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Boards have heard the message that pay has to be linked to performance, according to Mercer's study of US CEO compensation trends, based upon analysis of the latest proxy filings of 350 companies within the Fortune 1000.

Mercer's database of 350 companies consists of three size categories - top 50 with revenue of $40 billion or more, large with revenue of $7.4 billion or more and mid-size with revenue of $1.2 billion or more. 

These categories reflect Mercer's desire for companies to responsibly compare themselves - when reading reports during the proxy season - to like-size organisations. Selection was based on an industry mix which approximates the Fortune 1000.

Stunning reduction 

Mercer analysed median total direct compensation for CEOs, defined as base salary, short-term incentive compensation and expected value of long term incentives granted in the fiscal year covered by the proxy.

For CEOs of the top 50 companies analysed, median total direct compensation for 2007 was just under $14 million, but this represented a stunning 15.8 percent reduction from the prior year.

CEOs of large companies received median total direct compensation of about $9.4 million - essentially unchanged from the prior year.

CEOs of mid-size companies analysed by Mercer had median total direct compensation of $4.7 million, a modest reduction of 4.6 percent from the prior year.

In the case of jumbo companies, the dive in total direct compensation was driven by a sharp decline in long-term incentive grant values, down 18.9 per cent.

Cash compensation tracked performance 

Year-over-year changes in the components of pay varied among the three company categories.

While base salary constitutes a relatively small percentage of CEO compensation (19 percent on average), only 58 percent of organisations increased base salary.

It increased by 3.9 percent for CEOs in the top 50 companies, by 4.2 percent for large company CEOs and by 3.0 percent for mid-size company CEOs.

The study found that overall, cash compensation tracked performance: annual cash incentives declined significantly in the top 50 companies (13.5 percent) and mid-size (16.9 percent) over the prior year. Large company payouts were slightly higher (1.6 percent) over the prior year.

Long-term incentives - primarily in the form of equity - continue to be at the center of the CEO compensation story. This pay component continues to make up just under two-thirds of the total CEO pay package.

Long-term incentives 

A trend that began several years ago has fully taken hold: long-term incentives (cash and equity) awards based on achieving specified performance goals have become almost as common as stock options. Stock options are certainly not gone; most companies use a mix of equity vehicles.

Mercer senior executive compensation consultant Mike Halloran explains that companies, uneasy with the market's volatility, are taking a hard look at the drivers of long-term economic value, reassessing performance metrics and realigning variable compensation with financial, strategic and operational measures instead of more traditional metrics such as 'earnings'.

He adds that companies are struggling to set credible goals, however, with so much uncertainty created by the financial market crisis.

“While some companies can use a relative approach, tied to the performance of an external index or industry group, they need to be prepared to pay - and possibly pay well - for negative absolute performance,” Halloran says.

Pay-for-performance 

Peter Oppermann, a senior executive compensation consultant with Mercer, adds that pay for performance gets the spotlight in this environment.

Shareholders want it, the SEC is asking companies to disclose specific measures and targets, and companies are looking closely at how performance could be affected by an unpredictable economic environment.

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