- Our previous research shows that CEO pay plans may have been misaligned with long-term shareholder returns. The Council of Institutional Investors now is focusing on this topic.
- Over the past several proxy seasons, institutional investor sentiment on executive pay has become more negative, particularly among select large European asset owners and some of the most influential U.S. pension plans.
- While not all large asset owners agree, there appears to be an increasing focus on pay plan simplicity and transparency, and on the need for better alignment between CEO pay incentives and the creation of sustainable, long-term value.
In “The Legend of Sleepy Hollow,” Ichabod Crane encounters a headless horseman, who hurls his head at Crane, knocking him off his saddle. Crane is never seen again. In Northern European legends, headless horsemen typically target schemers who are marked by their hubris and arrogance. As Halloween approaches, CEOs and compensation committee members who devise complicated executive pay schemes that bedevil investors should be advised to be wary.
The problem is that investors are increasingly coming to believe that many such pay schemes don’t align the interests of CEOs and investors. Just last month, the U.S. Council of Institutional Investors (CII) took aim at overall pay plan complexity, and performance-based vesting measures in particular. In an accompanying press release, CII Executive Director Ken Bertsch said, “Steadily rising average pay, even when market performance is mediocre, suggests that pay-for-performance can be a mirage.”
As we noted in our previous research,1 awarding CEOs with higher pay incentive levels has not, in general, been aligned with total shareholder returns over recent history. What’s more, we found that the average testing and vesting period for performance-based equity awards for companies we studied was three years. And while our analysis showed that a three-year view supports other studies that were more supportive of current pay-for-performance practices,2 three-year vesting performance shares have in many cases turned out to be too short-term focused for long-term investors.3
More executive pay plans were dead on arrival
Over the past several proxy seasons, institutional investor sentiment on executive pay has become more negative, particularly among large European asset owners and at least a few of the most influential U.S. pension plans.4 In 2018, the California Public Employees’ Retirement System (CalPERS) announced new voting policies that resulted in a significantly higher percentage of disapproval votes than in the past. In addition, at least six other large institutional investors were identified as voting against at least 25% of all plans on a similar basis in 2017.5 According to Simiso Nzima, CalPERS’s investment director for corporate governance, “Over one, two or three years, performance might look good, but over 10 years, the relationship sometimes just isn’t there.”6 Our own research agrees with this assessment.7
At CalPERS, the percentage of negative votes rose even higher in 2019, as it did for several other prominent investors. The exhibit below shows the percentage of negative say-on-pay votes cast by five selected large asset owners8 against U.S companies over the past three proxy seasons. All but one increased its negative voting percentages every year.
“No” votes on executive pay increased among selected asset owners
Source: MSCI ESG Research, based on data provided by Proxy Insight, covering U.S. listed companies for which such data was available.
Stirring the cauldron
According to Norges Bank, which oversees the ISK 10 trillion (USD 1 trillion) Global Pension Fund Global, and has been particularly vocal in its criticism of the complexity of current pay plans, “The board should ensure that remuneration is driven by long-term value creation and aligns CEO and shareholder interests. A substantial proportion of total annual remuneration should be provided as shares that are locked in for at least five and preferably ten years, regardless of resignation or retirement.”9
Not all large asset owners agree. Some continue to support virtually all pay plans proposed, while others have been even more aggressive than the five shown here. The debate has yet to be resolved. But increasingly the emphasis has been on pay plan simplicity and transparency, and on the need for better alignment between CEO pay incentives and the creation of sustainable, long-term value. Investors are asking tough questions, and with a greater sense of urgency. CEOs seeking to avoid the fate of Ichabod Crane may want to listen.
1Marshall, R. 2017. “Out of whack: U.S. CEO pay and long-term investment returns. MSCI Research Insight. Marshall, R. 2016. “Are CEOS paid for performance? MSCI Research Insight.
2For example, see Kay, I. T., B. J. Lane and B. Wilby. 2015. “CEO Pay Well Aligned with Company Performance.” Pay Governance LLC.
3For additional insights regarding the drivers of long- versus short-term total returns see Gupta, A., D. Melas, R. Suryanarayanan and A. Urban. 2016. “Global Markets & Return Drivers.” Analysis for the Ministry of Finance, Norway, MSCI
4For an in-depth analysis of recent “Say on Pay” approval trends, see Weaver, R.L. 2019. “The 100 most overpaid CEOs: Executive compensation at S&P 500 companies: Are fund managers asleep at the wheel?” As You Sow.
5Mooney, A.. “EU fund houses demand say on US executive pay.” FTfm, Dec. 3, 2017
6Melin, An. “CalPERS ups pressure on companies over executive pay, harassment.” Bloomberg News, Sept. 18, 2018.
7Marshall (2016, 2017).
8These funds displayed an interesting combination of high and increasing negative percentages on CEO pay package but they are not representative of overall trends among asset owners.
9“CEO remuneration.” 2017. Norges Bank Investment Management. (2017).
Are CEOs Paid for Performance?
Out of Whack: U.S. CEO Pay and Long-Term Investment Returns