Market Performance and Pension Contributions Drive Rise in CEO Compensation, Prompting New Disclosure from Companies

Staff Report From Georgia CEO

Monday, August 31st, 2015

According to research released today by The Conference Board, the median total compensation of CEOs of U.S. public companies in the Russell 3000 index soared 11.9 percent in 2014 over the previous year and as much as 34.7 percent over 2010. Equity awards (excluding stock options) represent 34.7 percent of the total value of the CEO pay package, and the median grant-date value of stock awards grew about 25 percent in 2014.

A collaboration between The Conference Board and Arthur J. Gallagher & Co., CEO and Executive Compensation Practices: 2015 Edition documents trends and developments in senior management compensation at companies that issue equity securities registered with the U.S. Securities and Exchange Commission and were included in the Russell 3000 index as of May 2015.

"The performance of certain segments of the equity market—which, since the financial crisis and until a few months ago, has consistently delivered double-digit rates of return—was the main driver of the upward trend in CEO pay in the Russell 3000," said Matteo Tonello, Managing Director of Corporate Leadership research at The Conference Board and a co-author of the report.

Of the top 25 highest-paid CEOs in the index, eight were from the media and entertainment industry. David M. Zaslav of Discovery Communications ranked first on the 2014 list—reporting total compensation of $156 million, up 368 percent from $33 million in 2013. Only two women, Marissa Mayer of Yahoo and United Therapeutics's founder Martine Rothblatt, made the top list of earners. While total shareholder return hardly offers a complete representation of company performance, eight chief executives notably made the top list despite negative one-year TSR generated by their companies. Of those, one made the top list despite negative three-year TSR.

Companies comprising the S&P 500 Index also reported major compensation increases. However, the report found that among larger firms (with market capitalization of $5 billion or greater), these exceptional one-year rises in 2014 mostly resulted from decisions by many organizations to revise their calculations for CEO pension contributions. Key factors that prompted these changes include lower discount rates and longer life expectancies, as reflected in updated mortality tables from the Society of Actuaries. Once included in compensation agreements, adjustments triggered by such factors are outside the control of a board of directors.

"The impact of these pension revisions on large companies was quite significant in 2014, inducing most companies to explain their causes in proxy statements," said James F. Reda, Managing Director, Executive Compensation at Arthur J. Gallagher & Co. and report co-author. "S&P 500 firms funded an average $1.3 million to their CEO retirement benefits, compared to $467,000 in 2013. In fact, the 10.6 percent one-year increase in total CEO compensation reported last year by companies in the index drops to 4.4 percent if change in pension value is excluded from the calculation. Changes in pension value only apply to defined benefit pension plans, including supplemental executive retirement plans, which are less common in smaller companies. Thus, similar volatility in pension calculations was largely absent among Russell 3000 companies."

Other findings highlighted in CEO and Executive Compensation Practices: 2015 Edition include:

  • Total CEO compensation continues to grow, fueled by pension value adjustments, stock market performance, and peer pressure. Larger company CEOs earn significantly more overall, but the smallest companies had the highest five-year percentage growth in CEO compensation. CEO compensation surged in the healthcare sector between 2010 and 2014, with stock options weighting significantly more on total pay.

  • Only a small part of CEO earnings comes from base salary; performance-based components now dominate. Annual bonuses were up in 2014, with the largest five-year increase rate among smaller companies. Stock awards continue their rise as the most important component of CEO compensation, even though significant variation in use is seen across industries and size groups. Growth companies in the information technology, materials and healthcare sectors are the only subgroups that continue to rely extensively on stock options.

  • Most CEOs on the top 25 list are not from large companies; in some cases, CEOs made the list despite their company's faltering stock performance. In most cases, top earners reported a compensation increase from the previous year, and nine were among the best-paid U.S. CEOs for three years in a row.

  • More and more companies have been introducing cash flow as a performance metric in their short-term incentive design, while some type of income-related measures continue to be found in almost all such plans. After a steady increase from 2011 to 2013, the use of capital efficiency measures in long-term incentive plans declined in 2014. Despite growing concern about its application, TSR continues to be a widely used LTI performance measure, though its weighting has declined.

  • Say-on-pay analysis confirms a significant turnover in failed votes, with several companies losing the confidence of their shareholders this year after winning the vote by a wide margin in 2014.