Executive Remuneration – A US Perspective

EQ: US executive remuneration, or compensation as it is referred to, seems very different – quantum, structure to name a few. What does a typical US executive compensation structure look like?

ZA: With the sheer number of companies listed on U.S. stock exchanges I’m hesitant to use the word ‘typical’ as this can change considerably depending on market cap or even industry - it might make more sense to cover what ‘best market practice’ is considered to be when generally talking about U.S. executive compensation structure, and then speak to the variances from there.

From a structural standpoint, you’ve got two main components of executive compensation that typically comprise the majority of a pay package – fixed and variable compensation. In the U.S., fixed pay typically refers to base salary, which does not often exceed 30% of total compensation – I find that the larger the company, the less it is reliant on fixed compensation for their top executives. 

The other primary component of a pay package can be referred to as variable compensation, which covers both the short-term incentive plan (also referred to as the ‘bonus’ or ‘STIP’ and is typically a non-equity incentive plan) and the long-term incentive plan (also known as ‘LTIP’) and is typically comprised of equity incentive awards. STIPs are typically tied to various key performance indicators, which are used to measure targeted business goals. The LTIP ideally contains a mixture of equity vehicles (which can include stock appreciation rights, restricted stock, stock options and performance shares) tied to a multi-year vesting and/or performance period. 

Best market practice would indicate that a majority of equity incentive awards are tied to a mixture of absolute and relative performance metrics (with relative TSR being the most common one), though in practice this is very dependent on the size of the company and the industry it is in.

After this, we can factor in additional items such as perquisites and retirement benefits to complete the typical U.S. pay package.

EQ: In the UK we see the Remuneration Policy, ie the remuneration framework, put to a shareholder vote every 3 years, with the Remuneration Report submitted for an advisory vote at every AGM. What are the requirements for shareholder approval on US executive compensation? 

ZA: Most companies in the U.S. offer an annual ‘Say on Pay’ vote, where the shareholders of a company may cast a (non-binding, or ‘advisory’) vote on executive compensation policy, philosophy and the executive pay packages for at least five of the highest paid executives of a company at the annual shareholder meeting.

Public companies were first required in 2011 to hold a non-binding ‘say on frequency’ vote at least once every six years to ask shareholders how often to hold Say on Pay votes. Shareholders are typically given the option to hold say on pay votes every 1-3 years, and most companies in the U.S. now offer an annual Say on Pay vote due to overwhelming support from investors calling for an annual approach.

EQ: In June 2024, we saw Tesla shareholders support a pay deal for Elon Musk worth $56bn. Is this the direction of travel on executive compensation in the US? Do you ever see shareholders voting down executive compensation?

ZA: Although the Tesla situation was certainly a unique outlier, it is worth first acknowledging the rising nature of executive compensation in the U.S. – the root of this is often described in corporate governance theory as an agency problem, where a corporation’s managers are likely to ‘overpay’ because the ability to pay themselves typically falls under the umbrella of management power. The introduction of Say on Pay was in part designed to address this issue, though opinions on the effectiveness of this solution have been mixed.

To answer your question, we certainly see shareholders voting down executive compensation every year, though these failures aren’t widespread. For example, within the Russell 3000 index, we typically see less than 100 ‘failures’ every year. This proxy season in particular we saw the number of ‘failed’ votes in both the Russell 3000 and the S&P 500 reach a 10-year low, with just 26 Russell 3000 companies and only three S&P 500 companies failing to receive majority shareholder support for their Say on Pay proposals. Generally speaking, average support for Say on Pay proposals is quite high and has typically hovered around 90% for at least the last five years.

EQ: Here in the UK, we’ve finished another busy AGM season, and one of the key areas we support on is advice and engagement to gain support on executive remuneration. We recently published a Case Study on the Hunting Remuneration Policy which was more aligned to the US model. What role do you and your team play on advising your clients on executive compensation?

ZA: We provide support in a very similar context, and we like to think of our relationship with our clients as a year-round relationship that centres around the concept of ‘no surprises’. We take a look at both the structure and disclosure of a company’s executive compensation programme. We work from there to identify any potential ‘red flags’ that an investor or proxy advisory firm might identify based on their voting policies and modelling practices, and work with the company to align the disclosure with best market practice, and to create strategy around shareholder engagement to position them for the best outcome possible.

EQ: Finally, what do you think the future holds for executive compensation in the US?

ZA: There have been a handful of topics that have come to the spotlight over the last few years that I anticipate will remain relevant, which includes placing limits on severance pay packages, ‘clawback’ policies and whether the definition of materiality for these should include non-financial performance factors, gender and racial pay gap analyses and the incorporation of ESG-related metrics into incentive plan structure, to name a few. 

I anticipate the more contentious Say on Pay votes to continue to be driven by a misalignment of pay and performance relative to peers and/or incentive awards granted outside of the general structure of an executive compensation program (‘special’ one-off awards, for example), and lastly I anticipate shareholder support for Say on Pay to generally remain strong.