Shareholder activism, disclosure rules and a backlash against stock options that are viewed as paying someone simply for putting in time are changing the overall look of executive compensation.
Because of new disclosure requirements, many perks are sliding into the background, according to compensation analysts. Likewise, stock incentives geared to performance are on the rise, while options are on the decline.
An analysis by Mercer Human Resource Consulting LLC of New York found stock options accounted for only 46 percent of long-term incentive pay in 2006, down from 76 percent in 2002, and various forms of performance-based stock accounted for almost a third of long-term incentives in 2006.
In addition, companies are altering their practice of boosting severance and change-in-control packages to cover any related excessive compensation excise tax an executive would have to pay.
``I think the disclosure rules have sent a wake-up call to boards of directors and companies,'' said Andrew Goldstein, central division practice leader of executive compensation in the Chicago office of Washington-based Watson Wyatt Worldwide. ``They don't want to be explaining what looks like excessive compensation that can't be tied to performance.''
``Companies are getting much more aggressive in asking, `What is the business purpose of all the elements of their compensation plan?' And if there is no readily available answer, they are going to eliminate it,'' said Steve Van Putten, advanced senior manager and senior director of compensation in Watson Wyatt's office in Wellesley, Mass.
``They don't want that public confrontation. They are finding that a lot of perks don't have a business connection, and are also aware that there is greater scrutiny of restricted stock that vests just based on time and the perception that it represents pay for just showing up,'' Van Putten said. ``So now companies are putting in performance measures for that vesting.''
Ron Bottano, managing director of Los Angeles-based Executive Compensation Advisors, a Korn/Ferry International company, agreed. ``Many companies have decided to scrap the personal use by executives of corporate jets, security systems for executive homes and country club memberships, and just give their executives a lump sum and let them decide how to spend the money themselves.''
The pressure from large institutional investors cannot be discounted, he said.
There were more than 60 shareholder say-on-pay proposals this year to give investors a nonbinding vote on executive compensation, with the proposals garnering an average of 35.1 percent support from shareholders, according to Institutional Shareholder Services Inc. of Rockville, Md. The proposals passed at three companies: Verizon, Motorola and Blockbuster. In addition, Aflac - the American Family Life Assurance Co. of Columbus, Ga. - voluntarily adopted a say-on-pay provision starting in 2009.
``At the end of the day, it is important that boards get this right, or we will see more say-on-pay proposals,'' Bottano said. ``This is a very fertile ground. If they don't get it right, you will get Congress or shareholders setting rules around executive compensation.''
Those pressures also are pushing the trend toward more options geared to performance, an increased number of performance metrics in which a company measures itself against its peers and larger peer groups. Long-term rewards include stock-settled appreciation rights, performance shares, restricted stock and cash awards.
``If you give an executive stock, they focus on not letting the price go down,'' said Bill Coleman, senior vice president of compensation of Waltham, Mass.-based Salary.com. ``If you give them options, they swing for the fences to maximize the value and get the stock up.''
More than 70 percent of companies are using a relative measure against their peers in long-term compensation plans, compared with just 20 percent five years ago - and the companies in those peer groups often number 15-25, compared with just eight to 10 five years ago, Van Putten said.
What's more, companies are setting salary targets lower, but performance targets higher, said Joe Mallin, managing director in the Atlanta office of New York-based executive compensation consultant Pearl Meyer & Partners.
``You see very few pay philosophies that set salary targets at more than the midpoint, or 50 percent, of the market, compared to 10 years ago when it was 75 percent,'' Mallin said. ``But they are targeting performance plans so that executives have to achieve at the 75 percentile to achieve top payouts.''
Mallin also said there is ``a lot more tweaking of the plans on an annual basis.''
``When there is a mixed bag of incentives, you need to review them annually to get the proper outcomes, and those incentives need to be driven by the company's objectives, which can change from year to year,'' Mallin said.
In addition, said Bottano, with incentives now heavily performance-based, the executive pay debate will switch to ``how performance is measured and how you set the goals, rather than what are the targets.''
Companies have to determine three things, Van Putten said. ``They have to ask themselves what metrics to use, what are the right performance goals for their company, and over what period of time to set them.''
And even though most compensation plans are already oriented toward performance, Mallin thinks the say-on-pay movement will ``push them even more toward performance compensation.''
``Most compensation committees have one eye on what is the public perception of its pay package and the other on how it will play out with institutional shareholders,'' Mallin said.
``So they will be looking to see if they have the right measures in place to drive performance - which is the Holy Grail in this industry.''