By Cydney Posner
The Wall Street Journal published an article regarding the results of a recent Towers Watson survey of 270 proxies. The survey found "pay-for-performance praised but not honored and questioned the nearly universal allegiance to total shareholder return in chief executive pay plans."
While the concept of pay-for-performance for CEOs has won wide acceptance, it was unclear whether "these plans really reward performance, or just luck and gamesmanship." With regard to long-term incentives, 27% were performance-based plans, an increase from only 19% in 2010, while stock options accounted for only 35%, down from 41% that year.
According to the article, almost 82% of companies use total shareholder return to determine CEO payout in long-term incentives, and 61% rely solely on total shareholder return to calculate that payout. However, a Towers Watson representative questioned whether total shareholder return was "distorting outcomes" and could "be as much a matter of luck as performance, and can even be gamed."
First, the article notes, level of pay can depend on "accidents of timing." If a company begins its performance period with big growth expectations already priced into its stock and then delivers on those expectations, the stock may just stay in the same range without much increase in total shareholder return. On the other hand, if the performance period begins with a depressed stock price, even an increase back to normal levels "could result in a bonanza for the CEO." Similarly, the CEO has an incentive to create volatility in the stock -- a stable-but-high stock does not typically reap big rewards for the CEO based on total shareholder return. As a result, there could be an incentive to "drive the stock down, then win on the move back up. Moreover, a short-term, unsustainable run-up in the stock can still create rich rewards for the CEO." For plans that use relative performance measures, the survey suggests that "the selection of the peer group also affects the CEO's wallet but is often done without enough attention to such financial facts of life as beta, the metric that shows how a stock responds to broader market movements. Even companies in the same industry may move differently, or in different degrees, when the market moves, depending on company-specific risk factors. ‘Most companies don't net out differences in the company betas in constructing their peer groups,'" according to a Towers representative quoted in the article.