High-performing companies pay their executives in ways that the rest of the pack don’t. They think outside of the box and craft compensation packages based on their size and individual needs with an eye on long-term gains, Towers Watson concluded in a new report on the issue.
“Enduring, high-performing companies often take the road less traveled, designing their executive compensation programs in ways that vary from market norms,” Towers Watson analysts Melissa Costa and Todd Lippincott wrote. “The results of our research on executive pay practices in high-performing companies reinforce the notion that companies should resist the pressure to conform to a one-size-fits-all design that may not be a best fit for each individual organization.”
The pair emphasized that the top-performing companies don’t use a unified approach toward how they address executive pay. But stock options and evolving compensation are some common ingredients that they use to calculate executive pay. Otherwise, all bets are off.
“There’s no single lens for effectively evaluating executive compensation,” Costa and Lippincott wrote. “High-performing companies take a range of approaches and differentiate their executive compensation programs, sometimes in a way that many observers, including proxy advisory firms, would view unfavorably.”
Here are some of the common ingredients for executive pay at high-performing companies noted in the report:
• An evolving approach to how executives are compensated as a company grows and matures. Small companies that perform well often assign their executives a few “highly critical” performance metrics, according to the report, a number of which can evolve or change over time. But the broader market uses a greater number of metrics. Long-term incentives also don’t crop up in newer companies as much as they do in larger ones as companies mature. That said, high-performing larger companies often rely on simple incentives with just a handful of key goals, the report noted.
• Stock options. The Towers Watson report said that this element is an “integral” part of any long-term incentive program at high-performing companies. In fact, they are 50 percent more of the long-term incentive mix for these operations than in the broader market. But that counters traditional thinking for executive compensation because stock options are looked at as part of “short-term management thinking,” the report noted. Stock options for these company executives are also counterintuitive because high-performing operations don’t use long-term performance plans as much, Towers Watson said.
• If long-term performance plans are part of the executives’ pay, then return metrics are key. Towers Watson said that total shareholder return is often used as a factor in long-term performance plans relied on by most companies. But high performers on their own use other metrics that the broader market doesn’t, including return on invested capital, avoiding elements such as revenue and operating income.
• High-performing companies get their executives at a relative bargain. CEOs at high-performing companies may see pay that is higher over three years than CEOs in the market at large. But they give their shareholders higher value “at a significantly lower relative cost.”
• Execs at high-performing companies are often paid at the market average. Towers Watson found that target pay for CEOs at high-performing companies was often 3 percent below the market average for large companies and 1 percent higher for smaller ones. But actual take-home pay was higher than the market median, reflecting rewards and bonuses for delivering that high performance.
Towers Watson said it focused on 50 companies for the report from the S&P 1500 over a 15-year period ending in 2013. These companies all had a sustained superior performance in total shareholder return compared to the S&P 1500 overall. The group covered 16 industries and companies produced revenues ranging from $500 million to $150 billion, according to the report.