A new report provides insight into how companies can evaluate executive pay practices during a period of economic disruption caused by the COVID-19 pandemic.
Modern Principles for Sensible and Effective Executive Pay, released in September by consultancy Korn Ferry and the nonprofit Aspen Institute, shows that executive pay metrics may be starting to shift from a short-term focus on shareholders' returns to consideration of outcomes such as ensuring "fair" rewards throughout the organization and other factors that can improve the prospects of long-term business success.
The findings are based on more than two years of outreach to directors, executives, investors and asset managers, in consultation with experts in corporate governance, executive compensation, labor relations and the behavioral sciences.
"CEOs are increasingly understanding that in these incredibly uncertain times, they are not just leading a business," said Don Lowman, global leader of Korn Ferry's rewards and benefits practice. "They are leading a more integrated community of employees, partners, investors and those acting on behalf of significant and growing environmental and community needs."
Last year, the CEOs of many major companies signed a Business Roundtable declaration asserting that corporations should concentrate on providing benefits to all stakeholders rather than primarily on deriving profits for shareholders.
Althoughn most executive pay programs remain "firmly aligned with total shareholder return as the center of their performance measurement universe," the Korn Ferry and Aspen Institute report noted, that's starting to change. Korn Ferry's analysis of proxy statements of 150 large U.S.-based companies found that approximately 20 percent now have some form of "purpose-driven" strategic objectives, including environmental, social and corporate governance measures as key performance metrics for executive pay.
"While much more needs to be done to align purpose with pay, we are absolutely seeing a trend toward a more holistic view of what defines executive—and corporate—success," Lowman said. "When boards consider what is needed for organizations to flourish over the long term, nonfinancial drivers of performance become more apparent.
'When boards consider what is needed for organizations to flourish over the long term, nonfinancial drivers of performance become more apparent.'
"Companies need to temper their sharp focus on external benchmarking and allowing it to dictate executive pay outcomes," Lowman said. "We need a more holistic view of compensation, one that considers internal pay relationships and ensures that rewards and economics are shared appropriately across an organization."
The report recommends using credible goals with outcomes that are difficult to manipulate in incentive plans. For example:
- Goals that are challenging but achievable and are aligned with core strategic priorities.
- Goals focused on objective measures of nonfinancial and financial performance that are within the executive's ability to affect and influence.
In addition, the report advises that when designing incentive-pay programs:
- Grant financial rewards for achieving or exceeding targets that are reasonable and do not encourage excessively risky behavior.
- Provide incentives that have a meaningful financial downside for underperformance.
- Ensure that long-term incentives are aligned with at least a full business cycle for the company or industry to avoid focusing on short-term results.
The report also shared additional recommendations for creating an effective executive pay program:
- Use clear, jargon-free language to describe the program.
- Make sure the board of directors bears ultimate accountability for making executive pay decisions and aligning pay with the long-term health of the enterprise.
"Design and oversight of executive pay programs today is all about elevating the need for clarity, alignment with key goals, integrity, simplicity and fairness," Lowman said.
[SHRM members-only toolkit: Designing Executive Compensation Plans]
Variable Pay Changes
A recent report from HR consultancy Mercer, COVID-19: Managing Executive Pay and Incentives in Uncertain Times, draws on discussions with boards of directors and management, who shared that a number of alternative approaches are being considered regarding variable compensation for executives, such as:
- Reducing budgets for annual executive and employee cash-incentive programs as a result of lowered performance expectations. Organizations need to be mindful of doing this in conjunction with reduced performance goals so management will not be doubly penalized with reduced budgets and below-par performance ratings due to unacheived goals, resulting in low or no payouts.
- Revising targets for incentive awards for 2020 and beyond. This move is especially relevant if targets were set prior to the COVID-19 outbreak and for sectors most affected by the pandemic.
Rewards Under Pressure
Other research shows that increases in total compensation for U.S. CEOs slowed last year, as weaker corporate performance led to a drop in annual bonuses paid in 2020 for 2019 performance. The pandemic is expected to put further constraints on CEO pay increases this year.
Total earned pay for S&P 1500 CEOs, who lead 1,500 publicly traded U.S. companies, increased 5.5 percent at the median in 2019, a sharp drop from a 13.7 percent jump in 2018, according to an analysis of proxy disclosures by consultancy Willis Towers Watson. The increase marks the smallest rise since a 2.2 percent increase in 2016.
According to the firm's analysis CEO Pay at S&P 1500 Companies: 2020, the drop was primarily felt by small- and midsized public companies, however. While S&P 500 CEOs at the 500 largest publicly traded corporations saw a 13.1 percent increase at the median, total pay for S&P 600 and S&P 400 CEOs grew just 4.8 percent and 0.2 percent, respectively.
Across all studied firms, annual bonuses declined 3.2 percent at the median, down from an increase of 5.8 percent the previous year. The analysis indicated that the decline reflected weaker operating performance. The average annual bonus payout dropped from 114 percent of target in 2018 to 102 percent for 2019, the lowest mark since the Great Recession.
"This year's pay levels will undoubtedly be affected by temporary salary reductions and incentive program adjustments in response to the COVID-19 pandemic," said Don Delves, managing director and North American executive compensation practice leader at Willis Towers Watson. "Although it's still too early to determine the full impact on CEO pay programs, we have seen some CEOs take voluntarily reductions in pay to show solidarity with workers and reflect distressed business conditions."
'Some CEOs are voluntarily reducing pay to show solidarity with workers and reflect distressed business conditions.'
Some are calling for more meaningful reductions in executive pay. The progressive Economic Policy Institute recently released a study that found CEOs in the U.S. "earn 320 times as much as a typical worker." The study looked at how CEOs of the 350 largest U.S. firms by sales are paid, including stock awards granted but not yet "exercised" or realized.
"While the current economic crisis has likely impacted the compensation of CEOs, companies must still take action to ensure a 320-1 gap does not occur again," said Tanya Jansen, co-founder of beqom, a cloud-based compensation software firm. "Organizations have a responsibility to ensure compensation is aligned across the organization while always taking fair-pay philosophies, such as determining an employee's salary based on unbiased attributes like performance history, into account."