Study: Corporate CEO Pay Setup Working Properly

December 11, 2007 ( - A new Watson Wyatt Worldwide study suggests the executive pay-for-performance compensation model appears to be working.

A news release said the research found executives at high-performing companies are receiving a richer compensation package than their lagging counterparts. The study also found that more and more workers are forfeiting “in-the-money” stock options and companies are continuing to pull back on broad-based options grants.

According to the study, CEOs at high-performing companies earned significantly more realizable pay between 2004 and 2006, especially from long-term incentive (LTI) awards. Realizable pay calculates the current value of outstanding LTI awards – typically, in-the-money stock options, restricted stock and performance share payouts – granted over a specific time frame using the ending stock price, the release said.

Between 2004 and 2006, the median realizable LTI for CEOs at corporate higher performers was $5.2 million, compared to $1.7 million for CEOs at lower-performing companies.The study found similar results for realizable total direct compensation (TDC), which includes realizable pay from stock incentives as well as cash compensation and annual bonuses, which tend to be less sensitive to shareholder returns.

Being Shareholder Friendly

“The evidence from this year’s study clearly indicates that most Boards of Directors are linking executive pay to financial performance, when pay is measured by its realizable value,” said Ira Kay, global director of compensation consulting at Watson Wyatt, in the news release. “Executives who deliver above-average performance are earning significantly more than those who don’t deliver. And many executives are losing great amounts of wealth when their companies perform poorly. Both are shareholder-friendly outcomes.”

The study found some companies may be setting their pay opportunities higher than they should from a shareholder perspective. Companies offering executives above-market LTI pay opportunities but have only average stock price performance may still deliver above-market pay – not a shareholder-friendly outcome.

Additionally, Watson Wyatt found a large reduction in the value of stock-based compensation programs, as the estimated grant value per employee declined by roughly one-third between 2004 and 2006. The rate by which workers forfeited stock options increased nearly 20% last year, from 4.7% to 5.6%.

The study was based on public data from 1,072 companies in the S&P Super 1500. The study report is here .