Administration November 28, 2006

Study Finds Exec Pay Strongly Linked to Performance

November 28, 2006 (PLANSPONSOR.com) - A study by global consultant Watson Wyatt Worldwide has found executives at financially high-performing companies are realizing greater compensation than their counterparts at underperforming companies, suggesting a strong link between pay and performance.
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According to a press release on the study, Watson Wyatt found that CEOs at higher-performing companies have significantly greater “realizable” pay, especially from long-term incentive (LTI) awards. Realizable pay calculates the current value of outstanding LTI awards granted over a specific time frame (2003-2005 in the Watson Wyatt study) using the ending stock price.

Between 2003 and 2005, the median realizable LTI for CEOs at higher-performing companies was $4.4 million, compared with just $1.5 million for CEOs at lower-performing companies, the release said. The study found similar results for realizable total pay, which includes realizable pay from stock incentives as well as cash compensation and annual bonuses, which tend to be less sensitive to shareholder returns.

Other study findings, according to a summary on the firm’s Web site, included:

  • Companies that offer above-market LTI pay opportunities but have only medium-range stock price performance still deliver above-market pay. This is not a shareholder-friendly outcome. In contrast, companies that offer medium-range LTI opportunities deliver medium-range pay for medium performance and high pay only for high performance – a more shareholder-friendly outcome.
  • Companies with greater five-year LTI opportunities underperformed companies with lower LTI opportunities for the second year in a row.
  • Companies with greater executive stock ownership outperformed companies with lower ownership levels, further suggesting that pay opportunity has less of an impact than actual ownership.
  • The economic value of stock options at major US companies fell by 71% between 2001 and 2005, from a total of $137 billion to $40 billion. This is a clear response to shareholder concern over excessive dilution.
  • In 2005, organizations that kept a tight rein on option grants, as measured by run rates and accounting expense, outperformed their industry peers. The typical firm with low option run rates (less than 1% on average) in 2004 earned a shareholder return in 2005 that was more than 2.3 times as high as that of the typical firm with a high run rate.
  • While companies have dramatically reduced their stock option run rates, they have seen only modest decreases in their overall dilution levels.

The study was based on public data from 793 companies in the S&P Composite 1500. The full study report can be purchased from here .

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