More Value, Less Money for CEO Pay: The Role of Performance Awards in Executive Compensation

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By Jennifer Baehr. Executive compensation is a complex and controversial subject. Companies are often criticized for overpaying their executives, while shareholders are questioning the pay-setting process and the outcome it produces. This debate has triggered regulatory changes, which in turn have affected the composition of executive compensation packages. Over time, companies are offering less and less cash-based compensation and steadily increasing the portion of performance-based awards.

Last year, Microsoft’s CEO, Satya Nadella, was awarded a compensation package of $84.3 million. However, nearly 95 percent of his compensation consisted of stock grants, valued at $79.7 million. Nadella will not be eligible for the stock payout until 2019, TD Stock Optionsand the amount of the payout will depend on the performance of the company during his tenure, according to company’s proxy filings.

Microsoft’s pay package illustrates the large portion of executive compensation that is performance-based and the high level of transparency for public companies required by SEC. Performance-based awards are becoming increasingly popular among big companies that want to hold on to senior-level talent. According to Equilar, 83.2% of S&P 500 and 82.6% of S&P 1500 CEOs, received performance equity awards in 2014.

Share-based compensation, and in particular performance-based awards, allows for alignment of management compensation with shareholder interests. And with the adoption of the Say-On-Pay rule by the SEC in 2011, companies are required to conduct a separate shareholder advisory vote to approve the compensation of executives. (Read more about Say-On-Pay rule implications in our whitepaper.)

Another reason for companies to choose performance-based compensation is the Section 162 exemption for qualified performance-based compensation, which allows a tax deduction in excess of $1 million for compensation under shareholder-approved plans that link pay to objective measures of firm performance. Section 162(m) limits the corporate tax deduction for compensation paid to the CEO and the next four highest-paid executive officers to $1 million per person. This rule encourages companies to limit cash-based compensation and opt for performance awards.

The extreme case of forgoing cash compensation is a $1 salary, which has become popular among tech company CEOs. The $1 salary club includes Google’s co-founders Larry Page and Sergey Brin, Facebook’s CEO Mark Zuckerberg, Oracle’s executive chairman and CTO Larry Ellison, and many more. In addition to receiving a $1 salary, most of them also refused a cash bonus in lieu of stock and other performance-based awards. Keep in mind, this type of compensation package is not the norm.

As companies begin to rely more heavily on equity compensation, the need for an automated solution increases. Certent’s Equity Compensation Management platform provides the capability to administer 15 separate award types, as well as the ability to make grant modifications. To learn more about how Certent can help manage your company’s equity program, request a demo.

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