Executive Compensation Insights 2017 – part 3

Focuses on pay design and communication. It is time companies question perceived best practices such as the granting of performance shares or the use of relative performance evaluation. Simplification and better communication about pay-for-performance will create trust and allow managers to concentrate on what they should: create value.

Key findings

  • Total compensation paid to the CEOs of the largest 100 companies has grown markedly in recent years. From 2009 to 2016 the median increased 41.2%, 67.0% and 12.1% for SMI, SMIM and small-cap companies, respectively.
  • CEO compensation at SMIM companies is catching up with compensation at SMI companies – but there is a growing gap between SMIMs and small caps.
  • The main driver of the overall rise in executive compensation since 2009 has been non-financial-services (non-FS) rather than FS companies. For example, median CEO compensation at non-FS SMI companies has increased by roughly 50%, but has fallen around 27% at FS companies.

Our data allow a wealth of further analysis, and these are just a few of the key points. Feel free to contact us if there are other aspects of compensation you’d particularly like to talk about.

From 2009 to 2016, median total CEO compensation increased by 41.2%, 67.0% and 12.1% for SMI, SMIM and small-cap companies, respectively.
 
SMI and SMIM CEO compensation is converging – but a divergence is seen in compensation of CEOs at SMIM and small-cap companies.
 
Non-financial services companies – not banks and insurance companies – have been driving the increase in CEO compensation since 2009.
 
Shareholder wealth has grown faster than CEO compensation since 2009.

Summary and outlook

In short, this analysis shows that executive compensation has developed dynamically in Switzerland in the last 11 years. Important pre-conceptions – for example, that executive compensation in the financial services sector is always higher than in the other sectors – does not hold up against actual analysis of the data once the sample is extended outside the few largest companies that many other studies consider.

Of course, when assessing compensation, a key issue is not only the level of compensation, but also the structure of compensation, and how (variable) pay relates to the performance of the company. Insights 2017, part 2, covers this topic in more detail.

Key findings

  • When in a given year a Swiss company achieves a total shareholder return (TSR) in the top tercile of TSRs in the same industry in that year, variable CEO compensation disclosed as given for that performance year increases relative to the previous year by 9.5% at the median. In the bottom tercile of industry-adjusted share performance, variable CEO compensation falls by 3.8% compared with the previous year. This points to a working, but quantitatively modest direct pay-for-performance relation.
  • Indirect effects can be more significant: Companies are more likely to change their CEO when performance is lower. Specifically, in the top tercile of relative TSR, the probability of a CEO turnover is 14%; in the bottom tercile, it is 21%. Because after a turnover for poor performance, CEOs tend to work at smaller companies (if at all), a strong board can induce substantial implicit pay-for-performance and, thus, incentives.
  • Equity-based compensation has risen moderately over the last few years (but has somewhat declined in the most recent year of the sample). The median CEO holds 3.9 times his base salary in terms of equity wealth in the company he manages, inducing substantial exposure to the performance of the firm.

 

 

Variable CEO compensation increases when performance is higher

 
CEO turnover is substantially higher when relative share price performance is lower

 
A higher fraction of compensation is given in the form of equity in larger than in smaller firms

 
The wealth lever has increased substantially over time, indicating strong exposure of CEO wealth to shareholder wealth

Summary and outlook

In sum, several channels contribute to an alignment of executive pay and performance: direct pay-for-performance (variable compensation; “bonuses”), greater job stability in response to stronger performance, and the wealth lever. Not all channels are operating at all times, but a board needs to have an overview of the mechanisms at its disposal. Based on the results presented in this part 2, ExCo Insights 2017, part 3 will discuss new methods of pay design and will offer an analysis of the demands of shareholders in the upcoming annual general meeting season.

Key findings

  • Compensation design is fraught with “best practice” approaches that are actually often not appropriate. Companies should recognise the drawbacks of popular high-powered incentive systems with caps, should reflect on possible unintended side effects of the apparently intuitive use of “relative performance evaluation” (RPE, such as benchmarking to indices), should be wary of the risk-taking incentives of currently fashionable performance shares, and should consider using debt to complement standard equity-based incentives. Simplification – for example, granting straight-up shares rather than complex instruments such as performance shares – also has important advantages.
  • Ongoing communication with shareholders throughout the year, not just ahead of the Annual General Meeting (AGM), is essential to build trust and understanding regarding a company’s specific situation. This is particularly important given that a company also has to deal with powerful proxy advisors who sometimes use checklists and policies that management may regard as inadequate in the context of the concrete challenges a company needs to solve with incentive systems and governance choices.
  • We introduce the 5 Rs of value generation through effective governance: Recruit (select and retain the right board members, executives and employees), Reward (design and live incentives), Report (engage in value reporting and communication), Realise (execute value generation), and Rethink (reflect critically on practice of all four of the other Rs). An effective board has a holistic view of all of these matters. The weakest link of these five elements will determine the overall performance of the company.

 

 

 

A standard bonus scheme leads to unintended side effects 

 
Performance shares induce strong risk-taking incentives

 
The weakest link of the 5 Rs will determine the performance level a company can reach

Insights 2017, part 1

(October 2017)

Presents key figures for the level of compensation of CEOs, other executives, chairs and other board members at the largest 100 Swiss listed companies. It goes on to analyse the much-discussed differences between financial services (FS) and non-financial services (non-FS) companies – and unearths some surprising patterns.

Download

Insights 2017, part 2

(November 2017)

Looks at pay-for-performance in Switzerland. Our study’s long timeframe and large sample yield some fascinating findings. For example it emerges that despite recent claims to the contrary, pay and performance actually do correlate at Swiss companies.

Insights 2017, part 3

(December 2017)

Looks at new methods of pay design and analyses the demands of shareholders in the upcoming annual general meeting season. Compensation is an important element of governance but should not be looked at in isolation. There are other building blocks. Therefore, we have developed the 5 Rs concept.

What can you take-away?

Pay design remains challenging. So-called best practices all too often turn out to be perhaps well-meant, but ultimately value-destroying – but a company cannot, realistically, deviate too much from the norms set by some institutional investors and some proxy advisors without risking negative shareholder meeting outcomes. However, this is what it means to lead: to find the value-generating actions, to execute them, and to communicate them convincingly and steadfastly even in the face of short-term resistance. We have made some proposals for “rethinks” of compensation design. Importantly, compensation needs to be seen in conjunction with other aspects of governance, including in particular board and executive selection and succession and value reporting. The 5 Rs (Recruit, Reward, Report, Realise, Rethink) help structure these tasks. We look forward to working with you on them.

Contacts

Remo Schmid

Partner, People and Organisation, Zurich

+41 58 792 46 08

Email