Trends in Long-Term Incentives

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Trends in Long-Term Incentives

Upper Saddle River, N.J. – March 8, 2004 – Compensation Resources, Inc. released the results of a study they recently conducted of 642 companies covering the usage of Long-Term Incentives (LTI). Since 2001, the US business sector has been shaken by disclosures of mismanagement, poor corporate governance and outright criminal acts, all revolving around and involving the apparent excesses of Executive Compensation. The resulting media frenzy, public outcry, and indignant protests of shareholders and institutional investors, has resulted in some significant and far reaching changes to Executive Compensation. These have included the enactment of the Sarbanes Oxley Act (SOA), the potential and anticipated expensing of stock options by the Financial Standards Accounting Board (FASB), and ever increasing scrutiny and criticism of management by their Compensation Committees and Boards.
Although most of the criticism was levied at publicly traded companies, some of the changes impacted the Not for Profit (NFP) sector, as well as privately owned companies. To a certain extent, all industrial sectors must compete in the same marketplace for executives, and they must therefore provide similar, if not the same Executive Compensation Packages.
The results of the study identified some of the impact of these changes. 32.4% of the participants indicated that they have changed their LTI plans for 2004, with the largest change (36.8%) occurring among publicly-traded companies. Of the responses, the most frequent reason given was the need to refocus LTI to match their business strategy, while the publicly-traded companies more frequently indicated that they were seeking alternatives to stock options.
The public sector indicated that the company performance was the primary factor in determining awards (69%), whereas the publicly traded companies and not-for-profit sector indicated that individual performance was the most significant factor, by 57.9% and 50.0% respectively.
The study also revealed what we had long been suspected, that the size of the awards was most frequently based on a percentage of base salary. This was indicated by 43.7% of all companies, with publicly-traded companies indicating 52.6% used this method. Interestingly, an equal percentage of companies (18.3%) indicated that rewards are based on a fixed value based on pay grades or subjective determination.
Beginning in the mid-1990’s, Long-Term Incentives became the largest component of most executive pay programs at least for the publicly traded sector, resulting in unrivaled growth in the number of stock options that were granted to executives. Since the bubble burst in 2001, companies have been seeking ways to replace the lost value of those options, and attempting to maintain their inherent value though the use of alternative Long-Term Incentive Programs. The passage of Sarbones-Oxley Act and changes to the accounting standards, made the quest for alternatives even more intense, and in many ways, more creative. An interesting statistic of this study was that the value of LTI as a percentage of the entire compensation package, at least among the participating companies, has dropped significantly to 33% for publicly-traded firms, and only 6% for private companies, and 4% of NFPs. Given the current uncertainty relating to the expensing of stock options, this is not totally unexpected as other studies have shown that many companies have reduced the size of option grants and limited the participation in those programs. Time will tell if LTI programs will regain their position as the major component of the Executive Compensation Package once FASB clarifies its position and the stock market improves.