Long-Term Incentive Grant Practices for Executives via Frederic W. Cook & Co., Inc.

Long-term incentive design has long been sensitive to external influences. In 1950, after Congress gave stock options capital gains tax treatment, the use of stock options surged as employers sought to avoid ordinary income tax rates as high as 91%. Some forty years later, Congress added Section 162(m) to the tax code in an attempt to rein in excessive executive pay by limiting the deduction on compensation over $1 million to certain executives. Stock options qualified for a performance-based exemption leading to a spike in stock option grants to CEOs at S&P 500 companies (+45% in the first year according to a 2006 Wall Street Journal article).

Fast forward twenty years and the form and magnitude of long-term incentives, the principal delivery vehicle of executive compensation, continues to be a hot button populist issue. The 2010 Dodd Frank Act introduced U.S. publicly-traded companies to Say on Pay giving shareholders a direct channel to voice their support or opposition for a company’s pay practices. Another legislative addition to the litany of unintended consequences, Compensation Committees are challenged to balance the oftentimes conflicting interests of a growing number of stakeholders. As a result, we observe a narrowing range of long-term incentive practices and a growing bias for homogenous plan design. This report, the 42nd annual Frederic W. Cook & Co. Top 250 Report, details the long-term incentive practices of the 250 largest companies in the S&P 500. Notable trends and key findings from this year’s study are as follows:

Trends Impacting Long-Term Incentive Design

  • Say on Pay magnifies growing number of “interested” parties
  • Correlation between increasing number of stakeholders and decreasing prevalence of company-specific design
  • Activist investors edging out ISS as the “elephant in the room”
  • Despite increases in shareholder engagement, some companies continue to assume large investors blindly follow proxy advisor recommendations
  • Arguably easier for companies to follow conventional practices than to educate and defend innovative design

Long-Term Incentive Grant Type

Long-Term Incentive Grant Type

Overview and Background

Since 1973, Frederic W. Cook & Co. has published annual reports on long-term incentive grant practices for executives. This report, our 42nd edition, presents information on long-term incentives in use for executives at the 250 largest U.S. companies in the Standard & Poor’s 500 Index. This survey is intended to provide information to assist boards of directors and compensation professionals in designing and implementing effective long-term incentive programs for executives that promote the long-term success of their companies.

Survey Scope

The report covers the following topics:

  • Continuing, discontinued and new long-term incentive grant types
  • Grant type design features, including vesting and stock option term
  • Key performance plan characteristics, such as length of performance periods, payout maximums, performance metrics and measurement approaches
  • Grant types by industry
  • Long-term incentive mix

Top 250 Selection

The Top 250 companies are selected annually based on market capitalization, i.e., share price multiplied by total common shares outstanding as of February 28, 2014, as reported by Standard & Poor’s Research Insight (see Appendix for complete list of companies).

Volatility in the equity markets, corporate transactions, and the usual ebbs and flows of corporate fortunes result in changes in market capitalization and, thus, turnover in the survey sample. Of the 2014 Top 250 companies, twenty-five are new to this year’s report. As such, the trend data are influenced by these changes in the survey sample from year-to-year, in addition to actual changes in grant usage.

The table below profiles the industry sectors represented in the Top 250 in 2014, as defined by Standard & Poor’s Global Industry Classification Standard (GICS). Financials once again comprise the largest sector covered in the Top 250 report, with 49 companies (20%) in 2014.

Long-Term Incentive Grant Type

Summary of Grant Types in Use

Long-Term Incentive Grant Type

Stock Options / Stock Appreciation Rights (SARs) are derivative securities where stock price has to appreciate for an executive to receive value. Stock options are rights to purchase company stock at a specified exercise price over a stated term; SARs are rights to receive at exercise the increase between the grant price and the market price of a share of stock. The use of stock options has stabilized over the past three years after an extended period of decline.

Once considered the most shareholder-friendly grant type due to its inherent alignment with shareholder interests, stock options appear to be recovering from mixed employee perceptions and investor concerns about potential dilution and performance orientation. Some observers foresee an increase in the use of stock options as investor confidence in the markets is restored, employees recover from the hangover caused by extended exposure to underwater stock options, employers reconsider the role of leverage, and fungible share pools mitigate concern over potential dilution relative to full-value shares.

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