Top executives of U.S. public firms typically expect both upper six- or seven-figure salaries as well as a generous long-term incentive plan. Long-term management incentive plans today are principally comprised of stock options, stock grants and performance awards.
The rapid growth in upper management compensation and whether these very highly paid executives deserve this kind of compensation are certainly hot-button issues, but the current reality is that board compensation committees continue to regularly approve these giant pay packages for execs.
A January 5th blog post on the Harvard Law School Forum on Corporate Governance and Financial Regulations by James Park and Lanaye Dworak highlights that recent regulatory actions including the Dodd Frank Act and its “Say on Pay” component is leading to a standardization of large public company executive compensation plans.
Park and Dworak elaborate on the results of their study below : “As a result, we observe a narrowing range of long-term incentive practices and a growing bias for homogenous plan design. It is arguably easier for companies to follow conventional market practices than to educate and defend innovative plan design.”
Brief history of long-term management incentive plans
The authors highlight that use of long-term incentives for corporate management has historically sensitive to external influences, especially legislative reform. They pint out that in 1950, after stock options became capital gains tax by legislation, the use of stock options increased dramatically to try and avoid ordinary income tax rates up to 90%. Four decades later, Congress tried to rein in excessive executive pay by limiting the deduction on compensation more than $1 million to only specific executives. Under the new law, stock options qualified for a performance-based exemption, which led to a major upswing in stock option grants to CEOs at S&P 500 companies.
Executive long-term incentive plans in 2014
Park and Dworak note that stock option use has “stabilized over the past three years after an extended period of decline.” They note that “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.”
The authors also point out that the percent of companies granting restricted stock, including companies that disclosed performance-vesting criteria solely to satisfy regulatory requirements, was unchanged from 2013 to 2014 at 63%.
Most of top 250 firms in the S&P apply a uniform installment or ratable vesting approach (three equal installments) to stock options (81%) and restricted stock grants (54%). This year was the first time over half of the companies applied an installment vesting approach rather than a cliff vesting approach (100% vest at the end of the period) for restricted stock.
Park and Dworak also note that performance awards are the most common grant type for the fourth consecutive year with 89% of the Top 250 forms granting performance awards in cash or stock. They argue that the “proliferation of this award type is due, in large part, to Say on Pay as companies seek to demonstrate a relationship between pay and performance.”
In addition, performance awards comprise on average almost 50% of a Top 250 CEO’s total long-term incentive package. Moreover, according to data from the 42nd annual Frederic W. Cook & Co. Top 250 Report, stock options comprise around 30% of long-term management incentive plans and restricted stock accounts for the other 20%.
See full report below.