High-Performing Companies Resist One-Size-Fits-All Approach to Designing Executive Compensation Says New Towers Study
August 01, 2014
Companies with sustained good performance often “take the road less-traveled,” tailoring pay plans to meet their own unique business needs even if it means deviating from “market norms,” according to a new analysis by Towers Watson. The study, which looked at 50 S&P 1500 companies with the most sustained relative total shareholder return (TSR) performance over a fifteen-year period, analyzed a wide array of compensation designs and practices used by these top companies relative to the broader market. The results are a very interesting commentary on the disadvantages of a one-size-fits-all approach to pay design, and may provide some relief to companies seeking to design pay plans in a way that makes sense for their individual needs while also addressing internal concerns about the reaction of investors, proxy advisors and other stakeholders to departing from the norm. According to the study, several key practices which set the top performers apart were:
- Targeting Median Pay and Greater Use of Options. According to the study, long-term high performing companies continue to target the market median even while they are outperforming it. However, they use leverage in incentive plans to create upside for executives. This is reflected in the finding that despite market norms to the contrary, high performing companies emphasize stock options, which make up 50% more of the long-term incentive (LTI) mix for high performers versus the market generally.
- Focus on Return Metrics. Although the study showed that high performers place less emphasis on long-term performance plans than the average company (in part because they use stock options to a greater extent and performance shares to a lesser extent), when long-term performance plans are used, TSR is the most common metric. Next to TSR, the focus is on return metrics (such as return on capital); almost a third of high performers use return metrics versus 20% of the broader market. As the study notes, this may reflect an increased emphasis on good use of capital and operational efficiency.
- Long-Term Approach. High performers use longer-term vesting schedules for equity incentives; the majority of high performers have an option vesting period in excess of three years and two-thirds use a cliff vesting for time-based restricted stock.
- Evolving Pay Practices. High performers varied their pay structures according to the life cycle of their business, including using fewer incentive plan metrics early on and adding more measures as they grew.