June 21, 2017
Pay-for-Performance in the S&P 1500
– Liz Dunshee
This Seeking Alpha blog by Steven O’Byrne examines pay-for-performance in the S&P 1500. Here’s a summary of key findings:
1. CEO pay for performance at S&P 1500 companies is roughly 1/8 of the way to perfect pay-for-performance (i.e. relative performance explains only 12% of the variation in ten-year relative pay).
2. Pay-for-performance could be dramatically improved by better director supervision of CEO pay. If directors were able to achieve CEO pay alignment (r-sq) at their own company of 50%+ and limit their own company’s CEO pay premium to the current interquartile range, CEO pay at S&P 1500 companies would be roughly 3/4 of the way to perfect pay for performance (i.e. relative pay would explain 76% of the variation in ten-year relative performance across companies).
3. Only about a fifth of S&P 1500 companies have relatively well-managed CEO pay (i.e. only a fifth have alignment (r-sq) of 50%+ with an interquartile pay premium at industry average performance).
4. Say-on-Pay voting shows little ability to discriminate between companies with high alignment and moderate pay levels on one hand and companies with low alignment and extreme pay levels on the other. The average SOP vote support of companies with relatively well-managed CEO pay is only 1.2 percentage points greater than the average SOP support of companies with poorly managed CEO pay.
5. Directors have two readily available tools to improve pay for performance:
– The first tool is sharing analysis. Perfect alignment of relative pay with relative performance requires a fixed relationship between the CEO’s excess pay share of excess value and the CEO’s market pay share of expected value. The CEO’s market pay share of ex-ante expected value is easily calculated and should be a guideline for incentive plan sharing, but sharing concepts have largely disappeared from board deliberations and CD&A disclosure.
– The second, and more powerful, tool is “perfect” pay plans that lead automatically to perfect correlation of relative pay and relative performance. One perfect pay plan is the Dynamic CEO Compensation plan developed by finance professors Alex Edmans of London Business School and Xavier Gabaix of NYU. A second perfect pay plan is the perfect performance share plan developed by Stephen O’Byrne of Shareholder Value Advisors.
6. Better pay is correlated with better performance (i.e. ten-year relative TSR).