Modest Pay Increases, Tougher Performance Hurdles in Store for Executives in 2013

Pearl Meyer & Partners Survey Shows Dual Impact of Say on Pay, Increased Shareholder Scrutiny

Stock Options Remain Popular Among Smaller Companies, While Larger Companies Have Embraced Performance Shares

NEW YORK--()--The key word is “moderation” for executive pay in 2013, as U.S. companies look to limit increases in the absence of meaningful performance gains according to a new survey by independent compensation consultancy Pearl Meyer & Partners. Among the findings: nearly one of three respondents said their companies will cut or freeze CEO base salaries in the coming year.

“For more than two decades, the traditional ‘sweet spot’ for executive salary increases was 3% to 5% annually – now companies are tying levels more directly to actual performance by holding salaries flat or even cutting in poor years and making bumps of 5% to 10% in strong years,” said Jim Heim, a Managing Director at Pearl Meyer and Partners who oversaw the research.

The 167 survey participants in the firm’s fourth annual PM&P On Point: Looking Ahead to Executive Pay Practices in 2013 ranged from the Fortune 50 to emerging high-growth companies. Publicly traded companies accounted for 62% of survey participants, while 31% were closely or privately held, and the rest not-for-profits. Nearly one-quarter of respondents were outside directors, with the rest from management, including CEOs and members of human resources management teams.

Companies are strongly affected by the more activist investor environment, concerns over Say on Pay advisory votes, and the increased disclosure and scrutiny of programs, according to Heim. “We’re seeing companies make a deliberate effort to increase the rigor of their decision-making – including more documentation, more discipline and more reliance on actual facts and circumstance,” he said.

Performance conditions tend to differ considerably among different industries. Heim noted it’s a positive sign that companies’ pay predictions for 2013 and their approach to pay-for-performance programs also varied widely in the survey. “The devil is always in the details, and programs often are based on factors such as industry, company size and the company’s most recent Say on Pay vote results,” he said.

Annual bonus payouts expected to be at or below target across most industries

Only 28% of surveys participants anticipate performance-based bonuses will exceed 2012 levels and just 35% expect to provide an “above target” payout for exceeding performance goals. The Industrials/Materials sector, where more than half expect to pay an above target payout, had the most optimistic projections.

In determining bonus payouts, companies increasingly are combining two or more different performance metrics, such as revenue growth and EPS. However, profit-based measures continue to receive the greatest weighting. While strategic and non-financial measures are also commonly considered, they rarely weigh heavily in the bonus calculation.

Long-term incentive designs vary by size and industry

Stock options continue to be favored by smaller companies and in certain sectors, even as performance shares increase in prevalence across virtually all company size and industry categories. Options accounted for 42% of all executive LTI value for companies under $100M in revenue and 44% of LTI value for Information Technology executives. On the other end of the spectrum, options accounted for only 16% of LTI value at companies over $10B. Performance shares accounted for 52% of LTI value at the largest companies, but only 26% for companies with revenues less than $100M.

“The growing use of performance shares shows the strong influence of shareholder advisory groups such as Institutional Shareholder Services (ISS) that base their voting recommendations partly on companies’ use of specific practices,” observed Heim. “That’s driving many companies to just ‘follow the leader’ by incorporating those practices, even though in a difficult economic environment like this, alternative long-term incentive instruments such as stock options may still make better sense for some companies.”

The impact of Say on Pay on 2013 compensation planning

While relatively few Say on Pay votes failed in 2012, companies that received somewhat lower levels of support clearly feel more pressure to adopt specific modifications to their executive pay practices.

According to the survey, companies where fewer than 90% of shareholders voted in favor of Say on Pay are more likely to: add performance conditions to their equity grants; enhance stock ownership guidelines; implement pay clawback policies in the event of financial restatements; reduce or eliminate the possibility of discretionary incentive payments; and freeze executive base salaries. Interestingly, 36% of companies that received less than 90% positive votes said they will try to preview ISS pay-for-performance calculations in 2013, compared to 27% of all survey respondents.

Many outside Directors have a different outlook than company management

The 23% of survey participants who are outside directors at their companies were more likely than management respondents to predict a freeze or drop in CEO salary in 2013 (40% vs. 23% of management participants), as well as the adoption of higher performance hurdles (55% vs. 32% of management).

“Because Directors are ultimately accountable and bear the brunt of criticism for CEO pay decisions – particularly when pay appears out of alignment with performance – they tend to take a more conservative approach,” noted Heim.

What’s on the agenda for 2013?

Participants ranked “Understanding Total Executive Compensation” as their top priority for compensation programs in 2013, followed by “Understanding Pay-for-Performance Linkage.” “It’s clear that companies need to take a holistic perspective that includes projecting the full range of compensation across all performance scenarios, as well as payouts under various types of terminations and corporate transactions,” said Heim. “That kind of analysis reveals the real drivers behind different pay outs and helps Boards decide if they’re really comfortable with those outcomes, before they’re triggered.”

About the Survey

Pearl Meyer & Partners’ survey, PM&P On Point: Looking Ahead to Executive Pay Practices in 2013 was conducted from September 12 to October 10, 2012. The 167 participants included 58 executive officers, 38 board members and 71 human resources professionals.

The executive summary is available at http://www.pearlmeyer.com/2013ExecCompPlanning.

About Pearl Meyer & Partners

For more than 20 years, Pearl Meyer & Partners has served as a trusted independent advisor to Boards and their senior management in the areas of compensation governance, strategy and program design. The firm provides comprehensive solutions to complex compensation challenges for companies ranging from the Fortune 500 to not-for-profits as well as emerging high-growth companies. These organizations rely on Pearl Meyer & Partners to develop programs that align rewards with long-term business goals to create value for all stakeholders: shareholders, executives, and employees. The firm maintains offices in New York, Atlanta, Boston, Charlotte, Chicago, Houston, Los Angeles, San Francisco and San Jose, as well as London.

Contacts

for Pearl Meyer & Partners
Shawn-Laree O’Neil, 312-725-3740
sl@emeriocommunications.com

Release Summary

According to a new survey by Pearl Meyer & Partners, “moderation” is the key word for executive pay in 2013. Companies look to limit pay increases in the absence of meaningful performance gains.

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Contacts

for Pearl Meyer & Partners
Shawn-Laree O’Neil, 312-725-3740
sl@emeriocommunications.com