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CEO pay shifts to long-term, performance-based equity

Compensation packages for executives are increasing in value, but with a focus on longer-term equity rather than cash bonuses, panelists said at a Corporate Directors Forum presentation Wednesday. They said this is a positive shift, although it presents challenges.

“While the numbers have gone up, the good news from our vantage point is if you look at the increase, the increase in executive pay tends to be on the long-term incentives — so the equity component of compensation rather than the annual cash bonus or the salary,” said David Knopping, a partner in the compensation consulting segment of Radford. “So we’re really seeing an emphasis by boards and compensation committees of putting more pay in long-term incentives.”

Knopping said that compensation packages for CEOs and other C-suite folks were composed almost entirely of stock options 10 years ago, but now compensation committees and boards have introduced restricted stocks, restricted stock units (RSUs) and performance-based restricted stock into their offerings. He said the percentage of these incentives varies by sector.

“What companies within the general industry have done is they moved to RSUs well before companies within tech and life sciences,” Knopping said. “Within our technology client base, if you look below the executive level it tends to be all RSU’s, but at the executive level there we still find a mix.

“Within our life science clients we find it’s more of a blend,” he said. “Even among our largest clients there’s some component of options and some component of RSUs. And among pre-commercial companies there still tends to be a focus on options given the lottery ticket-type mentality. … So it’s mixed and it varies by industry.”

Linda Lang, director at WD-40 (Nasdaq: WDFC) and former chairman and CEO of Jack in the Box (Nasdaq: JACK), said that this increasing use of performance-based compensation is a beneficial shift, although setting appropriate goals to tether bonuses to isn’t easy.

“Setting the goals was probably the most challenging part of the CEO’s job — helping to frame and set those long-term goals for performance shares,” Lang said.

“Equity is a big piece of management comp for the CEO and the management team, and if you get it wrong they either get a windfall, which is not shareholder friendly, or like David said, early on it’s not motivating to the management team, so how do you strike that balance? That requires a very thorough understanding of where the company is headed.”

Lang and Knopping agreed that pay should be based on results, even if management did everything in its power to meet goals, and extenuating circumstances, such as a recession, got in the way.

“You can’t pay for effort, you have to pay for results,” Lang said. “Because during a downturn you’re working really, really hard, and in the case of both WD-40 and Jack in the Box, during the recession our business was significantly impacted and that was out of the control of the management team, yet we froze salaries and we did not receive a bonus and our options were under water for years until the economy came back, but people understood that — if the shareholders don’t benefit, the management team shouldn’t benefit."

Knopping said many companies use a peer group of similar companies to compare compensation packages, generally a useful practice for seeing median compensation packages across an industry, but it also comes with challenges.

“There becomes a problem with that in that no CEO wants to be below the median,” Knopping said. “So the question is, if you don’t want to pay below median and everyone targets above median, well all of a sudden the 75th percentile becomes the new median, and that’s the problem of escalation.”

Setting competitive yet reasonable compensation packages and tethering them to company goals that are at once achievable and aspirational is certainly a challenge, but Knopping said he’s seen movement in the right direction.

“Has pay gotten better? I would say we are down the right path,” he said. “There’s more long-term pay for performance alignment, there’s more transparency around how you pay cash bonuses, I think you have more executive teams willing to say, ‘You know what, we’re not going to give a salary increase right now and we’re not going to give a bonus because we don’t deserve it, but I need to give meaningful equity grants because I need to retain my team some way.’ And boards are willing to do that.”

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