CEOs are Paid for Performance-Chapter 2 Summary

Chapter Summary
Is CEO pay aligned with performance? The long-standing criticism among many is that pay packages at the individual company level are not related to corporate performance. Our research, along with many academic studies over the past decade, has shown time and again that this criticism of pay packages being unrelated to corporate performance is a myth. Our latest research of 2012 proxies for 300 large companies supports these findings by using realizable pay: higher paid CEOs work at higher performing companies and lower performing companies reward their CEOs with lower compensation.

Key Points
1.    There is no universally accepted methodology for evaluating the alignment between pay and performance. Variations of pay opportunity, realized pay, and realizable pay are typically used. Of these three, realizable pay, the method we prefer, provides the truest representation of the value attainable by an executive in a given period and is thus best for assessing pay and performance alignment.
2.    Our research finds that CEOs at high-performing companies—as indicated by above-median total shareholder return (TSR)—had significantly higher realizable pay values (72% higher) than their low-performing counterparts. This suggests a strong relationship between corporate performance and CEO pay and that there is pay for performance in the executive pay model.
a.    Our study focused on the comparison between 2009 – 2011 pay and performance for 295 S&P500 CEOs that had been incumbent for more than three years
3.    Shareholders largely agree that pay is indeed aligned with performance, evidenced by the overwhelmingly positive results we saw in 2011 and 2012 Say on Pay voting; 98% and 97% of companies’ executive pay programs were endorsed by shareholders in 2011 and 2012, respectively.
4.    CD&A disclosure continues to be an important medium for companies to illustrate their pay for performance philosophy, actions, and results to shareholders.
5.    Measuring the alignment of pay and performance using pay opportunity produces the reverse result – CEOs granted higher levels of pay opportunity are those working at low-performing companies. However, this is how the proxy advisor, ISS, and others view pay for performance.
6.    There are a number of factors that can damage pay and performance alignment, one of which is to set pay opportunity too high or too low relative to market. Good plan design can help mitigate any misalignment.
7.    Additional Pay Governance research of pay and performance alignment over a five-year period finds similar results: that realizable pay is the best pay metric to use for measuring alignment and that CEOs at high-performing companies had significantly higher realizable pay than their counterparts at low-performing companies.

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