This year’s study reveals the following key insights. Firstly, the compensation of chairmen, other board members, CEOs and other executives in SMIM companies has been catching up with SMI companies over the last 9 years and growing faster than compensation at small-cap companies. Secondly, equity-based pay is gaining in importance, especially in large and medium-sized companies. Thirdly, three distinct sources of managerial incentives to create value play a potentially powerful role: a direct pay-performance sensitivity, an executive turnover-performance sensitivity and share ownership, that is, a wealth-performance sensitivity.
Because compensation plans can be challenging for shareholders to understand, the importance of compensation reports (and annual general meeting materials) in explaining the mechanics underpinning these plans continues to increase. There is not, however, a single best practice on the disclosure of information. Instead, boards of directors, executive management and investors, in particular institutional investors such as pension funds, have the responsibility of considering what the appropriate design and disclosure approach for compensation matters in the specific context of a given company is. An ongoing dialogue between boards of directors, investors and other stakeholders remains essential for fostering long-term, positive company development.
In the nine years under consideration (from 2007 to 2015), the median remuneration of non-executive chairmen has increased in both SMI and SMIM companies: by 33.6% from slightly below CHF 1 million to slightly above CHF 1.3 million in SMI companies, and by a striking 84.1% from around CHF 380,000 to around CHF 710,000 in SMIM companies. In small-cap firms (the next largest 50 companies), the median remuneration of chairmen was CHF 310,000 in 2015, 6.2% below the level of 2007, but 18.3% above the level of 2008. The remuneration of other members of boards of directors has increased since 2007 in all three groups of companies, though to varying extents. (For details see the report.)
Over the nine years under consideration, median CEO pay has decreased in SMI companies by 10.3% from CHF 7.7 million to CHF 6.9 million, last year by about 7%. Median CEO total compensation increased in SMIM companies in the past year, by 5% to CHF 3.6 million and is now 25% above 2007 levels. As for the small-cap firms, in the last few years we have observed increases across the whole group. In this sense, it is surprising that median CEO total compensation in small-caps fell by 9.7% last year to CHF 1.2 million (3.9% above 2007). Taking 2008 as the reference year, in 2015 median CEO total compensation has increased by 30.3%, 44.3% and 9.6% for SMI, SMIM and small-cap companies respectively.
Compensation benchmarking without paying attention to pay structure differences is problematic. Our analysis reveals great differences in, and interesting dynamics of the composition of CEO compensation, with a general rise in equity-based compensation. In SMI companies, over the years, base salary has rarely accounted for more than 30% of total compensation, the equity-based element never less than 30% (and often close to, or more than, 40%). Indeed, the average percentage of equity-based compensation has been increasing steadily over the years, from 37% in 2007 to 48% in 2015; at the median, the trend is even more pronounced, from 32% to 49%. In SMIM companies, from 2008 to 2012, base salary (around 35-40%) was a much more important compensation component than equity-based compensation (around 25%). But these companies, too, are tending towards increased usage of equity-based pay for their CEOs. Consequently, in 2013 to 2015, equity-based and base salary both make up around 30% of the total. In small-cap companies, equity-based compensation is still at a low level, less than 20%, and has not increased noticeably over the survey period. Here, usually more than 40% of total compensation comes from base salary. For chairmen and other board members, in all three groups of companies the largest part of their total compensation, between 90% and 100%, comes from fixed and other compensation.
The past 9 years show a convergence in board and executive pay between SMI and SMIM companies. In 2007, the median chairman, board member, CEO and other executive of an SMI company received around 2.6, 1.8, 2.7 and 2.9 times, respectively, the pay of the counterpart in an SMIM company. Since then, these ratios have declined and are at 1.8, 1.4, 1.9 and 1.9 respectively in 2015. The convergence of board and executive pay between SMI and SMIM companies is not due to the larger companies paying their boards less, but to a catch-up process taking place in the mid-sized companies. By contrast, SMIM and small-cap companies appear to be diverging: the ratios mentioned have increased from 1.2, 1.6, 2.4 and 1.8 in 2007 to 2.3, 1.9, 2.9 and 2.2 in 2015 respectively. One interpretation of these intriguing findings is that, while the job of a board member or executive at a very large company has always been very demanding, it is, relatively speaking, in medium-sized public corporations where the greatest additional demands on the competencies and efforts of board members and executives have more recently surfaced.
We provide evidence about three components of incentives: direct pay-for-performance, indirect career incentives and wealth incentives. Firstly, in the top tercile of total shareholder return relative to the industry, variable CEO compensation increases year-on-year by 7.5% at the median; in the bottom tercile of industry-adjusted share performance, it falls by 6.6%. As such, changes in shareholders’ wealth and variable compensation of CEOs are aligned. Secondly, in the top tercile of performance, the probability of a CEO turnover is 12%; in the bottom tercile, it is 20%. Thus, “career concern incentives” can be quite important. Thirdly, the “wealth lever” can play an important role. While, in 2007, the median ratio of equity wealth to base salary was around 1.8 in the overall sample, this ratio has increased quite steadily to 4.3, with a particularly strong increase taking place in the SMI companies. In summary, our analysis suggests that value creation can be associated with substantial income and wealth changes for executives, and so can value destruction. In the report, we discuss in detail interesting differences among the three groups in all three dimensions.
We recommend that companies actively consider a straightforward, easy-to-understand approach to communicating board and executive compensation. The market standard, especially for pay-for-performance disclosure, has been rising over the past few years. Overall, we believe that companies will do well to consider compensation disclosure as a key element in a value reporting strategy. Effective value reporting requires that companies explain how their compensation policy matches their business strategy. In votes on compensation reports, shareholders are more critical when pay-for-performance is lacking (that is, rising variable compensation when share price performance is declining). Communication with shareholders, especially in difficult times, either in the compensation report, the preparatory materials for the annual general meeting (AGM) or by individual engagement with shareholders, is becoming increasingly important. Of course, there is always a challenge as regards the equal treatment of shareholders, but this challenge can be successfully navigated. When boards of directors realise that institutional investors are not “out to get them” but are (also) interested in the long-term success of the company, successful cooperation will occur that supports long-term value-creation for all concerned.
Download the full survey here:
Robert W. Kuipers
Partner People and Organisation
Tel: +41 58 792 45 30
Partner, People and Organisation
Tel: +41 58 792 96 34
Partner, People and Organisation