Fewer Companies Using Individual Performance in Executive Pay Plans, Says Study

About 43% of large companies now use an individual component in the executive annual plan, down from 48% three years ago, according to a new study by FW Cook. Cook released its 2022 Annual Incentive Plan Report that reviews the short-term incentive plan practices and the evolution of the program design since 2016 for executives at the 250 largest U.S. companies in the S&P 500 index.

The report is extensive and merits a look. Highlights from the analysis indicate:

• Plan Type. 88% of companies use a formulaic plan design with pre-defined metrics and weights. This is an increase of 5% since 2016 and is preferred by shareholders because of the clear linkage between pay and performance.
  
  
• Metrics. A combination of financial and non-financial metrics are commonly used and typically focus on incentivizing profit, growth and strategic non-financial initiatives.
  
  
  1. Number of Metrics. About 42% of companies use two financial metrics while 28% use three – only 17% now use one, compared to 25% six years ago.
     
     
  2. Financial Metrics. Profit is overwhelmingly the predominant metric (93%) and typically contains the largest weighting. Revenue is used by 57% of plans (increase from 46% in 2016) and cash flow to a lesser extent.
     
     
  3. Non-Financial Metrics. ESG has contributed to the increased use of corporate non-financial metrics, rising from 73% in 2016 to 78% in 2021. Team-wide strategic scorecards have increased in prevalence (58%) over more discretionary individual performance measures (43%).
     
     
• Goal-Setting. Economic uncertainty in the years since 2016 has created challenges around how companies establish their goal targets. However, the median 2021 target level for profit metrics was 6% over 2020 actual performance and 7% over actual for revenue which was generally aligned with targets established in 2019 from 2018 performance.
  
  
  1. Performance Goal Ranges. Financial metric threshold and maximum ranges have generally remained the same: +/- 10% of target for profit and +/-5% for revenue metrics. But some industries continued to set wider goal ranges, as was commonly done during the pandemic due to ongoing macro issues impacting the business.
     
     
  2. Threshold Payouts. 34% of companies have a 50% threshold payout, while 35% provide a 0% threshold payout.
     
     
  3. Maximum Payouts. 200% of target is considered to be the best practice among shareholders and proxy advisory firms and companies are increasingly converging to that (71% versus 62% in 2016).

The report also looked at CEO annual incentive payouts for 2021. As stock prices bounced back from the pandemic, median CEO pay increased from 120% of target in 2016 to 150% of target in 2021.