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Board-CXO Research Insights + Vision© Newsletter; May 2022: Reshaping Board’s CEO Playbook for Pay and Governance Trends

Forward-looking ideas from leading research for executives

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May’s 2022 Issue of Board and CXO Research Insights + Vision© Newsletter offers Fortune 2000 / SME executives with 250 to 8500 employee actionable insights for three-minute impact notes:

  1. 2022 CEO Compensation: SME Board’s Insights for Reshaping Pay – provides Boards with insights on adjusting the Compensation Nominating Committees on how the CEO compensation package with its components to align can be reshaped with a 2022 reset playbook.
  2. 2022 Board Playbook: CEO Bonuses, Independence, Transparency, and ESG Trends – provides Boards insights on current challenging topics with CEO bonus transparency, CEO and Chair independency, and CEO ESG goals, results, and disclosure reporting.

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2022 CEO Compensation: Fortune 2000 / SME Board’s Insights for Reshaping Pay

Let’s get ahead of the narrative of how the Board’s compensation is justified. A new CEO compensation article appears in the Financial News, Financial Times, and WSJ on excessive pay, bonuses, or long-term incentive bonuses every other week. With shareholder activism, it hits many CEOs – including Apple, IBM, Intel, JPMorgan, and many others.

For 2022, the Compensation Committees of Fortune 2000 and SME Boards must take a fresh look at trending pay insights to reset the CEO’s Compensation Playbook. The outcomes will guide the Board Committee(s) from missteps, negative media articles, and unwanted activism.

Finally, the Board’s CEO Pay-To-Workforce Ratio (PTWR) needs to be in line with each year’s annual survey. Most CEO pay that is above average PTWR increases employee friction with executive pay for disparity within the workforce.

Board’s Committee Impact Actions

  1. Hire the best industry fit/track record firm(s) for Compensation and Executive CEO Search
  2. Score CEO compensation package by component ratios by the industry for overall alignment
  3. Craft clear messaging and transparency on Board’s CEO bonus(es) intent/outcomes aligned and linked to shareholder long-term equity value.

Here’s what you need to know.

Getting the CEO Compensation Package Right

Today, Corporate Boards’ CEO compensation packages have increased to a higher percentage for the same duties and responsibilities for most executives in every industry. This pay trend has led many shareholders and stakeholders to vote against these new Board CEO compensation packages or individual components, especially bonuses.

Most CEO compensation packages have Annual Pay, Performance Bonuses, and Long-Term Stock Incentives. The Board aims to hire the best CEO with the right-sized industry compensation package in the Nomination Policy/Process.

Nominating or Compensation Committee

For a new CEO, the Nominating, Nominating/Governance, or Compensation committee will retain an industry compensation expert/firm to:

  • Analyze similar CEO compensation packages, and trends with peer candidates for recommendations
  • Understand/analyze the corporations’ compensation risk level for consideration
  • Comply with all committee compensation charters and policies
  • Align corporation culture/philosophy for the best fit
  • Comply with legal and regulatory compensation laws

Note: Nominating and Compensation Committees must have at least three Board directors who meet the SEC and stock exchange’s 162(m) and 16b-3 requirements for independence in publicly traded firms.

Compensation packages are submitted for review by the Committee. To hit the best outcome in the marketplace, the Committee picks the best independent compensation firm, such as Compensation Advisory Partners, FW Cook, Lyons Benenson & Company, Pearl Meyer, and Semler Brossy, in the marketplace. The Committee selects the industry peers for the candidates’ pool. The sourced CEO candidates may be from the compensation search firm or, most likely, from an international executive search firm, such as Korn Ferry International, Heidrick & Struggles, Russell Reynolds, and Spencer Stuart. This outcome(s) is to down-select the best CEO and understand the marketplace compensation peers and pay trends for the proposed CEO compensation package – pay, bonuses, and long-term performance incentives – for the Corporation Board’s vote. Usually, the entire Board accepts the compensation recommendations and CEO candidates.

CEO Annual Pay Component

First, the entire Corporate Board considers the Compensation Committee’s CEO’s annual pay recommendation from the compensation expert/firm for the yearly CEO compensation package. It depends on the industry, especially the country where the corporation is based. For example, the US CEO’s base pay is about 7+ percent of their total compensation package adjusted for the industry. On the other hand, Japanese CEOs’ pay norms are usually 70+ percent of their compensation package adapted for longer-term career assignments. Usually, the base pay is not incentive-based; CEOs need to show up for work.

CEO Bonus Component

Second, the Compensation Committee crafted the CEO’s annual and special bonuses with the compensation expert firm for the right precise performance-based bonuses for goals and metrics achieved, increasing shareholder value. CEO one-time annual bonuses are approximately 17-18 percent of their compensation package, depending on the industry. For any exceptional CEO and Executive bonuses, the Board must be transparent to the stakeholders and define key performance goals and metrics, such as revenue, profits, ROE, and share price. Otherwise, the CEO bonus could be a front-page news article that can anger stakeholder activists to vote no. Think JPMorgan CEO Dimon’s special $52.6M bonus. It was a one-off stock option retention bonus with stakeholder revolt in media coverage.

Once the Committee approves the bonus(es), the CEO’s compensation targets the expected outcomes and is aligned to increasing shareholder value. Typically, the CEO base and bonuses are 50%+ in their peer group by industry.

CEO Long-term Incentive Bonus(s) Component

Lastly, most Corporation Boards have specialized performance-based long-term incentive bonus(es) goals for shareholder value to be met by the CEO. Using experts, this compensation component from the Compensation or Nominating Committee helps CEOs focus on long-term goals and increase shareholder value. Suppose the CEO’s performance metrics are not done well. In that case, it may lead to short-term quarterly result-thinking or fast acquisitions to pump up corporation equity with little to no value to the shareholders.

Most CEO compensation packages usually have stock or options bonuses, including cash incentive-based awards. These incentive bonuses typically vary more by industry peers and are up to 75+ percent of the compensation package. Since Corporate Boards choose their peer group, there is a lot of discretion and leeway for a pay-for-performance model. Leading long-term bonus practices show performance goals met over a minimum of 5 years to extend out in most cases to 10 years.

In The Future

Since 2021, the CEO’s influence over the executive compensation package is minimized chiefly by fully independent members, so the Corporate Board CEO’s interests are aligned with the shareholders. Today and beyond, fewer Board Chair and CEOs will be combined seats to protect shareholders’ interests.

Boards must carefully evaluate internal and external candidates since external CEOs’ hires cost over 50% more in their compensation package and related expenses. Boards using external CEO hires will continue to engage in much higher compensation packages. It makes sense to be developing a succession CEO’s internal pipeline.

Finally, the shareholders and stakeholders watch CEO-Employee Pay disparities more closely – employees, government, and unions – for variances. Today, the US median CEO Pay-Employee Ratio in 2021 is 245:1, a 27.6% increase from 192:1 in 2020. Boards’ CEO pay should be at or below this ratio to minimize unwanted activism. Investors and stakeholders will watch closely how the 2022 proxy season plays out!

Selected References

American Economic Association, “The Market for CEOs+,” Cziraki, Peter, Jenter, Dirk, December 2020.

Harvard Law School Forum on Corporate Governance, “Proxy Season 2022: Early Trends in Executive Compensation”, Batish, Amit, Equilar, Inc., March 29, 2022. 

The Wharton School, The University of Pennsylvania, “Corporate Governance” Class notes, March 1 to May 6, 2022.

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2022 Board Reset Playbook: CEO’s Compensation, Independence, Transparency, Activism, and ESG

2022 continues to bring CEO compensation to full view for more scrutiny and “voting no” by the stakeholders.

It highlights the need for a fully independent board, updated playbook/policies, and CEO outcomes clearly linked to shareholders’ returns with improved stakeholders’ communications! So far this year, Apple, Coca-Cola, IBM, Intel, and JPMorgan boards, to name a few, had CEO pay voted down by shareholders for excessive pay and or bonuses. In the case of JPMorgan, the CEO and Board Chair combined seat votes on his CEO compensation.

2021 was an overall weak earnings year coming out of Covid restrictions. In 2022, CEOs had many headwinds reducing shareholder value. Global Corporation Boards increasingly do business-as-usual in approving higher CEO compensation packages. A closer look at the 2021 S&P 500 CEO’s pay packages shows they increased to $14.4M from $13.2M.

Corporate Boards need more proactive independent policies on executive compensation for their shareholders to mitigate stakeholder activism, such as “Voting NO” on a non-binding “Say on Pay.” However, shareholders voting no on CEO pay should be a regulating force that requires the Board’s immediate attention.

Board’s Playbook Impact Actions

  1. Split CEO and Chairman using a refreshed nominating policy for an independent board seat
  2. Reshape CEO Pay transparency on performance bonuses using stakeholder communications aligned to long-term equity value
  3. Reshape proactive Stakeholder Activism Playbook
  4. Refine/reset CEO Pay for rapid global challenges to earnings
  5. Overhaul/reset Corporate Board and CEO ESG Playbooks

Why?

Every month, there is a major Wall Street article on shareholders’ revolt against CEO pay, bonus, and long-term compensation packages. Stakeholder activism has two issues in this case:

First, the combined CEO and Chair seat use their influence over the Board, and shareholders view it as a lack of independence on pay.

Second, the Board does not communicate in detail and transparency for equity value and why it is being rewarded on its future merits/value proposition—for example, JPM CEO Dimon’s $52.6M special bonus.

Split Dual Role of Board Chair and CEO Seat for Full Independence

Shareholders have continued pressure to have a fully independent board by removing corporate insights. The Board is responsible to its shareholders. Doing so will remove potential conflict and internal influence between the Board and corporate management.

“Of the 449 seats filled on Fortune 500 boards in 2021, only 40% went to current or former CEOs, down from 60% in 2018″ – Heidrick & Struggles.

Furthermore, public corporations must adhere to the appropriate independent director regulations, such as NYSE, AmEx, and Nasdaq.

Today’s Boards are trending to split the Board Chair from the CEO to free up a new member and support its annual Board Seat Audit for more diversity, gender, and inclusion for a higher performance board.

CEO Pay Transparency: Equity Value Communication Failures

The Corporate Board’s vague or opaque messaging makes stakeholders vote No on “Say on Pay.” The Board has legal pay and bonus compensation authorities for financial and non-financial supplementary bonuses in cash, stock, or both.

Most Board awards for annual and one-off special performance incentive bonuses are justified to shareholders. However, the proper pay communication messaging must be clear and transparent. Stakeholders must have pay justification and goals linked to long-term equity value.

For non-financial incentive bonuses, the stakeholder’s focus is the CEO’s  ESG goals and performance-incentive bonuses. For stakeholders, the CEO’s performance goals must be concrete, deliverable and measurable, with clear outcomes and actionable improvements for the Board’s ESG Strategic Environmental and Social Intent for sustainability.

Activism: Stakeholder Requires a Board Refreshed Playbook

Like the JPMorgan $52.6M options bonus case, the Board justification message lacks support with opaque details to external stakeholders, such as significant investor share blocks. Corporate Boards must not ignore critical shareholders such as Norway’s Sovereign Wealth, Blackrock, Vanguard, and others.

“JPMorgan investors hand Jamie Dimon a rare rebuke with disapproval of $52.6 M bonus.” – CNBC, May 17, 2022

Most stakeholders are involved in advocating more transparency and improving CEO performance alignment to equity value for any bonus compensation. By not creating a transparent equity value creation link to CEO compensation packages, investors can move to a hostile takeover, add Board seats, and replace the Chairman to redirect the corporation.

CEO Global Rapid Challenges for Performance Incentives

Global GDP continues to go lower. The Ukraine war continues to drag out next year, and most countries’ spiraling energy costs are sky-high. The work labor shortage and rising pay challenges are not going away this year or next in the US and other countries.

Currently, US inflation is over 8% and appears to be moving to either stagflation or a recession phase starting in 2023-24.

“Apple faces up to $8 billion revenue hit due to Covid-19 lockdowns in China.”

– Business Standard, April 30, 2022

Today through 2023, CEOs should struggle to make or, in other cases, continue to lower revenue and earnings for this year. Think Apple! China’s Covid Lockdown policy will remain through 2023 and beyond, disrupting the global supply chains with pressure on lost corporate revenue, rising costs, and impacting earnings.

The CEO Strategic Playbook must address the massive global challenges/impacts and execute its courses of action to deliver the year’s projected revenue/earnings guidance. CEO base bonuses for performance incentives should be aligned, reset, and realistic each year.

Overhaul Corporate Board and CEO ESG Playbooks

CEO ESG’s non-financial goals are more critical and challenging from now on. CEOs need transparency on how the playbook plans are constructed and offer both investors and stakeholders long-term value and valuable insight. CEOs’ bonuses must be linked to currently accepted standards and defined using the best international and industry data and metrics. CEO non-financial incentive bonuses must include EGS components with measurable goals and outcomes for their industry.

“Nearly all 2022 (CEO) filings include a discussion on the ESG strategy and or compensation-related actions in the proxy statement.” – Compensation Advisory Partners, 4/2022.

CEOs need to take full ownership of ESG’s impact on their corporation, communities, and global ecosystems to the Board and external stakeholders for their goals and reporting. Today, some significant corporations’ ESG disclosures are so vague they are laughable to read! Notably, over 64% of Board members do not believe their ESG disclosure. SEC is taking note and scrutinizing ESG disclosures for more corporate fines in the future.

“Around 50% of these (S&P) companies include ESG as a metric in the incentive plan design – (up from 30% in 2019).” – Compensation Advisory Partners, 4/2022.

As We Advance

Shareholders/stakeholders, including the employees and media, must be considered when Corporate Boards design and award the CEO compensation performance-based package. At the same time, the stakeholders’ communications messaging must craft a detailed and precise storyline on how it’s justified and the long-term stock value for both financial and non-financial outcomes. To sum, Board decisions must link directly to stakeholders’ impact and value propositions for long-term equity growth.

Today and from now on, non-financial CEO performance bonuses and reporting for ESG will be under more scrutiny in the future. CEOs are well-advised to pay more attention this year to be ahead of its ESG challenges, messaging, reporting, and potential regulatory fines.

Going into 2023, there will be a continued shift in corporations’ awareness of the need for new Board members’ insights and perspectives—especially sustainability, diversity/inclusion, cybersecurity, innovation, and global geopolitical dynamics.

Selected References

Harvard Business Review, “When and Why Diversity Improves Your Board’s Performance,” Creary, Stephanie, et al., March 27, 2019.

Harvard Law School Forum on Corporate Governance, “The Evolving Role of ESG Metrics in Executive Compensation Plans,” Moats, Maria Castañón, et al., PricewaterhouseCoopers LLP, March 19, 2022.

The Wharton School, www.YouTube.com, CNBC Television Live Discussion, “How does corporate America engage with social activism?” Mary-Hunter McDonnell, et al., May 19, 2021.

The Wharton School, The University of Pennsylvania, “Looking your Worst: Downward Earnings Management after Activist Challenges,” Mary-Hunter McDonnell, et al., April 8, 2019.

Copyright @ 2022, STEVE HAWALD CEO CIO ADVISORY LLC and Board-CXO Research Insights + Vision© Newsletter©. DISCLAIMER: These articles are entirely the author’s opinion without financial payments and engagements. The peer review was by Tom Austin.

Disclosure

The views and opinions in this analysis are my own and do not represent positions or opinions of The Analyst Syndicate. Read more on the Disclosure Policy.