Are companies in denial when it comes to executives’ annual bonuses for 2011? Judge for yourself.
Among 265 companies that participated in a newly released Towers Watson survey, 42% said their shareholders’ total returns were lower this year than in 2010. No surprise there, given the stock markets’ flat performance in 2011.
Yet among those that reported declining shareholder value, a majority (54%) said they expected their bonus plan to be at least 100% funded, based on the plan’s funding formula. That wasn’t much behind the 58% of all companies that expected full or greater funding (see chart).
“It boggles the mind. How do you articulate that to your investors?” asks Eric Larre, consulting director and senior executive pay consultant at Towers Watson. Noting that stocks performed excellently in 2010 while corporate earnings stagnated — the opposite of what has happened this year — he adds, “How are you going to say to them, ‘We made more money than we did last year, but you didn’t’?”
In particular, companies would have to convincingly explain that annual bonus plans are intended to motivate executives to achieve targets for short-term, internal financial metrics such as EBITDA, operating margin, or earnings per share, and that long-term incentive programs — which generally rest on stock-option or restricted-stock awards, giving executives, like investors, an ownership stake in the company — are more germane to investors.
But such arguments may hold little sway with the average investor, who “doesn’t bifurcate compensation that discretely,” says Larre. Rather, investors simply look at the pay packages as displayed in the proxy statement to see how much top executives were paid overall, and at how the stock performed.
Larre attributes much of the current, seeming generosity to executives to complacence within corporate boards. This year, the first in which public companies were required to give shareholders an advisory (“say on pay”) vote on executive-compensation plans, 89% received a thumbs-up. But that came on the heels of 2010, when the S&P 500 gained some 13% and investors were relatively content with their returns. “They may not be as content now,” Larre observes. “I think the number of ‘no’ say-on-pay votes will be larger during the 2012 proxy season.”
Compensation committees could still exercise discretion to change their 2011 formula for bonus payouts, which for a calendar-year company are typically paid in April for the previous year’s performance. But 87% of survey participants said they don’t expect that to happen.
In fact, slightly more respondents (7%) predicted their compensation committee would increase payment levels beyond the formulaic amount than predicted a decrease (6%). “I don’t wear a hat, but if I did, I’d eat my hat if that’s what the actual results are,” says Larre. “Companies have underestimated the pressure compensation committees will feel if investor returns are not there.”