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Article | Executive Pay Memo North America

Highlights from June 9 executive pay webcast

Equipped for uncertainty: Executive pay programs and governance to offset a riskier future

|Governance Advisory Services |Executive Compensation
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By Mark Chen and Aman Malhotra | June 22, 2022

Highlights from our webcast include CEO pay trends, a guide for implementing ESG metrics into incentive plans, and board effectiveness.

On June 9, 2022, our webcast “Equipped for uncertainty: Executive pay programs and governance to offset a riskier future,” discussed how organizations can advance their executive pay and governance practices. There were around 700 registered guests from around North America (replay available). The slides from the webcast may be downloaded below.

During the webcast we discussed the following topics:

CEO pay bounced back in 2021

In 2021 CEO pay and broad LTI trends bounced back to pre-pandemic practices. Target total direct pay levels were up by 8%, reflecting zero increases to salary and target bonus but a 9% increase in target LTI. However, earned compensation was up significantly. Median pay earned by CEOs increased by 37% from 2020. Earned bonus increased by 39%. Earned LTI was up by 42%. LTI performance plan payouts were at 114% of target average in the 2019 – 2021 cycle, up from 105% in the 2018 – 2020 cycle. These increases can be attributed to strong financial and stock market performance in 2021. Also significantly less organizations applied discretion, and some even applied downward discretion in 2021 — when many applied upward discretion in 2020.

For 2022 we expect target cash compensation to increase due to pressures from the talent market. But earned LTI might suffer if the market continues trending downward.

~39% Earned bonus

~9% Target long-term incentives

~42% Earned long-term incentives

~8% Total target pay

~37% Total earned pay

No change Base salary

No change Target bonus

Figure 1. CEO pay trends for 2021

As external factors such as ongoing geopolitical issues, stock market volatility and the Great Resignation continue to affect compensation programs, organizations must stick to the following principles:

  • Don’t forget what’s in your compensation toolbox. Evaluate and use the compensation tools available to you. To address attraction and retention challenges, for example, consider increasing your new hire packages and expanding retention award and “top performer” award programs.
  • Focus on non-compensation components of the employee experience. Relevant focus areas may include flexible work arrangements, greater focus on diversity and inclusion, improved performance management and manager training.
  • Rely on precedence and good governance processes. Good governance can safeguard your organization during rapid and unpredictable change. Establish processes for goal setting and calibration adjustment and use structured discretion. Always remember that proactive monitoring and engagement is key.
Support for say on pay remains strong

Similar to pay practices, this year’s 2022 proxy voting season also has a “back to business” theme, as key say on pay results remain consistent. Average support and failure rates haven’t changed since 2021, at 90% and 10%, respectively. Enhancing board diversity and systematic change returned to the spotlight, and compensation is again focused on a guiding principles approach based on disclosure and rationale.

Ongoing focus on systematic change will require a proactive approach to shareholder engagement and responsiveness. This involves maintaining steady and efficient preparation by identifying the core members of your team (e.g., HR, legal, investor relations and external advisors), knowing the audience you want to engage, reviewing any concerns and policies of your shareholders and proxy advisors, and developing your strategy and talking points.

A proactive approach will also mean keeping an eye on your equity plans, especially in a highly volatile market. Be mindful of your available shares count, keep your team updated with your plans and regularly conduct a stress test on the shares reserve to prepare for the best and worst of times.

ESG in executive pay continues to gain momentum

Of the 310 S&P 500 organizations that we’ve reviewed, 92 organizations added ESG metrics to their 2021 or 2022 short-term incentive (STI) plan, and 42 of them had no ESG metrics beforehand. Eighty-one specifically added social metrics, such as women in leadership roles and diverse candidates and interview panels.

We saw a big increase year-over-year of the number of companies that incorporated ESG metrics in their LTI plans. Twenty-two of the 310 organizations we reviewed added ESG metrics to their 2021 or 2022 LTI plan and five more companies used an ESG metric in a one-time award. Of these 22 companies, 21 of them previously had no ESG metrics. In December 2021, only 5% (about 25 organizations) had ESG metrics in their LTI plan – with the addition of these 21 organizations the 5% will increase to low double-digits.

The webcast also covered two case studies of organizations that WTW helped to implement ESG metrics in their LTI plan by following our step-by-step guide.

Figure 2: WTW’s step-by-step guide for implementing ESG metrics in incentive plans
Figure 2: WTW’s step-by-step guide for implementing ESG metrics in incentive plans

The first case study features a global chemicals organization that implemented a diversity, equity and inclusion (DEI) index for their long-term performance share plan. This company first decided to create a working team of leaders from various HR functions to identify focus areas that are being measured and are material to the overall business and talent strategy. Once that was understood, a set guiding principles were established to help provide direction for the design and to hold themselves accountable. These guiding principles included the following: a minimum weighting of 15% per metric, balanced global and local priorities, and a focus on metrics that are outcome-oriented and quantifiable. The end result was an index that focused on increasing female representation enterprise-wide and key underrepresented groups in leadership and STEM jobs and identifying a diverse bench as their potential successors.

The second case study is about helping an oil and gas organization integrate their climate objectives within their LTI plan. In early 2021, the company expanded its focus on climate within its corporate strategy with an overall goal of being a net zero emitter by 2050. At the same time shareholders became more active with respect to climate, as shareholder support for climate resolutions at oil and gas companies tripled since 2018. From a pay program perspective this was relatively unchartered territory for the company. The importance of the climate goals within corporate strategy supported closer integration in the pay program but there was very little market context to reference. With this in mind the company undertook the following:

  • Expanded beyond its typical peer group to include the European oil and gas supermajors, all of whom include climate metrics within their LTI plans
  • Recognized the relatively wide range of European market practices that supported their initial thinking of using qualitative, near-term building-block metrics
  • Understood that achieving their climate goals would be expensive, and that the investments in infrastructure rested upon continued strong financial and share price performance. As such, it was important to maintain a material weighting on the existing metrics by introducing the climate metric at a lower 10% weighting.
Board effectiveness is more important than ever

Organizations are facing significant pressures to adopt systematic change, which requires an effective board to help them navigate these changes. For this they need members with a wide range of backgrounds, skill sets, areas of expertise and perspectives to successfully deliver on the important topics we covered earlier in our session:

  • A proactive human capital strategy
  • A well-designed and thoughtful executive compensation program
  • Productive deliberations about compensation design decisions and outcomes
  • Organizational preparedness to respond to the unexpected
Figure 3. Research agrees that over time, diverse teams outperform teams comprised of members with similar personalities and styles
Figure 3. Research agrees that over time, diverse teams outperform teams comprised of members with similar personalities and styles

To optimize effectiveness and impact, boards need to regularly evaluate their performance against the dimensions of corporate strategy and direction setting, board governance and oversight, board composition, board dynamics and board management. This assessment goes through the following steps:

  1. Understand the expectations of the board, committees and individual directors.
  2. Establish an assessment approach that reflect these expectations.
  3. Review the results with the board and commit to actions that will close gaps and boost the board’s performance.

Corporate strategy and direction setting

Board sets sustainable strategy, structure and policies

Board governance and oversight

Board balances commercial strategy while acting responsibly

Board composition

Board collectively brings diversity that enables robust decision-making process

Boardroom conduct and dynamics

Board champions culture and dynamics that creates an open environment for discussions

Board management and operation

Board setup, processes and structure facilitate effective collaboration and discussion

Figure 4. Characteristics of a high-performing board

How to get started

Ongoing evaluation

Regular evaluation is necessary to finding the right balance between collaboration and diversity of thought, and experience is the balancing act of an effective board. Board members must bring their critical, and sometimes skeptical, thinking to the boardroom. Directors need to spur new thinking and evaluate issues from non-obvious angles. But they must do this in a way that doesn’t incur undue conflict among the board. The effective board doesn’t fall in the trap of groupthink, nor do they lose focus, or patience, because of too many contrarian views.

An effective board will evaluate its performance against a series of questions:

  • Corporate strategy and direction setting: Is the board setting the right direction for the organization?
  • Board governance and oversight: Is the board practicing sound governance and oversight?
  • Board composition: Does the board mix and composition bring diversity of experience, background and thought &emdash; to enable robust decision making?
  • Board dynamics: Does the board facilitate effective exchange of ideas with efficient and agile governance?
  • Board management: Does the operations of the board facilitate effective collaboration?

In our experience, we see assessment against these factors as best practice and used by boards regularly to optimize their effectiveness and impact. This will help prepare your organization for a riskier world.

Authors

Senior Director, Executive Compensation and Board Advisory (Los Angeles)

Director, Executive Compensation and Board Advisory (New York)

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