Executive pay has been tightly controlled during the pandemic. Now it is set to rebound

We all know only too well the challenges of wage inflation and hiring of talent right now. While we may think this predominantly impacts low to mid-level roles, the reality is, the same issues extend to executive level roles too.

Overall, executive compensation has been tightly controlled since the impact of Covid-19. Pay freezes or reductions of salaries became commonplace. And pay-outs for short term/long term incentive plans (STIPs/LTIPs) were put on hold or significantly lowered in response to the financial impact on the company, or because of the inability to measure performance as the goalposts had moved. In addition, incentive plan targets changed to take account of recognising resilience in the face of the unusual situation and how business leaders had to pivot to ensure survival and keep employees motivated and supported.

Now, we are in a fast-recovery phase, executive compensation is rebounding, and looking ahead it is clear that there will be ground to make up for addressing the pay and bonus restrictions during the pandemic.

The Great Resignation

We are currently seeing a highly competitive labour market. The Great Resignation is impacting chief executive officers (CEOs) and other executives, along with other mid-level professionals, and there has also been a drive by CEOs and executives to pursue other opportunities. Some CEOs took it as an opportunity to take early retirement or simply take time out.

This change does allow other key talent to step into their shoes. But executive roles come with significant accountability and responsibility. Executives, particularly the CEO, oversee and build cultures that are aligned to the business strategy. Shareholder returns, profitable business and sustainable employee engagement and retention must continue to flourish - if the culture is positive, its continuation is important for long-term success. Therefore, the recruitment and retention of executive talent is critical.

Pay rise over 10%

Research suggests that CEO pay rises could be greater than 10%, particularly in technology, digital and biotech companies, as these are seeing a highly competitive labour market as the economy and companies continue to grow and receive investment. While executives in slower growth or heavily impacted industries might see increases in low to mid-single digits, individual CEO pay increases will continue to be closely tied to peer competitor compensation.

As we are already nearing the end of Q1, most organisations will have finalised this year’s incentive plans, but, generally, individual CEO plans will continue to be closely tied to overall company performance.

In terms of shares, because it has been difficult in setting goals over a two-to-five year period, this has hit the use of performance share plans. Share options are still important for some companies, but their use has also been in decline over the years.

Key points:

It is important to understand sector-based comparison groups when devising pay, plans and creating compensation packages. The composition of the comparison group is important. The group used needs to ensure that they are benchmarked against relevant firms that are similar in terms of business cycles and economic upturns and downturns.
The period that incentive plans run over is key. Long term predictions are difficult. The sanctions on Russia announced at the end of February because of the war in Ukraine are likely to affect many organisations. This is either driving shorter-term performance or lengthier performance periods, to take account of the economic waves.
Not relevant for most companies, but listed businesses tend to use relative total shareholder return (rTSR) in some capacity in their LTIP. The use of relative matrices aims to help neutralise goal-setting ambiguity, particularly because of continued economic uncertainty.
Plans need to consider future events, such as initial public offerings (flotations), divestments, mergers and acquisitions. Also consider:

- New CEO transition from either an internal promotion or external hire

- Drive to bring innovations to market

- Business operating model transformation

- Retention and external parity with other competitors

Environmental, social, and governance (ESG) metrics are much more prominent in both short-term and long-term incentive plans, in part due to the growing influence of passive investors. With ESG now a priority, it follows that boards and shareholders ask themselves if it is important, it should influence how they reward.

ESG covers several qualitative elements that the executive performance plan could consider. ESG can have a large or small influence on any plan, but essentially it is ensuring that ESG is part of the performance conversation and reinforces key messages. If ESG needs to have greater prominence with audacious and transformative targets these may be held within an LTIP plan, as opposed to a STIP.

It comes down to the fundamentals of how the organisation quantifies ESG and what measures feed into it, such as environmental impact, employee satisfaction, safety incidents. Or is it more transformational – for example, is it about transitioning into renewable technologies? Whether ESG sits within short- or long-term plans, it is about creating accountability driving the right priorities and measuring progress.

It is fair to say that nothing is going to settle down anytime soon. Executive pay and compensation needs to be responsive and agile and for some companies will be complex and will fall under regulation and governance requirements. But ensuring that comparison market data is up to date and key trends are understood will help to lift the fog. Executive compensation is a bit daunting at times, but at the very least it should be reviewed regularly, kept relevant, be incentivising and be aligned to business strategies, both in the short term and the long term.