Proxy Season: 2008 U.S. Executive Compensation Trends Emerge

By Stephen Miller Mar 26, 2008

The slowing U.S. economy is changing executive compensation practices, as reflected in proxy statements filed by public companies so far in 2008, HR consultancy Mercer finds in a new analysis. Companies see an unpredictable economic future and are struggling with how to establish short-term incentive goals, let alone ones that are credible over a two-to-five-year period.

Meanwhile, the Securities and Exchange Commission's directives for expanded disclosure of executive compensation practices, including recent guidance on compensation discussion and analysis (CD&A) requirements, has for many companies meant "a deep dive into the rationale for programs and intense debate over performance measures and goals," Mercer states.

And shareholders, who are experiencing deteriorating returns, are becoming more activist than ever and want to see compensation outcomes linked to sustained financial and share price results.

As a result of these mounting pressures, "the 2008 proxy season will surely be memorable," Mercer states. "Companies are going to great lengths to adjust to the changing economic, governance and regulatory environments. Many are making major adjustments to their business model and realigning compensation accordingly."

Specifically, Mercer's look at 2008 corporate proxies reveals that:

Pay for performance gets the spotlight. All of the factors shaping this proxy season are converging in one important arena—paying for performance. Shareholders want it, the SEC wants companies to disclose specific measures and targets, and companies are looking closely at how performance could be affected by an unpredictable economic environment. 

Mercer, however, also expects to see "disconnects" where awards based on 2007 performance are reported in 2008, a time of depressed share prices and perhaps poor first quarter earnings and revenue reports. Consequently, companies might face tougher challenges getting shareholders to accept their pay-for-performance claims.

Goal setting and performance measures revisited in an economic downturn. Uneasy with the volatility of the market, companies are taking a hard look at the drivers of real long-term economic value, reassessing their performance metrics and realigning their variable compensation with financial, strategic and operational measures, as opposed to more traditionally used metrics such as “earnings,” Mercer found. 

But with so much uncertainty created by the financial market crisis, companies are struggling—more so than ever—with setting credible goals.

Continued changes in long-term incentive strategy. Surprisingly, the pace of change in the long-term incentive arena doesn’t seem to have slowed. The experimentation with a mix of equity vehicles continues as companies alter the allocation among stock options, restricted stock, performance-based equity and even cash.

Some companies have looked at an uncertain economic future and made the decision to reduce or even eliminate performance-based equity until the economy stabilizes, Mercer found.

Reemergence of stock option repricing. Changes in stock price put stress on equity compensation programs, particularly those relying on options. Some companies are examining whether there is a compelling rationale for repricing stock options for all holders, not just executives.

The new twist on this old strategy is that now it requires shareholder approval, according to Mercer. It remains to be seen whether shareholders will acquiesce at a time when their returns are down.

Market fragmentation: A shift away from “typical” practice. As companies focus on implementing compensation programs tailored to their individual strategies, culture and priorities, analysts no longer see a “typical” compensation structure employed by the majority of companies—even within an industry group. 

Even the tech sector, where options were once the only equity vehicle used, now displays a wide array of approaches, using cash and a variety of equity vehicles, according to the report. Large companies were the first to break from this norm, but small and mid-size companies are quickly following suit.

Shareholder oversight has an impact. In light of the SEC's increased disclosure requirements for greater transparency and specificity, companies are re-examining their total executive rewards. The results are a series of steps intended to better safeguard shareholders' interests, including:

  • Targeting executive compensation to the 50th rather than the 75th percentile.
  • More rigor around establishing peer groups for comparing market practices.
  • Increased use of clawback (taking back previously awarded monies or benefits because of changed circumstances).
  • Anti-hedging policies ("hedging" being a defensive financial maneuver that involves taking two positions that will offset each other if stock prices change).
  • Decreased use of perks and benefits.

Finally, the increased pace of executive turnover has had the unintended consequence of affording boards the opportunity to revisit and reshape the terms of employment, including change of control and severance arrangements, Mercer found.

Stephen Miller is manager of SHRM Online's Compensation & Benefits Focus Area.


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