Recently Towers Watson released its  "2010/2011 Report on Long-Term Incentives, Policies and Practices." Here are a few highlights of current trends:

Award Types and Emphasis Shifting

Back in the 1990s, companies overwhelmingly relied on stock options as their primary or exclusive long-term reward vehicle.  As we entered the 21st century, the use of restricted stock (RS) became more prevalent, especially after Microsoft and Amazon.com moved from options to restricted stock in the 2003 time frame.  The Towers Watson study showed options being granted at 89% of companies in 1999, with a steady drop to about two-thirds (68%) of companies in 2010.  During the same time frame, restricted stock usage soared from 14% of companies in 1999 to 71% in 2010.

Performance awards (shares that grant and/or vest based on meeting certain performance metrics) also increased from 48% to 69% in the 1999 to 2010 span, with most of these types of awards going to senior level managers and executives, although we are starting to see them become somewhat more prevalent at lower levels in some companies.

Blended Approaches Becoming More Common

With options, restricted stock and units (RSUs) and performance shares all fairly prevalent today, many companies today are utilizing more than one type of long-term incentive (LTI).  In 2010, more companies were granting at least two types of LTI awards -- 73% of survey respondents indicated this practice, an increase of 10% from 2009, and an even greater increase from prior years.  Larger companies are more likely to utilize two or more types of awards than smaller companies.  Pre-IPO companies are still largely reliant on utilizing options as their primary LTI tool.

Performance Awards Moving Up

Towers Watson is seeing a strong trend towards performance awards, which are now the second most common type of long-term incentive offered by survey respondents, jumping slightly ahead of stock options in the most recent study.  This trend is almost certainly going to continue.  So-called "full value shares" (RS/RSUs) were the most common type of LTI offered in 2010, but restricted stock seems to have possibly peaked, with performance shares continuing on the rise.  The National Association of Stock Plan Professionals (NASPP) 2010 Stock Plan Design and Administration Survey also showed a strong trend towards performance awards, although that study did not show them outpacing the usage of stock options as the Towers Watson study did.

LTI Award Values

For employees earning under $200,000, award sizes (as a percentage of salary) remained flat from 2009 to 2010 in the Towers Watson survey. For employees at higher salary levels, however, award sizes increased, although not quite to 2007 and 2008 levels.

Summary

Both in the Towers Watson study and in our own practice, we are seeing more companies move away from stock options as their primary LTI vehicle.  For many pre-IPO and early stage companies, however, options still make the most sense.  For public companies though, stock options are becoming a less frequentlyused and a smaller piece of total LTI package.  Due to the shifts described above, many companies are now using more than one type of equity in crafting their LTI offerings and moving a greater percentage of their offerings to full-value shares (RS/RSUs) and performance shares.

A recently released study of board of directors compensation by Hewitt details the shifting trends of board compensation over the past few years.

The study reveals that about 42% of director compensation is in the form of "retainer" fees (non-contingent compensation paid for membership on the board, typically paid in for the form of cash), about 15% is in the form of meeting attendance and/or committee fees, while the remainder (43%) is in the form of equity/stock.  See the chart below for a graphical view (thanks to Hewitt and the Compensation Force blog for the graphic).

Other Interesting Information:

The study, which focused on public companies (the only ones required to report this kind of data) also reported that:

• About two-thirds of companies in the study had stock ownership retention guidelines that require board members to retain a certain amount of stock (commonly as a multiple of their annual retainer).
• Committee heads typically receive additional cash retainer compensation (the median was $10,000 annually for audit and compensation committee chairs).  This data has remained fairly stable for the past two years.
• Most retainer fees are paid in the form of cash.  A small minority of firms pay in the form of stock or via a stock/cash mix.
• Additional retainer fees are typically paid to "lead directors" (the lead non-employee/independent director) and non-employee board chairpersons.

The report summary is nearly 70 pages in length, so if this is a topic of interest to your work, please click on the link for more information.

Corporate performance and CEO pay are poorly correlated, according to executive compensation expert Graef Crystal.

Crystal recently completed a study for Bloomberg News on the relationship between shareholder returns and CEO pay, and found that no matter how the data was sliced, the relationship was a poor one.  In other words, the relationship between what shareholders earn on their investments in a company and and what CEO earns is not a very good one.

By viewing the interactive graph at this link,  one can see that the link between pay and stock performance is a tenuous one. The data is based on over 2009 data from 271 large public companies that have already reported their financial results and their executive compensation.  2009 was a very good year for the most stocks, but a generally poor one for most businesses, so we should expect some divergences.

In periodic posts in the coming months we will look closer at this topic, as it's a "hot" one that won't seem to go away.

Upcoming StrategicPay Series Workshop:

Don't miss our upcoming intensive  1/2 day workshop "Utilizing Market Data and Conducting a Competitive Pay Analysis" on June 10th.  See here for more information.

"White House Appoints "Czar" to Oversee Executive Pay"

My jaw just about hit the floor when I saw this headline several weeks ago in the NY Times and Wall Street Journal.  I know we have a drug czar, and an auto czar, but a compensation czar? (And aren't czars from old-world Russia?).  What's the world coming to? 

Now that the new Pay Czar is firmly in place, he's making his impact felt.  In addition to reviewing and setting guidelines for many of the largest bailout companies, he most recently got departing Bank of America CEO Ken Lewis to forgo his salary and bonus for this year.  While I'm certain not a fan of Mr. Lewis, it does raise government intervention into individual pay determination to to a new and disconcerting level.

The mixed messages and changing tunes on executive compensation coming out of Washington these days are enough to keep my head spinning, but this is a case of the Feds clearly over-stepping its bounds (and its expertise).

It seems to me that there has been a lot of attention (obsession?) paid to regulating executive compensation, instead of the far larger issues of regulating the the reckless use of financial leveraging, structured investments, securitization, and the rating agencies that helped create all of the "AAA" rated mortgage securities (that many turned out to be nothing close to investment grade).  And what has happened to the "risk management" profession (which was completely asleep at the wheel on this one)?

A very good article in the WSJ (subscription may be required to view article) on "Risk vs. Executive Reward" says it well.  Not even the experts (the people who work with and manage executive compensation plans regularly) can agree on cause-effect relationships of risk vs. pay, and when risk becomes "excessive."  A recent study by Watson Wyatt even debunks many of the conventional belief systems around risk and reward.

The keys issue to me are:

• The government has virtually no expertise in executive rewards, incentives, or compensation (just look at their own reward and performance management systems!).
• Companies should determine their own compensation plans (within the tons of rules and regulations that already exist), period.  It's called self-determination, and the feds want to take that away.  Let the "Say on Pay" movement handle shareholder dissatisfaction with the plans that are developed for public companies.
• Let Washington regulate the financial markets, and financial risk within financial and related institutions, but how a business chooses to drive performance and pay for that performance should be (mostly) none of their business.
• Executive compensation is already one of the most heavily-regulated and complicated areas in business already, with the intersection of financial reporting and disclosure, accounting regulations, taxation issues, securities law, all focused on this topic already.

Of course, there certainly have been some abuses, and most have taken a beating in the press (and other places) for it. But since when has just about anybody in Washington shown a true facility for running a real business, or determining how to incent performance?  Best I can tell, the Feds haven't even learned how to manage non-performance at the federal employee level yet, let alone managing business performance, or managing a business that has to earn a profit to survive (unless you're bailed-out by the Feds, of course!).

Granted, virtually all of this was happening under the noses of the executives currently being excoriated, but it certainly wasn't their compensation plans that lead us to the mess we are in today (and while many made millions during the latest bubble, they also lost many millions more when that bubble popped as well).

There is a lot of hard work that needs to be done to fix our financial system, but regulating executive pay is a bit issue compared to multi-trillion dollar mess than was created by horrible risk management, irresponsible business practices, the over-use of leverage and fancy Wall Street financial packaging that should all be regulated more closely.

OK, I'm getting off my soap box... Whew! I feel better already...

The SEC Proposes Revisions to Proxy Disclosure of Executive Compensation

(Note: the following post was written by guest blogger Frank Glassner, CEO of Veritas  Executive Compensation Consultants. This post is reprinted with the author's permission. See below for Frank's contact information)  

On July 10, the U.S. Securities and Exchange Commission (SEC) released a proposal to make several revisions to the manner in which executive compensation is disclosed in a public company's annual proxy, and related matters. If adopted, the revisions would apply to the 2010 proxy season.

For the most part, the proposed revisions represent fine-tuning of the comprehensive revision of the compensation disclosure requirements adopted by the SEC in 2006. They also contain new disclosure requirements that reflect public perception surrounding the causes of the current financial crisis—particularly the perception that incentive policies focused on short-term results have encouraged excessive risk-taking. This article outlines some of the principal revisions proposed by the SEC, which include:

Disclosure of Effect of Compensation Practices on Risk

The SEC has proposed an addition to the Compensation Discussion & Analysis (CD&A) section of the proxy discussing the manner in which the company's overall compensation policies can create incentives for employees that affect the company's risks, and the procedures the company has in place to manage such risks. This section of the CD&A would not be limited to the five most highly compensated officers, but would require a discussion of the manner in which bonus and other compensation plans and policies may create incentives for all employees to cause the company to engage in risky behavior that could have a material effect on the company. The proposal contains a number of specific issues that may need to be addressed in this section, including the extent to which the company has implemented policies to offset the tendency of incentive plans to reward short-term risk taking behavior, such as clawbacks and mandatory bonus deferrals.

Additional Disclosure About Directors and Nominees

The proposal would require that a proxy discuss the qualifications of directors and nominees for positions on the board of directors, with specific reference to the relevance of the director's or nominee's qualifications to the business of the company. The proposal would also require disclosure of all other board memberships held by each director or nominee during the prior five years (right now, only current memberships need be disclosed), and would expand the requirement to disclose legal proceedings in which directors and nominees (and executive officers) have been involved from the prior five years to 10 years.

Discussion of Leadership Structure

The proposal would require a discussion of the company's leadership structure and the philosophy behind the structure. Most notably, this would require companies to explain why the company has chosen to combine (or separate) the roles of chairman and CEO. The proxy would also be required to describe the role of the board of directors in the company's risk management.

Disclosure of Services Performed by Compensation Consultants

The proposal would require the company to disclose whether any other services have been performed for the company by compensation consultants and, if so, the amount of fees paid for such services. Although the SEC proposal would only require disclosure, Treasury Secretary Geithner has suggested that the administration may introduce legislation that would actually prohibit compensation consultants from performing other services for the company, reflecting a perception that compensation consultants who receive other business from the company have a conflict of interest that may cause them to recommend excessive compensation for senior management.

Reporting of Stock and Option Grant Value

Reversing a last-minute decision made when the current compensation disclosure rules were finalized in 2006, the new proposal would require that the total fair value of stock and option awards as of the grant date be included in the Summary Compensation Table. At present the Summary Compensation Table includes the amount of compensation expense that the company must recognize each year under generally accepted accounting principles. The SEC explained that the total fair value as of the grant date is a more meaningful figure in evaluating an executive's total compensation. In addition, the current market crisis has caused the amount of income recognized on an annual basis to be negative in years following the year of the original grant, which the SEC believes unrealistically reduces an executive's total reported compensation. To avoid duplication, the total fair value of grants will be deleted from the Grants of Plan-Based Awards table.

Accelerated Reporting of Shareholder Votes

Under the proposal, the result of shareholder votes would be reported on a Form 8-K, which generally must be filed within four business days of the shareholders meeting. Currently, the results of shareholder votes do not need to be reported until the company's next quarterly (10-Q) or annual (10-K) report.

Changes in Proxy Solicitation Rules

The SEC has also proposed changes to the rules governing the proxy solicitation process, specifically the circumstances in which a person communicating with shareholders must comply with the disclosure requirements applicable to a proxy solicitation. These changes would generally facilitate actions by minority shareholders and shareholder activists, including "just say no" campaigns in which a shareholder urges other shareholders to withhold votes in favor of management proposals. The new rules would also codify recent SEC guidance by facilitating "short slate" proxy solicitations, in which the person soliciting the proxy does so in order to vote for one or two specific candidates for the board, but also receives the discretion to vote for other board candidates (whether company nominees or other shareholder nominees) not listed in that person's solicitation.


Note: the following post was written by guest blogger Frank Glassner, CEO of Veritas.  Visit their website at www.veritasecc.com, call him at (415) 618-6060, or via email at fglassner@veritasecc.com. He'll gladly answer any questions you might have.

This post is reprinted with the author's permission. Thanks Frank.

"White House Appoints "Czar" to Oversee Executive Pay"

My jaw just about hit the floor when I saw this headline last week in the NY Times and Wall Street Journal.  I know we have a drug czar, and now an auto czar, but a compensation czar? (And aren't czars from old-world Russia?).  What's the world coming to? 

The mixed messages and changing tunes on executive compensation coming out of Washington these days are enough to keep my head spinning, but this is a case of the Feds is over-stepping its bounds (and its expertise).

It seems to me that there has been a lot of attention (obsession?) paid to regulating executive compensation, instead of the far larger issues of regulating the the reckless use of financial leveraging, structured investments, securitization, and the rating agencies that helped create all of the "AAA" rated mortgage securities (that many turned out to be nothing close to investment grade).  And what has happened to the "risk management" profession (which was completely asleep at the wheel on this one)?

A very good article in the WSJ on "Risk vs. Executive Reward" says it well.  Not even the experts (the people who work with and manage executive compensation plans regularly) can agree on cause-effect relationships of risk vs. pay, and when risk becomes "excessive."  A recent study by Watson Wyatt even debunks many of the conventional believe systems around risk and reward.

The keys issue to me are:

• The government has virtually no expertise in executive rewards, incentives, or compensation (just look at their own reward and performance management systems!).
• Companies should determine their own compensation plans (within the tons of rules and regulations that already exist), period.  It's called self-determination, and the feds want to take that away.  Let the "Say on Pay" movement handle shareholder dissatisfaction with the plans that are developed.
• Let Washington regulate the financial markets, and financial risk within financial and related institutions, but how a business chooses to drive performance and pay for that performance should be (mostly) none of their business.
• Executive compensation is already one of the most heavily regulated and complicated areas in business already, with the intersection of financial reporting and disclosure, accounting regulations, taxation issues, securities law, all focused on this topic already.

Of course, there certainly have been some abuses,and most have taken a beating in the press (and other places) for it, but since when has just about anybody in Washington shown a true facility for running a real business, or determining how to incent performance?  Best I can tell, the Feds haven't even learned how to manage non-performance yet, let alone managing performance, or managing a business that has to earn a profit to survive (unless you're rescued by the Feds, of course).

Granted, virtually all of this was happening under the noses of the executives currently being excoriated, but it certainly wasn't their compensation plans that lead us to the mess we are in today (and while many made millions during the latest bubble, they also lost many millions more when that bubble popped as well).

There is a lot of hard work that needs to be done to fix our financial system, but regulating executive pay is a bit issue compared to multi-trillion dollar mess than was created by horrible risk management, irresponsible business practices, the over-use of leverage and fancy Wall Street packaging that should all be regulated more closely.

OK, I'm getting off my soap box... Whew! I feel better already...

Reviewing the recently released Fredrick W. Cook Co. report "The 2008 top 250 - Long-Term Incentive Grant Practices for Executives" re-reminded me about how fast trends are moving in the executive compensation arena.

Less than a decade ago, executives were being showered with plain-vanilla stock options on a regular basis, and many executives had never even heard of terms such as restricted stock, "full-value" awards, or performance shares.  Today, those plain-vanilla options are on the decline, while restricted stock and performance shares are a regular part of the long-term incentive lexicon, especially in public companies.

The report, which focused on very large public corporations, shows a dramatic shift in long-term incentive practices in recent years, first away from stock options, then to restricted stock (or RS units - RSUs), and today more towards performance shares (essentially performance-restricted stock, instead of time-restricted stock). While some readers may wonder if trends in large public corporations are relevant to their organizations, at least in the executive compensation arena, most of the trends and innovations tend to start in larger corporations (who have the internal staff and external consultants to research and develop new or revised approaches to long-term incentives).

While stock options remain the most common form of long-term incentive (LTI) granted to executives, the percentage of execs receiving them has dropped from 90% to 79% between 2005 and 2008.  Over the same period, restricted stock, which gained ground earlier in the decade, has actually dropped slightly in usage (from 66% to 60%), largely at the expense of increased use of performance shares. 

Performance shares, which are earned (are granted and/or vested) based on the achievement of predetermined goals over a specified period of time, have gained significant traction over the past few years. In 2005, 40% of large-company executives received them, while in 2008 that percentage had increased to 60%. 

The report also states that this increasing trend toward performance shares will continue, with an increasing percentage of firms considering or planning their use in the future. According to the report, they are the only major type of LTIs that are increasing in prevalence of usage right now.

The movement towards performance shares is likely to please at least some of the executive pay critics who have claimed (often correctly) that many executive compensation plans and practices were not "pay for performance" oriented enough. 

Attended the Wall Street Journal / Hay Group 2008 CEO Compensation Study webinar earlier this week and learned a lot about what's happening in CEO pay over the past year. The trends and changes are many.

The study looked at proxy filings for 200 large (>$5B in revenue) public companies that filed their proxy reports in the 10/08 to 3/09 period, so the data is very current.  While I realize that most of our blog followers are not in companies of this size, many (if not most) major trends in executive compensation tend to come out of larger firms, who have the internal and external resources to research, develop and implement new and new, different and "game-changing" executive compensation programs.

While the issues and trends discussed in the study are too numerous to cover here, below are some of the major trends and issues discussed with regard to CEO compensation:

• CEO total compensation dropped in 2008 for the first time since 2001, when the U.S. was in a recession and suffering from post-Internet "bubble."
• The drop in Total Cash Compensation (TCC) was -8.5%, due to a drop in cash incentives of over 10% in 2008 vs. 2007 (base pay was up 4.5% in 2008; it won't be up that much this year though).
• Total Direct Comp (TDC), which is total cash comp or TCC, plus realized gains from stock or other sources was down 3.4%.
• The shift away from stock options towards performance shares (stock that grants and/or vests based on the achievement of predetermined performance targets) continues. The use of restricted stock was down slightly, largely at the expense of performance shares.

Some major executive comp practice trends noted in the survey were:

• More and more companies are reducing or changing some of the more egregious (at least from the outside critics' perspectives) executive compensation practices (see details below).
• Executive perquisites or "perks" were roughly flat in 2008 with 2007, after several years of gains. Recently imposed reporting requirements, as well as increased scrutiny of these perks may have slowed down their growth.
• Gross-ups (covering the taxes owed by an executive on compensation, often on special perks) are declining in prevalence, due to their widely negative perception. There's an article on this in the 4/21 Wall Street Journal (paid subscription required).
• Clawbacks (the ability to recover an ill-gotten gain) are increasing in usage (and are required under the Federal TARP program).
• The "Say on Pay" (non-binding shareholder votes on executive compensation plans) movement is gaining steam. While not required now, it was the feeling of the expert panel that eventually, this may be required by Congress (it already is for TARP recipients).

Other trends noted in the presentation:

• Increased emphasis on performance-oriented equity, such as performance shares. Performance shares have been gaining ground for the past few years, and the panel expect that trend to continue.
• Compensation committees should start to look at concept of "risk" in their executive comp plans. In other words, do the plans they help set encourage excessive executive risk taking? Comp committees should help to "manage" risk in designing executive rewards.
• Companies will be very conservative with base pay in 2009 (this is already happening, with many companies freezing base pay for executives).
• Reduced perks are likely, gross ups on the decline, and pressure to reduce or eliminate high-value golden parachutes.

Well, that's about it for now. The full report should be out in May, and would suggest that those of you who are interested in major trends in executive compensation should look for it via the WSJ or the the Hay Group.