Study: Directors Reining in Executive Comp.

April 12, 2004 ( - When investors have spoken about what many have considered chief executive pay packages that were entirely too rich, a new study found corporate boards are apparently paying close attention to that message.

While the 2003 The Wall Street Journal/Mercer Human Resource Consulting CEO Compensation Survey found that the median CEO salary bumped up 3.8% over 2002 to $950,000, more than a third of the 350 companies studied kept their CEO salary the same. The median annual bonus increased 6.7% to $1.1 million, but the CEOs at 39 firms got no bonus at all. Median total annual compensation (base salary and bonus) was $2.1 million in 2003, up 7.2% from 2002.

“Boards of directors and their compensation committees clearly have heard the messages delivered by investors, the government, and the general public over the past few years regarding executive compensation,” said Peter Chingos, a U.S. leader of Mercer’s executive compensation consulting, in a Mercer news release. “The 2003 annual pay figures show a desire to align pay with company performance, and also show some restraint on the part of boards. With median profit growth of 19.2%, directors could have justified higher annual pay increases for CEOs, but didn’t.”

Mercer researchers said long-term incentives have seen the most significant changes in executive compensation including a continued movement away from stock options. Some 278 companies awarded stock options to CEOs in 2003, compared to 295 in 2002, and the number of companies awarding option mega grants (with a face value of at least eight times the CEO’s total annual compensation) plummeted from 62 in 2002 to 22 in 2003.

Incentives Less of Pay Mix

The long-term incentives are also making up less and less of the chief executive pay mix, Mercer said. Over the past decade, long-term incentives have accounted for an increasing share of the CEO pay mix, topping out at 71% in 2001 before slipping to 68% in 2002 and then dropping to 63% in 2003. Annual compensation now accounts for 37% of the CEO pay mix (18% for salary and 19% for annual bonus), up from 32% in 2002 and 29% in 2001.

Focusing on long-term incentives, stock options dropped from 76% of the mix in 2002 to 62% in 2003, while restricted stock climbed from 12% to 20% and performance cash/shares rose from 12% to 18% of the long-term incentive mix. In addition, Mercer’s study shows that a total of 138 CEOs received restricted stock grants in 2003, compared to 104 in 2002.

According to Chingos, three factors are driving the movement away from stock options:

  • the Financial Accounting Standards Board’s proposed new rules regarding the expensing of stock options
  • high burn rates (defined as shares granted annually as a percentage of common shares outstanding)
  • high overhang/dilution levels (defined as shares reserved for outstanding grants plus shares available for future grants as a percentage of common shares outstanding).

“With burn rates and overhang at unprecedented levels, companies have too much stock tied up in equity programs. At the same time, companies are coming to realize that they will have to account for the cost of their stock options,” Chingos said. “This is causing them to ask a critical question: Are we getting enough value given the cost of our equity programs? “

Largely as a result of these recent changes to long-term incentives, median expected total direct compensation for CEOs (base salary, annual bonus, the binomial value of stock options, restricted stock, and other target long-term incentives) dropped 4.1% in 2003 to $6.2 million. In addition, expected long-term incentive value dropped 10.6% to $4.2 million, mainly due to the retreat from stock options.

CEOs aren’t the only ones affected by the decline of stock options. Mercer’s analysis also shows a drop in the use of broad-based stock option plans for the broader employee population.

The decline in CEO expected total direct compensation was an across-the-board phenomenon in 2003. Median total pay for CEOs dropped in seven of the 10 industry categories in Mercer’s study. Only companies in utilities, energy, and financial industries saw an increase in 2003 (median increases of 16.9%, 11.8%, and 1%, respectively). Median total pay dropped most dramatically in the telecommunications (median of -13.0%), industrial (-8.5%), and technology (-7.7%) sectors.

The survey covered 350 large U.S. companies.