrative and tabular) about executive compensation programs in their proxy statements. This provided shareholders, pension funds, activist investors, and proxy advisory firms more detail for scrutinizing pay-for-performance in executive compensation, and compelled corporations to consider changes to compensation programs.  As a result, in 2007 following the effective date for the new SEC rules, company usage of performance-based long-term incentives showed a marked increase.

Since then, long-term incentive practices have changed only modestly—until now. Armed with several years of expanded executive compensation disclosure in proxy statements, investors this year could voice their opinions by voting on any perceived link or disconnect between pay and performance. Further, with volatileU.S.and global economies, and investor displeasure with company performance, proxy advisory firms (ISS, Glass Lewis, etc.) are exerting greater pressure (if not influence) in recommendations on shareholder voting. These forces converged to bring about a considerable change in the executive compensation long-term incentive landscape, with a spike in the usage of performance shares and some simplification of grants in an effort for transparency.

Trends Among the Top 250.  Frederic W. Cook & Co. recently released its “Long Term Incentive Grant Practices for Executives 2011 Top 250 Report”, and quoted below are key findings:

“• For the first time in the history of this report, the use of long-term performance shares now is more prevalent than the use of stock options, while the prevalence of time-vesting restricted stock awards appears to have stabilized.

• Stock options continue to decrease in prevalence, but are not expected to go away, as they are by nature a performance-based long term incentive vehicle and a common complement to full-value share awards.

• Variations of basic grant types (like “premium” or “performance accelerated” stock options), common in years gone by, have dwindled and are on the brink of extinction, perhaps casualties of greater transparency and simplicity in a Say on Pay environment.

• Vesting periods of awards, and performance periods for performance awards, remain stable at three years.

• The use of profit measures and total shareholder return in long-term performance plans continues to be the most widely used performance categories, and the prevalence of types of measures used for performance awards has stabilized.”

Trickling Down Trend?  What conclusions, if any, should we draw from the Cook report?  First and foremost, we admit that what the Top 250 companies do and what smaller publicly-traded companies usually does differ considerably in amount and degree, but we also acknowledge the inevitable “trickle down” effect.  Beyond that:

  • As we have noted on many occasions, the use of full value grants (restricted or performance-vested stock) continues to find favor among investors, as well as regulators.  There are good reasons for this.
  • As we see further iterations of disclosure, greater attention is being paid to “outliers.”  We have written about the relatively modest fallout from the first round of Say on Pay, but the full story has yet to be told.
  • No executive compensation “story” can be told effectively without linking pay and performance with transparency.  Hiding the ball is not an option.
  • Efforts to promote good governance, especially in the area of executive compensation, are here to stay.  Even as we await another raft of regulations under Dodd-Frank (and others), now is a good time to review the fundamentals.

 Bob Musick, Titan Group LLC                                                           

Robert L. Musick, Jr.                                     Richard Deutsch

(804) 249-6027                                            (804) 249-6026

bmusick@titanhr.com                                   rdeutsch@titanhr.com


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