There is a widespread belief among shareholders, executives, board members, media, and academics that incentive plan metrics, goals, and the resulting performance and payouts, should be closely aligned with a company’s total shareholder return (TSR) over time. This alignment reinforces that companies are focusing on performance measures that correlate with shareholder value creation and setting sufficiently challenging goals so that if achieved, demand for the stock will go up, and if not achieved, demand for the stock will go down. Based on the high levels of majority shareholder support for Say on Pay (SOP) over the years, including 99% of companies receiving majority support in 2024, it would appear companies are meeting shareholders’ expectations.
Recent research reports conducted by one of the proxy advisory firms, however, suggest that both annual and long-term incentive plan goals may not be sufficiently rigorous, as most large companies have paid above-target incentives in each of the last 5 to 6 years. Pay Governance delved deeper into this phenomenon by examining if above target incentive payouts were aligned with returns to shareholders and how often individual companies exceeded target over the last 5 to 6 years. Our research indicates that over the last 6 years, S&P 500 companies* that had above-median annual incentive plan (AIP) and performance share unit (PSU) payouts also had higher TSR compared to companies that had below-median AIP and PSU payouts. Our analysis includes comparisons on both an industry sector and total sample size basis, with comparable results.
We also found that only a small percentage (3%) of companies persistently paid incentives significantly above target over the 5-to-6-year measurement periods.
Most AIPs are based on financial and non-financial measures that focus on the achievement of short-term results that position companies for long-term success. As a result, attaining these annual incentive measures may not have an immediate impact on stock price or TSR, but over time there should be a relationship of annual incentive payouts to shareholder returns.
Our AIP analysis is based on 6 years of data from 315 S&P 500 companies, totaling approximately 1,900 datapoints to assess shareholder alignment of AIP payouts and TSR both on an industry and total sample size basis. A summary of our key findings includes:
1. AIP Industry Analysis:As detailed in Chart 1, in every industry except communication services, companies with above-median AIP payouts have higher TSR compared to companies with below-median AIP payouts. For example, in the consumer discretionary industry, for the group of companies that had above-median AIP payouts (median payout = 156% of target) during the past 6 years, median TSR was +14%, while for the group of companies with below-median AIP payouts (median payout = 81% of target), median TSR was +3%.
AIP “All Industry” Analysis by Year: As detailed in Chart 2 which includes all industries, over the past 6 years, companies with above-median AIP payouts have higher TSR compared to companies with below-median AIP payouts. For example, in 2019, for the group of companies with above-median AIP payouts (median payout = 151% of target), median TSR was +39% while for the group of companies with below-median AIP payouts (median payout = 94% of target), median TSR was +30%.
Alignment of annual TSR and AIP payouts is not perfect for year-over-year comparisons due to macroeconomic factors. For example, in 2022, when the economy had recession concerns, overall TSR was negative, but AIP payouts were only modestly different from prior years because internal operating goals were likely lower but still achieved. Each company sets their guidance and goals based on expectations of strong tailwinds or headwinds and other strategic factors typically during the first quarter of the fiscal year, which can result in above-target AIP payouts even when fiscal year-end TSR is below prior year.
Most performance-based long-term incentive plans are linked to the achievement of multi-year financial measures that are intended to align with shareholder outcomes. As a result, shareholders are likely to closely scrutinize long-term incentive plan payouts that do not align with shareholder returns. Indeed, one of the major proxy advisory firms has begun to take a closer look at the design and performance measures of these plans if they determine there is a pay for performance disconnect.
Our PSU analysis is based on the five completed PSU cycles (in the case of 3-year performance cycles: 2017-2019, 2018-2020, 2019-2021, 2020-2022, and 2021-2023) for 290 S&P 500 companies, totaling 1,450 datapoints to evaluate shareholder alignment of PSU payouts and TSR. A summary of our key findings includes:
1. PSU Industry Analysis:As detailed in Chart 3, all industry segments show that companies with above-median PSU payouts have higher TSR compared to companies with below-median PSU payouts. For example, in the consumer discretionary industry, for the group of companies with above-median PSU payouts (median payout = 150% of target) during the past five cycles, median TSR was +54 while for the group of companies with below-median PSU payouts (median payout = 88% of target), median TSR was +34%.
2. PSU “All Industry” Analysis by Cycle: As detailed in Chart 4, over the past five cycles for all industries, the group of companies with above-median PSU payouts have higher TSR compared to the group of companies with below-median PSU payouts. Among the group of companies with below-median PSU payouts, their average PSU payout over the past five cycles is below 100% of target for all cycles. For example, in the 2018-2020 cycle, for the group of companies with above-median PSU payouts (median payout = 172% of target), median 3-year cumulative TSR was +59% while for the group of companies with below-median PSU payouts (median payout = 93% of target), median 3-year cumulative TSR was +28%.
Are there other factors that confirm the alignment of AIP/PSU payouts and TSR results?
Yes, three additional factors affirm this alignment:
3. Separately, Pay Governance conducted research [1] on the alignment of CEO pay with TSR based on the Pay Versus Performance rules mandated by Dodd Frank. Our analysis found a strong correlation of Compensation Actually Paid (CAP), with TSR over 2020-2023.
Contrary to the concern and criticism that AIP and PSU performance measures may not be sufficiently rigorous and the resulting incentive payouts may be too high, our study shows that such payouts are aligned with shareholder outcomes. This may partially explain why shareholders have consistently and strongly supported Say on Pay for the last several years. We recommend that companies continue to set appropriate and rigorous performance targets when issuing investor guidance and setting incentive plan goals. This disciplined process observed by many companies increases the likelihood that payouts are aligned with operating performance, shareholder experience, and yield motivation and retention value.
Typical analytical tools used by Pay Governance and many companies for selecting appropriate performance measures and testing goal rigor include:
1. Ensure that incentive metrics are correlated with TSR.
2. Compare the goals before final approval with a multidimensional assessment of internal and external expectations of the company’s performance including, for example, analysts’ expectations for company and peers, history of goals, and other relevant factors.
3. Assess historical alignment of incentive payouts and TSR.
4. Utilize realizable pay and CAP to assess the payouts for a multi-year period and alignment with TSR to evaluate if changes are required to improve alignment.
General questions about this Viewpoint can be directed to Patrick Haggerty (patrick.haggerty@paygovernance.com), Ira Kay (ira.kay@paygovernance.com), or Mike Kesner (mike.kesner@paygovernance.com).
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In our previous Viewpoint, “Recap of the 2024 Say on Pay Season,” [1] we discussed the historically low rate of Institutional Shareholder Services (ISS) opposition to Say on Pay (SOP) proposals at S&P 500 companies in 2024. In our follow-up Viewpoint, “Record Low ISS S&P 500 Say on Pay Opposition: The Trends Behind the Decline,” [2] we reported that the general reduction of outlier CEO pay and improvement in compensation committee responsiveness to shareholder concerns likely contributed to reduced ISS SOP opposition. In continuation of our 2024 SOP Viewpoint series, we explore actions S&P 500 companies took in response to ISS SOP opposition and how these actions were received by ISS and shareholders. We also summarize key themes on which we anticipate proxy advisors and investors will focus in the 2025 SOP season.
For the sample of 47 S&P 500 companies that received ISS opposition to 2023 SOP proposals, we researched responses as disclosed in 2024 proxy statements. Actions that resulted in improved ISS and shareholder support in 2024 were:
1.Demonstrating shareholder engagement and responsiveness
2.Revising incentive plan designs and enhancing disclosure
3.Addressing pay practices that are regarded as “problematic” by ISS
As a result of the above actions, approximately two-thirds of the companies improved their SOP outcomes and received a favorable ISS recommendation in 2024. The remaining one-third of the companies received consecutive ISS opposition to SOP proposals.
We analyzed the S&P 500 companies’ actions taken in 2024 to address 2023 ISS SOP opposition by dividing our sample into three groups:
1.Companies that received ISS SOP support in 2024 following a 2023 SOP outcome of ≥70%shareholder support, representing 19% of our sample.
2.Companies that received ISS SOP support in 2024 following a 2023 SOP outcome of <70% shareholder support , representing 47% of our sample.
3.Companies that received consecutive ISS SOP opposition in 2023 and 2024, representing 34% of our sample, regardless of the 2023 SOP vote outcome.
ISS closely evaluates the response of compensation committees to shareholder SOP concerns when support levels are <70%. As such, there is less external pressure from proxy advisors and investors to take significant action when prior year SOP support was deemed sufficient by ISS’s standards (≥70%). When SOP support is <70%, there can be a pathway to SOP success the following year through meaningful actions that are demonstrated in disclosure.
Across all companies in our sample, average SOP shareholder support increased by 26 percentage points (see Figure 2) from 2023 to 2024; in fact, all but three companies in the total sample experienced an improvement in the SOP vote outcomes. Companies that had low support the prior year and ISS support in 2024 (Group 2) had the largest year-over-year increase in support (+44 percentage points).
Across all three groups, we observed consistent themes in the approaches companies took to respond to unfavorable SOP outcomes. Among companies that received the greatest improvement in SOP support, we identified the following strategies:
1. Demonstrating Shareholder Engagement and Responsiveness
ISS expects companies that receive <70% SOP support to engage with shareholders to understand their concerns and take meaningful actions in response. Among all S&P 500 companies that received ISS SOP opposition in 2023, two-thirds of companies were expected to demonstrate responsiveness to shareholders.
All companies that had <70% SOP support in 2023 and received a favorable SOP recommendation from ISS in 2024 were deemed as being sufficiently responsive by ISS. In contrast, poor responsiveness was the most common reason for consecutive ISS SOP opposition among companies that had <70% SOP support in 2023. Each of these companies that received ISS opposition disclosed shareholder outreach efforts, but ISS considered the response to be inadequate, typically because specific actions were not taken to address investor concerns.
Companies with detailed shareholder outreach disclosure on average engaged with investors representing about 60% of shares outstanding. Robust disclosure also included detailed shareholder feedback and specific actions taken in response to investor input, typically in the form of an easily digestible table with “What We Heard” and “What We Did (in response).” Many companies also provided a letter addressed to shareholders from the compensation committee chair or members describing actions taken in response. As shown in Figure 3, these disclosures were more prevalent among companies receiving a favorable ISS recommendation and nearly universal for companies that effectively demonstrated responsiveness.
2. Incentive Plan Design and Disclosure Enhancements
Changes to incentive plan designs and/or enhancing disclosure were keys to the successful SOP outcomes for the S&P 500 companies in our sample.
Companies that received a favorable ISS recommendation in 2024 took different approaches depending on the level of SOP support received in 2023 (see Figure 4). For companies with prior SOP support of ≥70% (Group 1), incentive plan design changes and forward-disclosure of program changes were most prevalent (78% and 44%, respectively). Companies with <70% SOP support (Group 2) similarly revised incentive plan designs and forward-disclosed changes (82% and 36%, respectively) but also commonly provided enhanced disclosure (64% of companies). Most of the companies that received consecutive ISS opposition (Group 3) did not make incentive design or disclosure changes.
Examples of annual incentive plan design changes disclosed by companies in our sample included changes to payout opportunities; introduction, removal, or reweighting of metrics; [A1] and removing or reducing discretionary components. Examples of long-term incentive (LTI) plan design changes disclosed by companies in our sample included reducing or capping maximum payout opportunities; introduction, removal, or reweighting of metrics; extending performance measurement to a multi-year period; and increasing the proportion of performance-based equity in the organization’s LTI mix. Disclosure enhancements commonly included expanded rationale for how incentive payouts were determined; greater transparency around goal setting and specific goals at threshold, target, and maximum; and demonstrating how executive pay is linked to company performance and shareholder value creation.
3. Addressing “Poor Practices”
Investors and proxy advisors are generally more supportive of companies that eliminate or commit to eliminating practices that have been criticized as poor or problematic. These actions were more common among the sample of companies that received ISS SOP support in 2024 following ISS SOP opposition in 2023 (see Figure 4). Examples of future commitments commonly offered included eliminating or significantly limiting the use of one-time awards, not amending outstanding equity awards unless there are extraordinary circumstances and eliminating or limiting positive discretion in incentive payouts. Examples of other practices that were addressed by companies in our sample included adopting or amending a severance policy prohibiting or limiting cash severance, moving from single to double trigger equity vesting upon a change in control, revising the compensation benchmarking peer group, reducing perquisite values, and increasing stock ownership guidelines.
There are several key themes on which we expect proxy advisors and investors to focus in the 2025 SOP season. We anticipate proxy advisors and investors alike will continue to be vigilant for large one-time awards and will scrutinize the rationale and design features of such awards. In addition, we expect that upward discretion or positive adjustments when determining incentive payouts will be closely evaluated. For companies that ISS deems to have pay for performance misalignment, ISS will have an increased focus on performance-vesting equity award designs, rigor, and disclosure. Providing robust disclosure and having simple pay designs that align with shareholder value creation and company strategy, while avoiding executive pay and governance missteps, will continue to be a successful path to a favorable SOP outcome.
As evidenced in the prior SOP season, for companies that had SOP support of <70%, ISS will continue to focus on compensation committee responsiveness as demonstrated through robust disclosure of the outreach process and specific actions that directly address investor concerns. After an unfavorable SOP outcome, there is a reliable formula for SOP success, achieved through meaningful actions that are clearly demonstrated in proxy disclosure.
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Realizable pay ("RP”) is composed of cash compensation paid (e.g., salary, actual bonus awards and payouts of cash-based long-term incentives) and the value of equity awards using the stock price at the end of the assessment period. RP assesses outcome-based compensation and has long been the “gold standard” for demonstrating shareholder aligned pay for performance. RP incorporates stock price performance, which is critical because the majority of executive pay opportunity is equity-based compensation. However, such analyses have generally not been extensively used and, if performed, are not typically disclosed in the proxy. This all changed with the SEC’s finalization of the Pay Versus Performance (PVP) rules, which were mandated under The Dodd-Frank Wall Street Reform and Consumer Protection Act. The PVP rules became effective for companies with fiscal years ending on or after December 16, 2022; after a 2-year phase-in period, companies are now required to compare the compensation actually paid (CAP) to the CEO and the average of the other NEOs to the company’s total shareholder return (TSR) and other financial measures over a 5-year period (3 years for Smaller Reporting Companies).
In its final rules, the SEC acknowledged the importance RP played in shaping the new PVP disclosure requirement:
“We believe that theadopted approach in the final rules is similar to the concept of realizable pay, recommended by some commenters, as it reflects an attempt to measure the change in value of an executive’s pay package after the grant date, as performance outcomes areexperienced.” [i]
Based on our research, there is a very strong correlation between CAP and TSR across the S&P 500, and much can be learned from this disclosure. However, the PVP rules have several shortcomings that require additional analysis to gain a complete understanding of just how aligned compensation is with performance, as discussed below. We believe that RP provides more accurate insights, however, the gathering of this information may be more time intensive than using the CAP amounts reported by the company and its peers in the PVP tables.
This Viewpoint discusses how to use outcome-based compensation such as RP or CAP to demonstrate shareholder aligned pay, the major differences between CAP and RP, potential causes for a pay for performance disconnect, and possible ways to improve alignment.
The core provisions of the current SEC compensation disclosure rules were initially promulgated in October 2006 and became effective for companies with fiscal years ending after December 15, 2006. These rules represented a major overhaul of the prior compensation disclosure requirements and introduced the Compensation Discussion and Analysis (CD&A), Summary Compensation Table (SCT), Grant of Plan Based Awards Table (GOPBAT), and Stock Options Exercised and Stock Vested Table, among many other new disclosure requirements. At the time the rules were issued, SEC Commissioner Christopher Cox stated:
"The better information that both shareholders and boards of directors will get as a result of these new rules will help them make better decisions about the appropriate amount to pay the men and women entrusted with running their companies. Shareholders need intelligible disclosure that can be understood by a lay reader without benefit of specialized expertise or the need for an advanced degree. It's our job to see that they get it."[ii]
These rules indeed provide several insights into a company’s compensation philosophy, executive compensation decision process, use of peer groups to establish compensation levels, rationale for the selection of annual and long-term incentive measures, grant date values for equity awards, and performance used to determine the amount of annual incentives and long-term performance-based awards that were earned during the year. These insights are very effective from a corporate governance perspective, as they allow shareholders to better understand compensation committees’ rationale for the pay opportunity awarded each year.
The impact of the 2006 disclosure changes, however, did little to further shareholders’ understanding of how pay outcomes moved with shareholders’ results and placed too much emphasis on the grant date value of equity incentives as determined under ASC 718 (previously FASB 123R). It is difficult to overstate the emphasis the SEC — and investors, academics, the media, and proxy advisory firms — placed on the “one number” reported in the SCT for total compensation. For example, the SEC’s Director of Corporate Finance, John White, stated at the time the rules were issued:
"Investors will now be provided with one number (our emphasis) for total annual compensation for each named executive officer. The clarity and comparability of this one number will be complemented by the principles-based narrative disclosures in our new Compensation Discussion and Analysis section and by the requirement that these disclosures be made in plain English.” [ii]
The lack of performance-adjustments on pay, especially equity, and emphasis on the one number led to the creation of new but flawed pay for performance models. These include those developed by the proxy advisory firms to inform their highly impactful Say on Pay voting recommendations that rely almost exclusively on the total compensation amount reported in the SCT. These models have determined in dozens of instances that compensation was not aligned with performance, whereas an outcome-based model would have shown far better alignment. This problem persists today, as a high percentage of the proxy advisors Against recommendations appear to be heavily influenced by quantitative pay for performance models (Record Low ISS S&P 500 Say on Pay Opposition: The Trends Behind the Decline). This could be changing, as the proxy advisory firms have indicated they may consider the PVP disclosure in their qualitative assessment of a company’s compensation program when forming their Say on Pay voting recommendations.
To combat the overemphasis on the grant date value of long-term incentives, companies, compensation consultants (including Pay Governance), and some institutional investors developed their own pay for performance models that relied on outcome-based pay models concepts such as RP. These models considered pay outcomes and company performance over a select performance period (e.g., 3-5 years). In some cases, companies included these analyses in the CD&A to demonstrate shareholder-aligned compensation and assist in more effective communications with investors about such alignment.
The following sections discuss RP and PVP, provide a detailed comparison of these two approaches, discuss possible causes of a misalignment of pay and performance, and the potential adjustments that can be made to improve future alignment.
RP is a relatively straightforwardconcept and includes the sum of actual cash compensation earned, the aggregate value of in-the-money stock options, the current value of restricted shares, actual payouts from performance-share or -cash plans, plus the estimated value of outstanding performance-share or -cash plans granted during the performance period being examined (typically 3-5 years). It is also assumed that all shares earned during the performance period are held until the end of the applicable performance period.
When performing a RP analysis, the CEO’s RP is compared to that of the RP of the peer companies’ CEOs to determine the subject company’s percentile rank. The company’s TSR (or any other appropriate financial measure) is also compared to the TSR of its peers to determine the company’s performance percentile rank. The resulting RP and performance percentiles are then compared to determine if there is an alignment of pay and performance. For example, 50 th percentile RP and TSR would indicate a perfect match of pay outcomes and performance. In practice, however, perfect alignment rarely occurs, but pay outcomes within certain ranges (for example, between the 40 th and 60 th percentile) would likely demonstrate sufficient alignment to the Board and shareholders.
Below is a sample disclosure of RP included in a recent proxy (company name omitted in accordance with our editorial policies). It illustrates strong alignment between CEO RP (at the 21 st percentile) and relative TSR (at the 30 th percentile):
The SEC was concerned that RP and its disclosure, as described above, were not calculated consistently across companies, typically when valuing performance-based equity awards and stock options (which are often the largest components of CEO pay) and therefore worked diligently to develop a model that would allow for comparability across companies.
PVP
As noted, the PVP rules were mandated under the Dodd-Frank legislation. At the time the rules were being finalized, there was a recognition by Congress that the existing disclosure requirements, which focused on SCT compensation, failed to demonstrate shareholder alignment of compensation and performance and that such disclosure could help mitigate excessive risk taking by executives.
The most revolutionary aspect of the PVP rules was the definition of CAP, which provides for updates to the grant date values of equity incentives included in the SCT for actual stock price and the performance factor of performance-based equity awards. The PVP disclosure of CAP and the related performance data were intended to approximate an RP analysis but fell short in one major way: they do not provide comparisons of both pay and performance on a relative basis. This relative comparison of pay and performance is what provides investors with context for the quantum of pay and is critical to reaching meaningful conclusions about the pay for performance relationship.
Understandably, the SEC could not require the inclusion of peer CAP comparisons alongside the peers’ TSR data, as such compensation data is not available until the proxy filings of all the peers are made available publicly. But once filed, this data can be used in a similar fashion as RP to compare the percentile rank of the CAP data with relative TSR or any other appropriate financial measure to determine if pay outcomes are aligned with performance.
Pay Governance conducted an analysis of the most recent PVP disclosures covering the 2020-2023 performance period and found a statistically significant correlation between cumulative 4-year CAP and TSR. In addition, several companies studied also had shareholder-friendly pay outcomes (we generally define a shareholder-friendly outcome when TSR rank exceeds the CAP rank by more than 25 percentile points). Key findings shown below:
The following compares key elements of RP and CAP and is intended to provide the relative pros and cons of using these measures to assess shareholder-aligned CEO pay and performance.
A typical RP methodology measures both pay and TSR performance on a relative basis (i.e., using percentile ranking). This normalizes the results and allows for more useful comparisons to peers. In addition, RP analyses may include other important metrics relevant to a company, allowing relative performance evaluations to be conducted across several performance metrics in addition to TSR.
Salary, bonuses, and annual incentives are the least contentious components of compensation in terms of how they should be measured. However, CAP does not annualize or make any adjustments for newly hired executives, which can result in distortions of annual cash compensation.
With RP, Pay Governance investigates each incumbent to present the truest picture of annual cash compensation. This often involves reading CD&A’s and 8-Ks to find salary rates or annualizing amounts based on hire dates.
CAP can overstate or understate compensation for a given year by including the change in value of grants made in years prior to the PVP performance measurement period . These prior year awards often include tranches of equity awarded 3 and 4 years prior to the commencement of the PVP measurement period. It is essential that when using this type of analysis to try to match the performance and pay (mostly stock grants) periods as much as possible. Indeed, based on Pay Governance’s analysis of 160 S&P 500 companies, the change in CAP was significantly affected by the change in value of the prior year awards (74% of the change in CAP from 2021 to 2022 and 58% of the change in CAP from 2020 to 2021) (What Shareholders Can Learn from the SEC’s New Pay Versus Performance Disclosure). The significant proportion attributable to prior year awards is due to the cumulative effect of the number of unvested shares remaining from grants made during these prior periods.
Another difference occurs as CAP stops tracking changes in the value of equity awards once they vest. This SEC requirement essentially assumes the executive sells all the shares immediately upon vesting, which is often not the case. The SEC notes that once vesting occurs, the executive’s decision to retain or sell the shares is an investment decision, and any change in stock price thereafter is unrelated to compensation. In high volatility markets, this valuation approach could differ significantly from other methods, such as valuing at the end of the performance period as does RP.
In contrast, RP assumes that all the shares granted and vested during the 3- or 5-year measurement period are retained until the end of the period to measure the impact of the change in stock price on awards granted during the measurement period. While this assumption ignores that some shares may have been sold or withheld to cover taxes and exercise price, the impact is normalized on a relative basis, as RP makes the same assumption for all companies in the peer group.
The same points discussed above for time-based RSAs/RSUs regarding an overstatement of compensation due to including equity grants made outside the measurement period and disconnect of valuing awards at vest are also true for time-based stock options and SARs.
In addition, there is typically a large variance observed between CAP and RP due to CAP’s use of expected valuation models, (e.g., Black-Scholes) versus RP’s use of intrinsic value. This variance is most pronounced for underwater stock options and SARs, where RP would include a value of $0, and a Black-Scholes valuation used to determine CAP will often include a material value based on the award’s potential future value (unless awards are significantly underwater).
CAP’s requirement that in-flight performance cycles be valued based on expected performance is one of the largest differentiators to RP. Expected performance estimates are often based on confidential information and are rarely disclosed in the PVP table footnotes or the broader CD&A. CAP values for in-flight performance share units (PSUs) that are based on a market condition (i.e., stock price hurdles, relative TSR, or absolute TSR) are based on a Monte Carlo simulation of future performance. RP is based on the estimated payout of performance-based awards and the peer data relies on the footnotes to the Outstanding Equity Awards Table, which discloses actual performance for the most recently completed performance cycle and either threshold, target, or maximum payout levels for the remaining in-flight PSU awards. In cases where companies electively disclose estimated payout levels for in-flight awards within the CD&A, RP will reflect those values.
CAP ignores the value of in-flight performance cycles for cash-based long-term incentives, which is at odds with the mark-to-market valuation requirement for equity awards. Thus, CAP ignores what could be a material portion of an executive’s long-term incentive in determining PVP until the final year of the performance period. RP, on the other hand, considers the awards made during the performance period, including payouts of relevant completed cycles and estimated levels of achievement for in-flight awards.
Most companies have either frozen or terminated existing defined benefit plans or never adopted such plans, and very few companies provide preferential earnings on NQDC plans. Moreover, where such arrangements do exist, the impact is generally modest to immaterial. Removing the value attributable to various changes in assumptions of pension plans and only accounting for service cost and prior service cost resulting from plan amendments helps reduce such numbers but could still be present as outliers in an analysis of PVP.
RP excludes all values associated with pension and NQDC plans, as such amounts are generally modest to immaterial. As a practical matter, very few companies would have been willing to incur the expense of calculating the service cost for each executive for each year for inclusion in RP absent the SEC mandate. Now that this data is available where applicable, it could be included in RP should it be relevant and material to a company’s analysis of pay and performance.
CAP includes All Other Compensation as disclosed. In many cases, the values are nominal. However, the inclusion of severance for a terminated CEO or NEO can materially distort the pay for performance relationship. RP excludes all values associated with All Other Compensation due to immateriality and/or to better reflect ongoing compensation.
Compensation Committees and management may find that using a relative analysis of cumulative CAP and TSR against a company’s peer group or industry sector can provide a meaningful evaluation of pay and performance, the results of which may help improve compensation programs.
Companies in the green zone, where relative CAP rank is commensurate with TSR rank, indicates that compensation outcomes are consistent with the shareholder experience, and diligent monitoring remains essential to ensure continued alignment. For companies in the yellow or red zones, there may be several program design features that might be worth examining to improve alignment, including:
Both RP and PVP have revolutionized the assessment of executive pay for performance that can be used to demonstrate alignment of pay and performance both internally and externally, rather than relying on a static assessment of pay for performance based on SCT grant values of equity incentives. Indeed, recent academic research suggests that the PVP data is already influencing investors’ voting preferences. [iii]
Whether to use RP or the PVP data to construct a shareholder outcome-based pay for performance analysis may depend on the degree of precision a compensation committee may require when assessing pay for performance, the relative importance of certain pay elements such as cash long-term incentive, and the level of effort the company wishes to expend to prepare the analysis, among other considerations. In either case, these methods are far superior to SCT compensation-based pay for performance analyses, which do not consider pay outcomes and can result in both false positive and false negative conclusions regarding pay and performance alignment.
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