For 2010, Matching Executive Pay to Performance—For Real

By Dec 7, 2009

While Wall Street remains a focal point of public anger over executive compensation, many companies outside of the financial sector are working to more closely match pay to performance and re-examine a number of the pay program features that have proved particularly troubling to shareholders and employees.

Compensation Planning: Looking Ahead to Executive Pay Practices in 2010, a survey report by compensation consultancy Pearl Meyer & Partners, found that even companies that believe they are outperforming their peers project only modest salary increases. Survey respondents indicated that they were taking a cautious approach to design and payout levels of short-term and long-term incentive rewards.

“Such clear differences in pay decisions between strong and poor performers are an indication that pay for performance is working at many firms,” said Jim Heim, managing director of Pearl Meyer & Partners. ”The survey also confirms that companies are slowly but steadily migrating away from many traditional executive perquisite programs.

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“Clear differences in pay decisions between strong and

poor performers are an indication that pay for performance

is working at many firms.”

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The survey was conducted in September 2009. Participants included 100 executive officers, 33 board members and 262 HR professionals representing 377 distinct U.S. organizations. These ranged from large Fortune 50 to emerging high-growth firms. Nearly three-quarters were publicly traded, and 20 percent were closely or privately held, with tax-exempt or government-charted organizations accounting for the remainder.

Miss Benchmarks, Lower Raises

Not surprisingly, the survey found that corporate performance declined across all industry categories in 2009. Only 20 percent of respondents expected to beat their 2009 internal benchmarks for profitability, and only 16 percent expected revenue growth to exceed internal budgets.

Consequently, nearly 64 percent of respondents froze or trimmed executive base salaries in 2009, and more than 20 percent expected to freeze salaries in 2010. Among companies projecting strong performance through the end of the 2009 fiscal year, nearly 90 percent said they will limit salary growth in 2010 to 4 percent or less. “Given the continued volatility in the economy, many companies are being especially careful to control their fixed costs,” Heim said.

Still, in terms of 2010 executive pay decisions, there were clear differences between those expecting their performance to be "above peers" for 2009 and those expecting results "lower than peers," Heim said. For instance:

Among strong performers, 53 percent expect base salary increases above 3 percent (compared to 32 percent of lower performers).

86 percent of strong performers expect to receive bonus payouts for fiscal 2009 performance (compared to 65 percent of lower performers).

40 percent of strong performers expect an above-target payout (compared to 31 percent of the lower performers).

Incentive Pay Cuts

Nearly one-quarter of respondents said their organizations do not plan an annual incentive payout in 2009, and the majority of those making payouts expect award levels to be below target.

Twenty-two percent of respondents changed their annual performance metrics in 2009 (e.g., from earnings per share to cash flow), and 16 percent widened the range of performance eligible for payouts. “Expanding the performance zone helps to avoid extreme upside or downside results by moderating compensation levels,” Heim said.

Relative Performance Metrics

For 2010, 39 percent of respondents expected to raise the bar on performance goals, and 28 percent planned to switch to relative performance metrics (where performance is measured against peer firms or industry indices). Many governance advocates say that relative measures help neutralize the impact of general market changes not directly related to executive performance. They recommend including a mechanism to prevent rewarding “best of the worst” outcomes.

Long-Term Incentive Programs

About one-third of respondents expect to increase the number of shares in long-term incentive (LTI) grants to executives in fiscal 2009, although, depending on the timing of the awards, grant values might be down relative to 2008 because of low share prices. Companies were contemplating LTI modifications heading into 2010 to promote a longer-term performance perspective:

10 percent have implemented new executive stock ownership guidelines, and 4 percent increased existing requirements.

14 percent have contemplated adding new “hold until retirement” provisions, and 7 percent considered new “hold past retirement” provisions for equity grants to executives, although few implemented these plans in 2009.

4 percent increased the length of vesting (e.g., from three to four years) for stock grants, and another 3 percent expected to implement such changes in 2010.

“The pace of adoption for these practices will accelerate with a sustained market recovery,” Heim observed. “Many executives will be willing to sacrifice at least some liquidity and diversification opportunity for the growth potential of continued equity grants.”

Severance and Change-in-Control Payments

While the vast majority of respondents did not revise their arrangements for payments to executives on termination or change in control, there is a clear trend toward decreased benefits in this area. Eight percent of respondents in 2009 decreased gross-up provisions to executives, which cover the taxes triggered by “parachute” payments following a change in control.

Traditional Perquisites

Executive perquisites account for a small percentage of total compensation value but have proved to be a significant driver of investor and employee dissatisfaction. The survey found companies migrating away from provisions for executives such as:

Personal use of corporate aircraft. 13 percent reduced in 2009 and about 3 percent were contemplating a decrease in 2010.

Car allowance. 16 percent reduced in 2009, and about 9 percent were considering doing so in 2010.

Reimbursements for financial planning services. 12 percent reduced in 2009, and over 7 percent were considering a reduction in 2010.

Concerns for 2010

When asked to identify the compensation topics that raise the most concern for 2010, 23 percent of respondents indicated that they were “extremely concerned” with “selecting performance measures and setting goals for incentive plans.”

“Companies are conducting more robust analysis of ‘value drivers’ in order to identify the specific measures of performance that correlate most closely with long-term shareholder value creation,” noted Heim. “We’re also seeing greater consideration being given to shareholder expectations of forecasted growth with respect to goal setting in bonus plans.”

Additionally, 21 percent of respondents were “extremely concerned” about the issue of “modifying pay programs for a changing economic environment.”

Stephen Milleris an online editor/manager for SHRM.

Related Articles:

2010 Compensation Budgets Dip Slightly from Projections, SHRM Online Compensation Discipline, November 2009

Employee Equity Plans Likely to Survive Slow Economy, SHRM Online Compensation Discipline, November 2009

Executive Pay: Perception and Reality, HR Magazine, April 2009

Quick Links:

SHRM Online Compensation Discipline

SHRM Salary Survey Directory

SHRM Compensation Data Center

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