The Advisors' Blog

– Ira Kay and Terri Shuman, Watson Wyatt Worldwide

Last week, we published a survey entitled “Effect of the Economy on Executive Compensation Programs,” which shows companies are making more dramatic changes to their executive pay programs in recognition of the recession and financial markets’ decline. The results reflect that companies continue to re-evaluate the long-term implications of their executive pay policies, but it is still not clear that the changes boards have made are aggressive enough to placate shareholders.

This update to our December, 2008 survey found:

– Fifty-five percent of respondents have frozen salaries – 34 percentage points higher than reported in the December 2008 survey.
– Twenty percent of respondents have reduced or are considering reducing salaries versus only 8 percent in the December 2008 survey.
– Approximately half (48 percent) of respondents plan to decrease this year’s bonus pool, with the decrease to average about 40 percent.
– Thirty-eight percent are making changes to their annual incentive plan performance measures and 30 percent are making changes to their long-term incentive plan measures.
– Twenty-three percent of respondents have added a clawback policy.
– About one-third of respondents are shifting toward time-based restricted stock and performance-based shares.
– One-third of respondents are reducing their long-term incentive grant values, with the average reduction to average at thirty-five percent.
– Only 1 percent of respondents have taken action on underwater stock options, although 17 percent are considering doing so.

We also surveyed company views on the current regulatory landscape. Approximately half of companies surveyed said that they were moderately to significantly concerned about “say on pay” measures (56 percent), expanded Compensation Discussion and Analysis (CD&A) disclosures (50 percent), deferred compensation limits (46 percent) and excluding “excessive risk” from compensation programs (43 percent). Despite the latter concern, more than seventy 70 percent of companies surveyed have not added a formal risk assessment process, and sixty-nine percent have not certified in their proxy that a risk assessment has been performed.

We see these TARP sections relating to excessive risk potentially being expanded (either by regulation or as a good governance practice) to companies outside the financial industry as the notion of actions compensation committees must take to fulfill their fiduciary obligations continues to evolve.

However, we would caution against adopting “conventional wisdom” in changing executive pay architecture, as companies need to find a balance between programs that create adequate incentives for executives to perform versus those that do not encourage excessive risk taking. Watson Wyatt will soon be publishing the results of some very important research on this issue that helps to empirically illustrate those pay elements that are risk “mitigators” versus those that are risk “aggravators.” We think this will be a “must-read” for compensation committees trying to balance these concerns.