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CEO pay continues to be discussed extensively in the media, in the boardroom, and among investors and proxy advisors. Despite strong TSR in 2020, CEO pay remained flat due to the negative impact of the COVID-19 pandemic, particularly resulting from lower bonus payouts. CEO median total direct compensation (TDC; base salary + actual bonus paid + grant value of long-term incentives [LTI]) increased at a moderate pace in the first part of the last decade: in the 2% to 6% range for 2011-2016. CEO pay accelerated with an 11% increase in 2017 — likely reflecting sustained robust financial and total shareholder return (TSR) performance — before returning to 3% in 2018 and 1% in 2019, more in line with historical rates. Our CEO pay analysis is focused on historical, actual TDC, which reflects actual bonuses based on actual performance; this is different from target TDC or target pay opportunity, which uses target bonus and is typically set at the beginning of the year.
As proxies are filed in early 2022, we expect that 2021 overall CEO actual TDC will increase in the low- to mid-single digits and possibly as high as 8% as some companies gave larger LTI grants. We expect bonus payouts to be potentially higher as a result of conservative goals set during a time of COVID-19 uncertainty. There will be some variation with companies in strong-performing industries likely seeing higher increases in compensation. CEO 2021 actual pay will be supported by steady base salaries and LTI grants, as most companies had strong financial performance at the time awards were granted (typically Q1). With regard to 2022 CEO target pay, we are expecting increases to be in the mid-single digits given very strong financial and TSR performance (S&P 500 was +29% in 2021) as the economy continues to grow and Boards increasingly try to motivate and retain executives in a very competitive labor market. Executives in industries with favorable economic conditions and higher growth (e.g., technology and biotechnology) will likely see more significant pay increases (greater than 10%) while those in hard-hit industries may see flat target pay.
CEO pay rebounded 31% in 2010 after 9% and 13% decreases during the financial crisis of 2008 and 2009, respectively. Since then, year-over-year pay increases have been moderate — in the 1% to 6% range — except for the 11% increase in 2017 (Figure 1). A rebound in pay is expected in 2021 and 2022, but not as dramatic a change as during the “Great Recession,” as pay did not decrease at the median this time around although CEOs in industries negatively impacted by COVID-19 did see substantial decreases.
Over the last 10 years, LTI vehicle use has shifted away from stock options, mostly in favor of performance-based plans. From 2010-2020, performance plan and restricted stock prevalence increased, and stock option prevalence decreased (Figure 2). The rise in performance-based plans can largely be attributed to the introduction of Say on Pay and the preferences of proxy advisors and some shareholders for LTI programs that they consider to be “performance based” (note: the proxy advisors do not consider stock options with only time-vesting features to be performance based). This being said, the prevalence of performance-based awards declined slightly in 2020, likely due to the difficulty companies had in setting multi-year goals with confidence during the pandemic.
In recent years, CEO actual pay increases have been supported by strong company TSR. In fact, pay increases over the last 10 years have trailed TSR performance by ~10% when examining the compound annual growth rates (CAGR) of compensation and shareholder return: the TSR CAGR was 14% while CEO pay grew at 4%. TSR performance is notable for 2019 and 2020 (31% and 18%, respectively); however, CEO pay generally remained flat, changing by only 1% and 0%, respectively (Figure 1). This moderation in pay in recent years can mostly be explained by companies and Boards exercising good judgment and restraint due to the COVID-19 pandemic.
There is a positive correlation between share price performance and CEO pay. In a positive stock price environment, Compensation Committees are often more supportive of CEO pay increases, typically delivered via larger LTI grants, while CEO base salaries increase modestly or periodically (i.e., less frequently than an annual basis) and comprise a small portion of the executive pay package. Annual actual bonuses, though not as significant as the LTI portion of total compensation, can have a meaningful impact on whether compensation grows year over year. When a company is having a good year and is exceeding budget goals as well as investor and analyst expectations, the CEO bonus often pays above target and increases year over year (often, the share price also increases as company performance is strong). That said, there will be some years where a CEO’s bonus pays above target when the company exceeded its budgeted goals while the share price declines due to stock market volatility or correction and sector rotation. The opposite can also happen, goals are not met, resulting in lower bonuses while the stock market goes up — this is what happened to many companies in 2020 in part due to the COVID-19 pandemic. However, we expect that bonuses will be up in 2021 as a result of strong performance coupled with conservative goals set during the pandemic.
1) We expect 2021 overall CEO actual TDC to increase in the low- to mid-single digits due to stronger financial results than projected at the beginning of the year when bonus goals were set; there will be some variation with strong performing industries likely seeing increases in compensation.
a) The Aggregate S&P 500 Index year-over-year revenue and operating income for 2021 are currently forecasted to increase by 16% and 37%, respectively (S&P Capital IQ).
2) We expect median CEO target pay increases in early 2022 to be in the mid-single digits and possibly higher given very strong financial and TSR performance (S&P 500 was +29% in 2021); this increase will be primarily made by increases in LTI compensation.
a) In certain high-growth industries (e.g., technology and biotechnology) and high-performing companies, CEO increases could be greater than 10% (primarily with larger LTI awards) because of a highly competitive labor market, while executives in slow-growth industries or heavily impacted companies might see no increases.
The above projections assume continued global rollout and broad usage of the COVID-19 vaccine with minimal disruption to the U.S. economy from variants; they do not account for additional major market shocks (e.g., geopolitical uncertainty, dramatic changes in the economic or political environment, unanticipated modifications to the Federal Reserve’s interest rate policies, or significant drops in the overall stock market).
The CEO pay analysis consists of S&P 500 companies led by CEOs with a ≥3-year tenure. Pay data includes base salaries and bonuses paid for each year as well as the reported grant date fair value of LTI awards. Our analysis of consistent incumbent CEOs was designed to highlight true changes in CEO compensation (as opposed to changes driven by new hires or internal promotions, which typically involve ramped-up pay over a period of 1-3 years).
Our methodology used year-over-year CEO actual pay and was based on the accounting value of LTI as reported in proxy summary compensation tables. These amounts are more akin to pay opportunity than realizable pay, which includes in-the-money value of stock options, ending period value of restricted stock, and estimated value of performance shares. Our past research has strongly correlated realizable pay and TSR performance. While we have shown there is a positive correlation between CEO annual pay increases and TSR performance, we are confident the correlation is not as significant as that between realizable pay and TSR increases.
Rule 10b5-1, established by the Securities and Exchange Commission (SEC) in the year 2000, permits executive officers and directors of publicly traded companies to establish a trading plan for the sale or purchase of company stock and provides these individuals an “affirmative defense” against claims that shares were traded based on material non-public information (MNPI). A typical Rule 10b5-1 plan specifies the sale or purchase of a predetermined number of shares at a specified price (or prices) over the term of the plan.
Companies (i.e., issuers) may also establish Rule 10b5-1 plans for stock buybacks.
It is important to note, neither executive officers and directors nor companies are required to use a Rule 10b5-1 trading plan to execute company stock transactions, and many trades are completed without such plans.
Currently, there are no disclosure requirements when a 10b5-1 trading plan is adopted, modified, or terminated. And, although such plans must be adopted when the participant is not aware of any MNPI, under present rules there is no waiting period before a stock transaction can take place. Thus, it is possible to adopt a trading plan and sell shares on the same day, although in our experience many plans include a 30-day “cooling-off” period before the first stock transaction can be completed.
On December 15, 2021, the SEC released proposed rules that significantly change both the plan provisions and disclosure requirements that must be met for executive officers, directors, and issuers to avail themselves of the affirmative defense afforded such plans. The SEC cites several concerns with the current rules including the potential for abuse and lack of transparency. The proposed rules are currently subject to a 45-day comment period, and public companies and other interested parties are encouraged to offer responses to some, or all of the 72 issues raised by the SEC staff in the release.
The SEC’s proposals for Rule 10b5-1 plans are extensive and a major departure from current rules governing such plans. The major changes are divided into two parts: the proposed plan requirements that must be met for the affirmative defense to be available and the proposed disclosure requirements, which are intended to improve transparency.
The SEC indicates that executive officers and directors will likely need to consult with legal counsel before attesting to the issuer that they are not in possession of MNPI. The SEC also expressed concern that an executive officer might influence the release of positive MNPI just before a scheduled trade date or conversely, delay the release of negative MNPI until after the scheduled trade date, which is why they added the “operated in good faith” requirement.
— The process for determining if an insider has MNPI;
— The process for documenting such a determination and the approval of such requests; and
— How the issuer ensures compliance.
— The name and title of the director or officer;
— The date on which the director or officer adopted or terminated the contract instruction or written plan;
— The duration of the contract instruction or written plan; and
— The aggregate number of securities to be sold or purchased pursuant to the contract, instruction or written plan.
The new rules apply to all domestic and foreign issuers; there is no exemption for small reporting companies or emerging growth companies. In addition, the proposed disclosures required in Forms 10-Q and -Kwould be subject to the certifications required by Section 302 of the Sarbanes-Oxley Act.
Some members of Congress and certain courts have commented that the affirmative defense under Rule 10b5-1(c)(1) has allowed corporate insiders to use MNPI to trade company shares on an advantaged basis. Further, several academics (e.g., Alan D. Jagolinzer, M. Todd Henderson, Taylan Mavruk, Artur Hugon and Yen-Jung Lee) have prepared studies attempting to show that executive officers and directors utilizing Rule 10b5-1 plans have outperformed executive officers and directors that did not use a Rule 10b5-1 plan. While the SEC proposal has tried to affirmatively address these concerns, the proposed rules, if finalized in their current form, may also lead to a significant reduction in the use of such plans.
We encourage companies to review the SEC proposal and consider how the proposed rules might impact the company’s insider trading policies as well as any requirements that executive officers and directors must use Rule 10b5-1 trading plans when buying or selling company stock. The SEC has published a brief Fact Sheet, “Rule 10b5-1 and Insider Trading: Proposed Rules” on its website, which provides a two-page summary of the principal rules and procedures proposed. 
From time to time, the Securities and Exchange Commission (SEC) provides interpretative accounting guidance, referred to as staff accounting bulletins (SABs), to public companies. On November 24, 2021, the SEC released SAB 120, which addresses the estimation of the fair value of share grants such as stock options, restricted shares, performance awards, and other equity awards when a company issues an equity award just prior to the release of positive non-public information. This type of equity award is referred to in SAB 120 as a “spring-loaded” award. If the award is spring-loaded, the SEC believes the company may need to value the award for accounting and proxy purposes at an amount greater than the reported share price at the date of grant.
It is important to note that the statements of SEC staff in accounting bulletins are not rules or interpretations of the SEC nor are they published as bearing the SEC’s official approval. Such statements represent interpretations and practices followed by the Division of Corporate Finance and the Office of the Chief Accountant in administering the disclosure requirements of the federal securities laws.
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 718 (ASC 718) is based on the premise that compensation costs resulting from share-based payment transactions are to be recognized in company financial statements at fair value. ASC 718 specifies the accounting treatment of a wide range of share-based compensation arrangements including stock options, restricted share plans, performance-based awards, stock appreciation rights, and employee stock purchase plans.
The SEC acknowledges that a company generally possesses non-public information when entering share-based transactions. The SEC notes that an observable market price on the grant date is generally a reasonable and supportable estimate of the current price of the underlying share in a share-based payment transaction in the event of “a routine annual grant to employees that is not designed to be spring-loaded.”  The SEC further opines, however, that when share-based payment arrangements are entered into in contemplation of or shortly before the planned release of material non-public information, and such information is expected to result in a material increase in share price, the company should consider whether an adjustment in the observable market price is warranted. According to the SEC, “determining whether an adjustment to the observable market price is necessary, and if so, the magnitude of any adjustment, requires significant judgment,” which leaves it up to companies to determine the fair value that should be used for accounting and proxy reporting purposes.
SAB 120 provides an obvious example of a spring-loaded share transaction:
"Facts: Company D is a public company that entered into a material contract with a customer after market close. Subsequent to entering into the contract but before the market opens the next trading day, Company D awards share options to its executives. The share option award is non-routine, and the award is approved by the Board of Directors in contemplation of the material contract. Company D expects the share price to increase significantly once the announcement of the contract is made the next day. Company D’s accounting policy is to consistently use the closing share price on the day of the grant as the current share price in estimating the grant-date fair value of the options.
"[Question:] Should Company D make an adjustment to the closing share price to determine the current price of shares underling [the] share options?
"Interpretative Response : Prior to awarding share options in this fact pattern, the staff [(i.e., SEC)] expects Company D to consider whether such awards are consistent with policies and procedures, including the terms of the compensation plan approved by shareholders, other governance policies, and legal requirements. The staff reminds companies of the importance of strong corporate governance and controls in granting share options, as well as the requirements to maintain effective internal control over financial reporting and disclosure controls and procedures.
“In estimating the grant-date fair value of share options in this fact pattern, absent an adjustment to the closing share price to reflect the impact of Company D’s new material contract with a customer, the staff believes the closing share price would not be a reasonable and supportable estimate and, without an adjustment the valuation of the award would not meet the fair value measurement of FASB ASC Topic 718 because the closing share price would not reflect a price that is unbiased for marketplace participants at the time of the grant.” 
In addition to the guidance above pertaining to spring-loaded share awards, SAB 120 provides additional miscellaneous guidance to companies regarding the application of ASC 718. This guidance includes such applications of ASC 718 regarding:
Pay Governance recommends that corporate management ensure members of the Board’s compensation committee be made aware of this latest SEC development — especially if the Company is contemplating making any off-cycle equity grants prior to the close of the fiscal year. We also recommend that the company consult with their legal and accounting advisors to determine if additional documentation is needed to demonstrate that annual and/or off-cycle awards were not made in contemplation of the release of positive non-public information. Because Pay Governance LLC is a management consulting firm, we are prohibited from providing an official opinion regarding accounting, corporate tax, or SEC reporting issues that may be rendered by either qualified legal or tax counsel or a certified public accounting firm.
 “Staff Accounting Bulletin No. 120: 17 CFR Part 211.” U.S. Securities and Exchange Commission. November 24, 2021. https://www.sec.gov/oca/staff-accounting-bulletin-120
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