High-performing companies design exec pay plans around stock options, incentive plans

When it comes to executive pay, the debate over whether how much is too much continues

When it comes to executive pay, the debate over whether how much is too much continues. Whether you think top executives deserve to be paid 20 times or 200 times the average worker, a new study revealed that high-performing companies take a notably different approach to their executive compensation programs. 

The Towers Watson study looked at executive compensation plans at 50 companies with the most consistent outperformance in total shareholder return versus the S&P 1500 over the past 15 years, bringing to light that such businesses take into account stock options and incentive plans—and incorporate the use of return metrics. 

The study was conducted to determine whether companies with high performance follow practices that differ from other companies, according to Todd Lippincott, North America executive compensation leader at Towers Watson.

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“The short answer is they do. In fact, we found that many high performers take approaches and differentiate their pay programs in ways that many observers, including proxy advisory firms, would view unfavorably,” Lippincott said in a statement. 

While there is strong movement in the market to adopt long-term incentive (LTI) plans, high-performing companies place a greater emphasis on stock options, both in terms of prevalence and LTI mix, the study revealed.

Among these companies, stock options represent about 50 percent more of the LTI mix than in the broader market. In addition, the high performers place less emphasis on long-term performance plans (e.g., LTI plans that have explicit performance measures such as relative total shareholder return)—one of the more surprising findings, Lippincott said.

“Stock options, in particular, are often singled out as a symbol of short-term management thinking. It’s interesting that companies that actually sustained performance over time have embraced them,” he said. “The prominence of stock options among this group, with their stronger share price performance, also explains why they are able to deliver higher actual (versus target) compensation than the market.” 

Target pay opportunities were generally very similar between high performers and the overall market median, adjusted for company size. However, despite the median target opportunity, their actual realizable pay exceeded market median levels, often significantly—by 43 percent among large companies and 28 percent for small companies. Greater upside in bonus and LTI payouts supported these enhanced payouts. 

The study reinforced the importance of considering a company’s development stage when determining the appropriate executive compensation design. The study also identified other pay practices that high-performing companies emphasize, including the use of return metrics (e.g., return on invested capital, return on equity) when long-term performance plans are used and a stronger long-term pay orientation.

While conventional wisdom says that successful companies pay their head executives multi-million dollar salaries, new research finds that the more organizations pay their CEOs, the more they perform poorly and hinder business. In fact, recent data from the University of Utah shows that execs in the top 10 percent for compensation produced 10 percent smaller returns for their investors over the a period of three years.

Executive compensation continues to be high on the list of priorities among U.S. corporate boards, especially as the Securities and Exchange Commission (SEC) continues to review rules regarding the transparency of executive compensation.

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Erin E. Harrison

Erin E. Harrison is the Editor in Chief of InsideCounsel magazine. Harrison’s professional background includes extensive expertise in both print and online media, highlighted by...

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