The Wall Street Journal/Hay Group CEO Compensation Study 2010

Performance outweighs governance concerns as CEO pay increases markedly

As public companies braced for the impact of the first year of mandatory ‘say on pay’, the passage of the Dodd-Frank Financial Reform Act, and increasing governance oversight on all things related to executive pay, their boards approved pay levels that were substantially higher than in 2009.

Coming into 2011, most expected to see much greater pressure on CEO pay levels. Instead, the results from this year’s The Wall Street Journal / Hay Group 2010 CEO Compensation Study suggest that despite the drumbeat of enhanced pressure on executive pay issues, strong company performance will still carry the day in driving pay levels.

However, while pay levels showed increases that were in line with company performance improvements, the structure of pay saw meaningful changes, as more companies increased their emphasis on performance-oriented long-term incentive programs, and continued to eliminate some of the “extras” like executive perquisites.

As a result, after a 2009 in which pay-for-performance hit a bump in the road, companies looked to be back on track by showing strong alignment between pay and performance in 2010, and by adopting structures to enhance this alignment in the future.  

Pay levels increase at a marked rate, buoyed by strong company performance

After a 2009 in which total compensation actually fell for CEOs of the largest companies, the trend reversed itself in a big way in 2010. Base salaries remained flat at $1.1 million, while annual incentive payments increased by 19.7 percent to $2.2 million, yielding a 12.8 percent increase in overall cash compensation at $3.4 million. For the first time in two years, long-term incentives increased, they grew 7.3 percent to $6.2 million.

From a performance perspective, both companies and their shareholders had very big years. The median company showed an 17 percent increase in net income from 2009, alongside a very strong one year total shareholder return of 18 percent.

The biggest pay increases were seen in the Basic Materials sector, where pay levels increased 27.7 percent on the strength of a 60.4 percent increase in net income, and a 14.3 percent one-year total shareholder return. On the other end of the spectrum, Health Care companies showed the smallest increase at a 0.2 percent, while holding the second-smallest increase in net income at 7 percent, and the lighest shareholder return at 4.5 percent.

The heavily-watched Financials sector showed some of the most interesting results of our study, as companies increased their net income 26.1 percent and returned 15.8 percent to their shareholders, while holding pay levels to a modest 1 percent increase – an indication that boards in the sector are continuing to tread very carefully amidst regulatory scrutiny and the court of public opinion.

Companies emphasize long-term performance and balance in their equity portfolios

After a turbulent 2009 in which companies moved towards retention-oriented time-vested stock plans, they reversed course in 2010 by increasing their emphasis on plans that only pay out when companies achieve long-term objectives.

Performance awards made up 41% of the long-term incentive value provided to CEOs in 2010, up from 37% in 2009. Time-vested restricted stock was essentially flat moving to 25% (from 24%) of long-term incentive value, while stock options declined from 39% in 2009 to 34%. This was perhaps the strongest evidence that companies are taking pains to better align total LTI value with specific longer-term company outcomes.

However, companies also moved to further diversify their use of long-term incentives by increasing the number of vehicles they use. All three major LTI vehicles increased in prevalence, with 71 percent of companies now taking a “portfolio” approach to their long-term incentive grants. Stock options remained the most frequently used with 70 percent of companies using this vehicle (up from 64 percent in 2009), followed closely by long-term performance plans used by 68 percent of companies (compared with 58 percent in 2009).

Time-vested restricted stock also saw an uptick, used by 55 percent of companies (up from 46 percent in 2009). For the second year in a row, the actual value of these LTI awards by the end of the year was likely to be significantly higher for CEOs then they had been when they were first granted, given the strong increases in shareholder value over 2010. When combining these new grants with the equity grants made during the stock market lows of early 2009, most CEOs were likely to be sitting on substantial “in the money” equity value by the end of 2010.

Perquisites continue their fall

Fifty-five companies (16 percent of the sample) disclosed eliminating at least one perquisite. Atop this list were tax gross-ups on perquisites, with 28 companies eliminating these, followed by 10 companies eliminating country club memberships. Personal use of the corporate aircraft remained the most prevalent perquisite in Hay Group’s study, with 219 companies (63 percent) providing this perquisite.

Perquisites can be difficult for many companies to manage, as they look to balance the need to provide benefits that serve legitimate business purposes with shareholder outrage over items that many believe executives should be able to pay for themselves. For most companies, this balance becomes even more difficult to manage in a down economy, with increasing pressure by the federal government on these ‘extras.’ By the end of the year, many companies decided that these items weren’t worth the attention they were getting, forcing executives to bite the bullet and pay their own way on many of these items.

Looking back, looking ahead

The post-mortem of 2010 suggests that despite increasing governance, Main Street and regulatory pressure on executive compensation, pay levels will continue to increase when company performance improves.

Thus far, the 2011 proxy season has not been much of a test of shareholders’ views on executive pay programs. As pay levels have increased, and even as shareholder advisory groups like Institutional Shareholder Services and Glass Lewis have recommended voting AGAINST company ‘say on pay’ proposals, relatively few shareholders have actually used their advisory vote to oppose pay decisions.

This outcome begs the question of the degree to which shareholders actually concern themselves with company pay levels while their returns remain high. Clearly, the better test of whether or not executive pay is linked to performance – and of shareholders’ tolerance for those outcomes – will always tend to be in years where companies did not perform well. Even 2009 may not have been enough of a test of this relationship, as although companies paid higher compensation to CEOs for making less money than they had in the previous year, shareholder received a remarkable return – and voted down a very small percentage of ‘say on pay’ proposals.

However, the results from our 2010 study do suggest that more company boards are starting to plan for that rainy day where shareholders do not have such strong years. The focus in 2010 was more on the structure of their executive pay programs, in the hopes that they will achieve alignment between future performance and future pay outcomes when performance isn’t as strong.

We expect these trends to continue, where the focus in the boardroom will remain on the key features and elements of the pay program, including those that directly impact pay-for-performance outcomes – setting performance goals, use of discretion vs. formulas, choices of equity vehicles – as well as those that are more optical in nature – like the presence of perquisites, severance & change-in-control provisions, and stock ownership guidelines.

We also believe that shareholders will continue to evolve as evaluators of pay outcomes, by developing more of their own tools and philosophies to assess these areas. As they take on greater accountability in these discussions, we look for shareholders to place less emphasis on the opinions and analyses of the shareholder advisory groups. As a result, effective shareholder communication – through public disclosures as well as through direct outreach – will only become more important for all companies to consider. Companies themselves are evolving in learning who their largest and most influential shareholders are, who they listen to, and how they tend to vote on these issues.

About The Wall Street Journal / Hay Group 2010 CEO Compensation Study

Hay Group’s study focuses on the primary elements of compensation for CEOs of the 350 largest U.S. companies to file their final definitive proxy statements between May 1, 2010 and April 30, 2011.

Learn more about the study