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Introduction

There is a widespread belief among shareholders, executives, board members, media, and academics that incentive plan metrics, goals, and the resulting performance and payouts, should be closely aligned with a company’s total shareholder return (TSR) over time. This alignment reinforces that companies are focusing on performance measures that correlate with shareholder value creation and setting sufficiently challenging goals so that if achieved, demand for the stock will go up, and if not achieved, demand for the stock will go down. Based on the high levels of majority shareholder support for Say on Pay (SOP) over the years, including 99% of companies receiving majority support in 2024, it would appear companies are meeting shareholders’ expectations.

Recent research reports conducted by one of the proxy advisory firms, however, suggest that both annual and long-term incentive plan goals may not be sufficiently rigorous, as most large companies have paid above-target incentives in each of the last 5 to 6 years. Pay Governance delved deeper into this phenomenon by examining if above target incentive payouts were aligned with returns to shareholders and how often individual companies exceeded target over the last 5 to 6 years. Our research indicates that over the last 6 years, S&P 500 companies* that had above-median annual incentive plan (AIP) and performance share unit (PSU) payouts also had higher TSR compared to companies that had below-median AIP and PSU payouts. Our analysis includes comparisons on both an industry sector and total sample size basis, with comparable results.

We also found that only a small percentage (3%) of companies persistently paid incentives significantly above target over the 5-to-6-year measurement periods.

* We excluded companies in the Energy, Utilities, and Real Estate industries due to regulatory differences as well as unique compensation practices and incentive metrics that do not align with other industries.

Our Research Demonstrates Consistent Alignment of Incentive Payouts and TSR Over Time

AIP Alignment

Most AIPs are based on financial and non-financial measures that focus on the achievement of short-term results that position companies for long-term success. As a result, attaining these annual incentive measures may not have an immediate impact on stock price or TSR, but over time there should be a relationship of annual incentive payouts to shareholder returns.

Our AIP analysis is based on 6 years of data from 315 S&P 500 companies, totaling approximately 1,900 datapoints to assess shareholder alignment of AIP payouts and TSR both on an industry and total sample size basis. A summary of our key findings includes:

1. AIP Industry Analysis:As detailed in Chart 1, in every industry except communication services, companies with above-median AIP payouts have higher TSR compared to companies with below-median AIP payouts. For example, in the consumer discretionary industry, for the group of companies that had above-median AIP payouts (median payout = 156% of target) during the past 6 years, median TSR was +14%, while for the group of companies with below-median AIP payouts (median payout = 81% of target), median TSR was +3%.

‍AIP “All Industry” Analysis by Year: As detailed in Chart 2 which includes all industries, over the past 6 years, companies with above-median AIP payouts have higher TSR compared to companies with below-median AIP payouts. For example, in 2019, for the group of companies with above-median AIP payouts (median payout = 151% of target), median TSR was +39% while for the group of companies with below-median AIP payouts (median payout = 94% of target), median TSR was +30%.

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Alignment of annual TSR and AIP payouts is not perfect for year-over-year comparisons due to macroeconomic factors. For example, in 2022, when the economy had recession concerns, overall TSR was negative, but AIP payouts were only modestly different from prior years because internal operating goals were likely lower but still achieved. Each company sets their guidance and goals based on expectations of strong tailwinds or headwinds and other strategic factors typically during the first quarter of the fiscal year, which can result in above-target AIP payouts even when fiscal year-end TSR is below prior year.

Long-Term Incentive Plan / PSU Alignment

Most performance-based long-term incentive plans are linked to the achievement of multi-year financial measures that are intended to align with shareholder outcomes. As a result, shareholders are likely to closely scrutinize long-term incentive plan payouts that do not align with shareholder returns. Indeed, one of the major proxy advisory firms has begun to take a closer look at the design and performance measures of these plans if they determine there is a pay for performance disconnect.

Our PSU analysis is based on the five completed PSU cycles (in the case of 3-year performance cycles: 2017-2019, 2018-2020, 2019-2021, 2020-2022, and 2021-2023) for 290 S&P 500 companies, totaling 1,450 datapoints to evaluate shareholder alignment of PSU payouts and TSR. A summary of our key findings includes:

1. PSU Industry Analysis:As detailed in Chart 3, all industry segments show that companies with above-median PSU payouts have higher TSR compared to companies with below-median PSU payouts. For example, in the consumer discretionary industry, for the group of companies with above-median PSU payouts (median payout = 150% of target) during the past five cycles, median TSR was +54 while for the group of companies with below-median PSU payouts (median payout = 88% of target), median TSR was +34%.

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2. PSU “All Industry” Analysis by Cycle: As detailed in Chart 4, over the past five cycles for all industries, the group of companies with above-median PSU payouts have higher TSR compared to the group of companies with below-median PSU payouts. Among the group of companies with below-median PSU payouts, their average PSU payout over the past five cycles is below 100% of target for all cycles. For example, in the 2018-2020 cycle, for the group of companies with above-median PSU payouts (median payout = 172% of target), median 3-year cumulative TSR was +59% while for the group of companies with below-median PSU payouts (median payout = 93% of target), median 3-year cumulative TSR was +28%.

Are there other factors that confirm the alignment of AIP/PSU payouts and TSR results?

Yes, three additional factors affirm this alignment:

1. Companies with positive TSR are more likely to pay AIP and PSUs above target.

• In the five PSU cycles reviewed, 67% of payouts were at/above target and in 91% of these cases, the companies had positive TSR while only 9% had negative TSR. This indicates that misalignment or shareholder-unfriendly outcomes are not prevalent.
• Across all six AIP cycles reviewed, 69% of payouts were at/above target, which is similar to the results reported in the proxy advisory study. Of these companies, 72% had positive TSR while 28% had negative TSR. It is our experience that AIP payouts are generally less correlated to TSR compared to PSUs, as the AIP measures are often designed to promote future success.
• Combining both AIP and PSU incentive plans represents 3,200 data pairs. Based on the combined dataset, 67% of payouts were at/above target. Of the companies with at/above target payouts, 80% had positive TSR while 20% of those companies had negative TSR. In our view, this demonstrates a robust alignment of incentive payouts with shareholder outcomes among the 290 companies included in the test companies over the past 6 years.

2. The role of providing guidance to investors.

• Generally, exceeding annual guidance positively impacts stock prices unless subsequent guidance disappoints.
• If a company consistently beats guidance, resulting in above-target payouts perceived as being too easy to achieve, the market may eventually respond negatively.

3. Separately, Pay Governance conducted research [1] on the alignment of CEO pay with TSR based on the Pay Versus Performance rules mandated by Dodd Frank. Our analysis found a strong correlation of Compensation Actually Paid (CAP), with TSR over 2020-2023.

Conclusions and Implications for Individual Companies

Contrary to the concern and criticism that AIP and PSU performance measures may not be sufficiently rigorous and the resulting incentive payouts may be too high, our study shows that such payouts are aligned with shareholder outcomes. This may partially explain why shareholders have consistently and strongly supported Say on Pay for the last several years. We recommend that companies continue to set appropriate and rigorous performance targets when issuing investor guidance and setting incentive plan goals. This disciplined process observed by many companies increases the likelihood that payouts are aligned with operating performance, shareholder experience, and yield motivation and retention value.

Typical analytical tools used by Pay Governance and many companies for selecting appropriate performance measures and testing goal rigor include:

1. Ensure that incentive metrics are correlated with TSR.

2. Compare the goals before final approval with a multidimensional assessment of internal and external expectations of the company’s performance including, for example, analysts’ expectations for company and peers, history of goals, and other relevant factors.

3. Assess historical alignment of incentive payouts and TSR.

4. Utilize realizable pay and CAP to assess the payouts for a multi-year period and alignment with TSR to evaluate if changes are required to improve alignment.

Appendix

General questions about this Viewpoint can be directed to Patrick Haggerty (patrick.haggerty@paygovernance.com), Ira Kay (ira.kay@paygovernance.com), or Mike Kesner (mike.kesner@paygovernance.com).

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[1] Ed Sim, Ira Kay, and Mike Kesner. Does Compensation Actually Paid Align with Total Shareholder Return? Harvard Law School Forum on Corporate Governance. August 8, 2024. https://corpgov.law.harvard.edu/2024/08/08/does-compensation-actually-paid-align-with-total-shareholder-return/

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In our previous Viewpoint, “Recap of the 2024 Say on Pay Season,” [1] we discussed the historically low rate of Institutional Shareholder Services (ISS) opposition to Say on Pay (SOP) proposals at S&P 500 companies in 2024. In our follow-up Viewpoint, “Record Low ISS S&P 500 Say on Pay Opposition: The Trends Behind the Decline,” [2] we reported that the general reduction of outlier CEO pay and improvement in compensation committee responsiveness to shareholder concerns likely contributed to reduced ISS SOP opposition. In continuation of our 2024 SOP Viewpoint series, we explore actions S&P 500 companies took in response to ISS SOP opposition and how these actions were received by ISS and shareholders. We also summarize key themes on which we anticipate proxy advisors and investors will focus in the 2025 SOP season.

Overview

For the sample of 47 S&P 500 companies that received ISS opposition to 2023 SOP proposals, we researched responses as disclosed in 2024 proxy statements. Actions that resulted in improved ISS and shareholder support in 2024 were:

1.Demonstrating shareholder engagement and responsiveness

2.Revising incentive plan designs and enhancing disclosure

3.Addressing pay practices that are regarded as “problematic” by ISS

As a result of the above actions, approximately two-thirds of the companies improved their SOP outcomes and received a favorable ISS recommendation in 2024. The remaining one-third of the companies received consecutive ISS opposition to SOP proposals.

We analyzed the S&P 500 companies’ actions taken in 2024 to address 2023 ISS SOP opposition by dividing our sample into three groups:

1.Companies that received ISS SOP support in 2024 following a 2023 SOP outcome of ≥70%shareholder support, representing 19% of our sample.

2.Companies that received ISS SOP support in 2024 following a 2023 SOP outcome of <70% shareholder support , representing 47% of our sample.

3.Companies that received consecutive ISS SOP opposition in 2023 and 2024, representing 34% of our sample, regardless of the 2023 SOP vote outcome.

ISS closely evaluates the response of compensation committees to shareholder SOP concerns when support levels are <70%. As such, there is less external pressure from proxy advisors and investors to take significant action when prior year SOP support was deemed sufficient by ISS’s standards (≥70%). When SOP support is <70%, there can be a pathway to SOP success the following year through meaningful actions that are demonstrated in disclosure.

Across all companies in our sample, average SOP shareholder support increased by 26 percentage points (see Figure 2) from 2023 to 2024; in fact, all but three companies in the total sample experienced an improvement in the SOP vote outcomes. Companies that had low support the prior year and ISS support in 2024 (Group 2) had the largest year-over-year increase in support (+44 percentage points).

Figure 2: Change in SOP Shareholder Support^[3]

‍Strategies for a Favorable SOP Outcome

Across all three groups, we observed consistent themes in the approaches companies took to respond to unfavorable SOP outcomes. Among companies that received the greatest improvement in SOP support, we identified the following strategies:

1. Demonstrating Shareholder Engagement and Responsiveness

ISS expects companies that receive <70% SOP support to engage with shareholders to understand their concerns and take meaningful actions in response. Among all S&P 500 companies that received ISS SOP opposition in 2023, two-thirds of companies were expected to demonstrate responsiveness to shareholders.

All companies that had <70% SOP support in 2023 and received a favorable SOP recommendation from ISS in 2024 were deemed as being sufficiently responsive by ISS. In contrast, poor responsiveness was the most common reason for consecutive ISS SOP opposition among companies that had <70% SOP support in 2023. Each of these companies that received ISS opposition disclosed shareholder outreach efforts, but ISS considered the response to be inadequate, typically because specific actions were not taken to address investor concerns.

Companies with detailed shareholder outreach disclosure on average engaged with investors representing about 60% of shares outstanding. Robust disclosure also included detailed shareholder feedback and specific actions taken in response to investor input, typically in the form of an easily digestible table with “What We Heard” and “What We Did (in response).” Many companies also provided a letter addressed to shareholders from the compensation committee chair or members describing actions taken in response. As shown in Figure 3, these disclosures were more prevalent among companies receiving a favorable ISS recommendation and nearly universal for companies that effectively demonstrated responsiveness.

Figure 3:

‍2. Incentive Plan Design and Disclosure Enhancements

Changes to incentive plan designs and/or enhancing disclosure were keys to the successful SOP outcomes for the S&P 500 companies in our sample.

Companies that received a favorable ISS recommendation in 2024 took different approaches depending on the level of SOP support received in 2023 (see Figure 4). For companies with prior SOP support of ≥70% (Group 1), incentive plan design changes and forward-disclosure of program changes were most prevalent (78% and 44%, respectively). Companies with <70% SOP support (Group 2) similarly revised incentive plan designs and forward-disclosed changes (82% and 36%, respectively) but also commonly provided enhanced disclosure (64% of companies). Most of the companies that received consecutive ISS opposition (Group 3) did not make incentive design or disclosure changes.

Examples of annual incentive plan design changes disclosed by companies in our sample included changes to payout opportunities; introduction, removal, or reweighting of metrics; [A1] and removing or reducing discretionary components. Examples of long-term incentive (LTI) plan design changes disclosed by companies in our sample included reducing or capping maximum payout opportunities; introduction, removal, or reweighting of metrics; extending performance measurement to a multi-year period; and increasing the proportion of performance-based equity in the organization’s LTI mix. Disclosure enhancements commonly included expanded rationale for how incentive payouts were determined; greater transparency around goal setting and specific goals at threshold, target, and maximum; and demonstrating how executive pay is linked to company performance and shareholder value creation.

3. Addressing “Poor Practices”

Investors and proxy advisors are generally more supportive of companies that eliminate or commit to eliminating practices that have been criticized as poor or problematic. These actions were more common among the sample of companies that received ISS SOP support in 2024 following ISS SOP opposition in 2023 (see Figure 4). Examples of future commitments commonly offered included eliminating or significantly limiting the use of one-time awards, not amending outstanding equity awards unless there are extraordinary circumstances and eliminating or limiting positive discretion in incentive payouts. Examples of other practices that were addressed by companies in our sample included adopting or amending a severance policy prohibiting or limiting cash severance, moving from single to double trigger equity vesting upon a change in control, revising the compensation benchmarking peer group, reducing perquisite values, and increasing stock ownership guidelines.

Figure 4:

Expectations for the 2025 SOP Season

There are several key themes on which we expect proxy advisors and investors to focus in the 2025 SOP season. We anticipate proxy advisors and investors alike will continue to be vigilant for large one-time awards and will scrutinize the rationale and design features of such awards. In addition, we expect that upward discretion or positive adjustments when determining incentive payouts will be closely evaluated. For companies that ISS deems to have pay for performance misalignment, ISS will have an increased focus on performance-vesting equity award designs, rigor, and disclosure. Providing robust disclosure and having simple pay designs that align with shareholder value creation and company strategy, while avoiding executive pay and governance missteps, will continue to be a successful path to a favorable SOP outcome.

As evidenced in the prior SOP season, for companies that had SOP support of <70%, ISS will continue to focus on compensation committee responsiveness as demonstrated through robust disclosure of the outreach process and specific actions that directly address investor concerns. After an unfavorable SOP outcome, there is a reliable formula for SOP success, achieved through meaningful actions that are clearly demonstrated in proxy disclosure.

General questions about this Viewpoint can be directed to Linda Pappas ( linda.pappas@paygovernance.com).

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[1] Perla Cuevas, Jose Lawani, Linda Pappas, and Olivia Wright. Recap of the 2024 Say on Pay Season. Pay Governance. August 29, 2024. https://www.paygovernance.com/viewpoints/recap-of-the-2024-say-on-pay-season

[2] Perla Cuevas, Jose Lawani, Linda Pappas, and Olivia Wright. Record Low ISS S&P 500 Say on Pay Opposition: The Trends Behind the Decline. Pay Governance. October 10, 2024. https://www.paygovernance.com/viewpoints/low-iss-sp500-sop-opposition-trends-behind-decline

[3] SOP vote outcomes and ISS vote recommendations were collected from ISS Corporate’s Voting Analytics database.

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