With an economic recovery on the horizon, many U.S. companies are beginning to retool their executive compensation plans to reflect a new reality, according to the outsourcing and consulting firm Hewitt Associates.
Hewitt surveyed 176 major companies and found that nearly one-half (47 percent) say that attracting and retaining key executive talent is still difficult but easier now than it was before the economic downturn. Companies cite weakness in stock prices as a continuing problem, eroding their ability to use equity incentives as an attraction and retention tool.
"Lower bonuses, higher financial performance expectations and underwater stock options are common themes for survey participants," said Tracy Davis, senior consultant with Hewitt Associates. "Having to deliver a competitive compensation package with less equity and cash has forced companies nationwide to reevaluate their pay delivery strategies."
Executive bonuses fall short
The Hewitt study shows that nearly two-thirds of companies paid out executive bonuses below target this year (for 2001 performance.) Of those, 14 percent did not have a bonus at all, 13 percent paid out between 1 and 49 percent of target, and 38 percent of organizations awarded bonuses between 50 and 99 percent of target. Meanwhile, 35 percent of companies had bonus payouts at or above 100 percent of target, which is significantly lower than each of the last five years, when more than 50 percent of Fortune 500 companies had bonus payouts greater than target.
As a result of declining bonus opportunities, several survey respondents indicated that they are taking a more cautious approach with executive bonus plan designs for 2002. For instance, 30 percent of the companies modified their plans with new performance measures, 11 percent increased their target award opportunities, and 10 percent modified threshold levels of performance before any bonus will be paid.
"Economic uncertainty has led many companies to revise their executive bonus plans in an effort to motivate executive and managerial talent," said Davis. "The most significant changes are occurring with new performance metrics, including both traditional financial measures, such as earnings per share and return on equity, as well as discretionary or internal performance measures. However, it is critical that any modifications are also aligned with the interests of the shareholders and the strategic direction of the company."
Companies look to curb stock dilution
Additionally, this study reveals that stock dilution is a major issue for companies nationwide. In fact, more than 25 percent of the respondents expect to exceed a 2 percent run rate 1 on 2002 stock option grants, and the majority of the remaining companies project a run rate of 1 to 2 percent. In response to growing concerns about stock dilution, 44 percent of companies indicated that they are considering a change to their stock option programs, or have already taken action to counter the effects of dilution. Specifically, 21 percent of companies have limited or are considering limiting stock option grant sizes; 16 percent have increased or plan to increase stock option award differentiation based on performance; and 12 percent have capped or are considering a cap to annual share usage.
"There are several concerns companies have with stock options," said Davis. "Currently, the main issue is dilution, but organizations are also anxiously awaiting the outcome of proposed legislation, and possible action by the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) that would require a P&L charge on stock options."
