In the face of a slowing US economy and weakening corporate performance, CEO total direct compensation among many large companies is declining, as boards have heard the message that pay has to be linked to performance. That is the conclusion of Mercer's study of US CEO compensation trends, based upon analysis of the latest proxy filings of 350 companies within the Fortune 1000.
Mercer's database of 350 companies consists of three size categories - top 50 with revenue of $40 billion or more, large with revenue of $7.4 billion or more and mid-size with revenue of $1.2 billion or more. These categories reflect Mercer's desire for companies to responsibly compare themselves - when reading reports during the proxy season - to like-size organizations. Selection was based on an industry mix which approximates the Fortune 1000.
Mercer analyzed median total direct compensation for CEOs, defined as base salary, short-term incentive compensation and expected value of long term incentives granted in the fiscal year covered by the proxy.
For CEOs of the top 50 companies analyzed, median total direct compensation for 2007 was just under $14 million, but this represented a stunning 15.8 percent reduction from the prior year. CEOs of large companies received median total direct compensation of about $9.4 million - essentially unchanged from the prior year. CEOs of mid-size companies analyzed by Mercer had median total direct compensation of $4.7 million, a modest reduction of 4.6 percent from the prior year. In the case of jumbo companies, the dive in total direct compensation was driven by a sharp decline in long-term incentive grant values, down 18.9%.
Year-over-year changes in the components of pay varied among the three company categories. While base salary constitutes a relatively small percentage of CEO compensation (19 percent on average), only 58 percent of organizations increased base salary - it increased by 3.9 percent for CEOs in the top 50 companies, by 4.2 percent for large company CEOs and by 3.0 percent for mid-size company CEOs.
The study found that overall, cash compensation tracked performance: annual cash incentives declined significantly in the top 50 companies (13.5 percent) and mid-size (16.9 percent) over the prior year. Large company payouts were slightly higher (1.6 percent) over the prior year.
Long-term incentives - primarily in the form of equity - continue to be at the center of the CEO compensation story. This pay component continues to make up just under two-thirds of the total CEO pay package. A trend that began several years ago has fully taken hold: long-term incentives (cash and equity) awards based on achieving specified performance goals have become almost as common as stock options. Stock options are certainly not gone; most companies use a mix of equity vehicles.
"Uneasy with the market's volatility, companies are taking a hard look at the drivers of long-term economic value, reassessing performance metrics and realigning variable compensation with financial, strategic and operational measures instead of more traditional metrics such as 'earnings', said Mercer senior executive compensation consultant Mike Halloran. "But with so much uncertainty created by the financial market crisis, companies are struggling to set credible goals. While some companies can use a relative approach, tied to the performance of an external index or industry group, they need to be prepared to pay - and possibly pay well - for negative absolute performance."
"In this environment, pay for performance gets the spotlight, said Peter Oppermann, a senior executive compensation consultant with Mercer. "Shareholders want it, the SEC is asking companies to disclose specific measures and targets, and companies are looking closely at how performance could be affected by an unpredictable economic environment. The problem is that some companies will have disconnects, where awards based on 2007 performance are reported in 2008, a time of depressed share prices and perhaps poor Q1 earnings. Companies will have a difficult time getting their pay-for-performance story heard.
Surprisingly, Mercer's analysis showed that there has not been the pullback in company-funded perquisites such as personal aircraft use, club dues and personal financial advice that some might have expected, perhaps because these constitute a small percentage of total direct compensation. Among the 350 companies whose proxies Mercer analyzed, 87 percent of the companies provided at least one type of perquisite, and the median value of these was $81,000.
"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, said Diane Doubleday, global leader of Mercer's executive remuneration services. "Boards of directors, who believe that there is always a market for top talent, are anxious to retain their own talent to provide the leadership, vision and execution needed to meet the challenges of a volatile business cycle.
"Looking ahead, shareholder optics will continue to exert a major influence on board decisions, said Ms. Doubleday. "Compensation is more frequently being targeted to the 50th rather than the 75th percentile. We see more rigor in establishing peer groups, and increased use of clawback, anti-hedging and other policies to protect shareholders. If the economic outlook continues to be uncertain, there is likely to be debate at many companies about whether they need to adjust, reduce, or even eliminate performance-based equity until the economy stabilizes. This will continue to be a lively debate in the coming year.
Mercer is a leading global provider of consulting, outsourcing and investment services. Mercer works with clients to solve their most complex benefit and human capital issues, designing and helping manage health, retirement and other benefits. It is a leader in benefit outsourcing. Mercer's investment services include investment consulting and multi-manager investment management. Mercer's 18,000 employees are based in more than 40 countries. The company is a wholly owned subsidiary of Marsh & McLennan Companies, Inc., which lists its stock (ticker symbol: MMC) on the New York, Chicago and London stock exchanges. For more information, visit www.mercer.com.
