Towers Watson is in the midst of analyzing the proxy statements, proxy advisor recommendations and say-on-pay outcomes of 2013. So far, it’s been a relatively quiet proxy season, with continuing high levels of shareholder support for say-on-pay votes and continuing incremental changes in pay design and pay levels. However, one potentially troubling trend we’re seeing is growing conformity, which may call for a shift to more tailored approaches to executive pay.

Here’s a look at what we’re finding in our research.

A Season of Incremental Change and Strong Say-on-Pay Results
For most companies, 2012 was a weaker year than 2011 in terms of operating financial performance. Sales and earnings growth were significantly lower in 2012. It’s thus not surprising that most companies took a conservative approach to pay last year, as reflected in their 2013 proxies. For example, actual bonuses for CEOs fell approximately 15% from the prior year at the median and total Summary Compensation Table pay and earned pay, which includes the impact of exercised stock options, were basically flat.

However, companies did report increases in target total direct compensation of approximately 6%, fueled by modest increases in all direct pay elements: base pay, target annual incentives and long-term incentives.

Shareholder returns for companies in 2012 were quite healthy, with median total shareholder return of about 15%. If you juxtapose these returns with a conservative approach to CEO pay, you’d expect say-on-pay results to be generally positive, especially for those companies that already addressed irritants (like tax gross-ups).  And that’s what we’re finding so far in 2013, acknowledging that we’re still early in the say-on-pay voting season.  Most companies are enjoying   support at or above the 90% level.

While all may appear calm on the surface, there is definitely some movement below. We’d highlight four areas of action:

  • First, we’re seeing companies continue to shift to a three-vehicle long-term incentive (LTI) design, including options, restricted stock and some form of performance-linked component.
  • Second, and specific to long-term incentives, total shareholder return (TSR) has become the most prevalent performance measure, and many companies are using it in much the same way. For example, more than 90% of companies are using TSR on a relative basis. And more   than 80% of the time, they are using it as the primary vesting factor for the LTI award, generally comparing their own TSR to that of a peer group or index and determining the number of LTI units that vest.  Less than 20% of companies are using TSR as a circuit-breaker or modifier.
  • Third, we’re seeing companies actively seeking improved say-on-pay results. Obviously, companies that failed their votes last year are trying to avoid a repeat. But, what’s especially interesting is that companies just below the 90% approval level (say in the 70%–90% range) are more aggressively undertaking changes deemed to be shareholder-friendly. These can take many forms, but include increasing the performance links in their programs, making incentive targets more robust, initiating more extensive shareholder dialogue and significantly remaking their Compensation Discussion and Analysis (CD&A) to make it not only more understandable, but clearer in outlining how pay and performance are linked.  (For more on the kinds of actions companies are taking, see “2013 Proxy Season Preview: Survey Finds Companies Sharpening Their Focus on Pay for Performance,” Executive Compensation Bulletin, November 8, 2012.) 
  • Finally, companies are taking matters into their own hands and disclosing a pay-for-performance analysis in their CD&As. If you recall, under Dodd-Frank, the SEC is supposed to release guidelines on disclosing pay for performance. We’re still awaiting their release. In the meantime, about 25% of the companies we analyzed included a pay-for-performance summary in their CD&A this year. This is up from roughly 15% in 2012. And interestingly, there’s little consistency in how companies are approaching disclosure, as they are looking at multiple definitions of both pay and performance.

Greater Conformity 
Differences in disclosure aside, a broader observation is that there seems to be a push toward greater levels of conformity in the market with respect to executive pay programs. We see this most directly with the widespread adoption of TSR-driven performance share plans and the adoption of the three-component LTI program. We’re also seeing this in other elements of pay, such as company pay philosophies and targeted positioning, as well as in executive contracts and benefits. We’ve even seen recent contraction in pay levels between the lower and upper quartiles of the market.

There are a number of likely drivers for this conformity, with proxy advisor guidelines — which can appear quite prescriptive — being prominent among them. Other drivers may be the scrutiny associated with say on pay, especially in the early years of shareholder voting, and general economic uncertainty.

Financial markets themselves have reflected greater conformity as well. Based on a 15-year review of company TSR levels and betas, we found that companies are moving in greater lock-step today than at any period over the past 15 years.

Challenging Conformity Through “Pay for Strategy”  
From a performance perspective, companies generally seek to break from the pack and distinguish themselves versus the market. In financial terms, this could be measured in operating terms (e.g., sales, earnings and cash flow growth, return on investment) and in value-creation terms, such as TSR.  More broadly, this could relate to areas that support the sustainability of the organization’s performance over time, such as innovation, product and service expansion, enhanced customer engagement and employee productivity.

The key question is whether the current and increasingly conforming paradigm for pay will support the objective of performance differentiation. “Pay for performance” has become the buzzword of the day. But, this is a rather high-level concept and not tailored to the company.  “Performance” is generally shorthand for share price appreciation or TSR —not a company’s unique approach to how it wants to drive shareholder value creation.

Obviously, share price performance is a critically important consideration and there’s no doubt executive pay should be closely linked to it. But might there be alternative — and potentially more effective — ways to not only link pay and value creation, but motivate actions to sustain this value over time? Our early research on what we’re calling “sustaining high-performing companies” (those that had sustainable performance over 15 years that ranked in the top 1% of the Russell 3000) indicated that they differentiate their pay programs in a number of ways. (For more this research, see “Getting Pay for Performance Right: What High Performers Do Differently,” Executive Pay Matters, October 2012.) 

Our research and our experience suggest that a pay-for-strategy approach can provide more direction for design than pay for performance and can support greater differentiation. What we mean by pay for strategy is a framework in which the company’s pay program is carefully tailored to support its unique business strategy, with pay calibrated to long-term value creation. For most companies, we see a range of opportunities for tailoring. For example, we could envision tailoring the short- and long-term incentive measures to goals around sales and earnings growth, as well as returns and strategic measures (e.g., innovation, customer). We could also link plans much more directly to factors clearly in the control of executives (e.g., business-unit specific goals versus across-the-board corporate measures), as we know that line of sight can be a critical success factor in executing a strategy.  A larger component for individual performance could also be appropriate within the plan.

For the short-term plan, this tailoring could be done within a pool-based approach (versus an additive plan) and, for the long-term plan, it could be done in the form of performance shares or performance cash. The size of annual and long-term incentive awards could also vary based on an assessment of performance.

Very reasonable concerns around shareholder alignment (or paying for the execution of a poor strategy) could be addressed through the use of TSR modifiers or circuit-breakers in plans (i.e., those requiring a minimum level of TSR performance before payouts are made), increased share ownership guidelines and/or plans that use greater levels of (structured) discretion by the compensation committee.

A pay-for-strategy paradigm could also be used to assess the alignment of strategy with other elements of the pay program, such as the company’s targeted pay positioning and pay philosophy, the role of benefits and wealth-creation opportunities and multi-year realizable pay expectations for sustained high performance or weak performance.

The key is to look at the totality of the rewards proposition and assess its strategic fit. In all likelihood, there are opportunities for a closer connection between strategy and pay and the need for trade-offs among the various components of the package.

CEOs and companies that can communicate to their executive teams a much closer link between their rewards and their specific business strategies, while not losing sight of shareholders, will be better able to motivate differentiated performance. They’ll also be in a better position to craft a differentiated value proposition for high-performing executives that will support attraction and retention objectives.

For more insights on pay for strategy and what high-performing companies do differently, listen to the recording of our recent 2013 proxy webcast.

About the Authors

Todd Lippincott

Todd Lippincott
Towers Watson New York

Olivia Wakefield

Olivia Wakefield
Towers Watson Boston

Jim Kroll

Jim Kroll
Towers Watson New York

Todd Lippincott, based in New York, is the leader of Towers Watson’s executive compensation practice in the Americas. Olivia Wakefield is a director in the executive compensation practice in our Boston office. Jim Kroll is a senior executive compensation consultant in New York who leads Towers Watson’s governance advisory practice. Email,, or