Setting compensation and incentive plans may be one of the trickiest, most nuanced aspects of the CEO and board’s responsibilities – made even more complicated by the pandemic and the move to remote and/or hybrid staffing models. The dramatic workforce dislocations with surging unemployment 18 months ago and the grindingly slow recovery makes a tough situation worse.
It has been a tale of two cities since February 2020. There were 10.93 million open positions or 1.3 positions for every unemployed American at the end of July 2021. While the average hourly wage has increased 8.0% to $30.73, according to U.S. Census Bureau data, this marked increase was in large part due to significant layoffs of low-skilled hourly workers and to a lesser degree, increased wages required as employers struggled to re-staff. The dramatic increase in stock market and real estate values pushed U.S. household net worth to yet another record of $141.7 trillion at the end of 2Q21. Of the $5.8 trillion increase in 2Q21, $3.5 trillion was attributed to the increase in public equities and $1.2 trillion to increased home values. Of course, not all Americans own equities or homes, exacerbating the yawning inequity gap.
Data: Federal Reserve Bank of St. Louis; Chart: Thomas Oide/Axios
As year-end approaches, many corporate boards now are deliberating over 2021 bonuses and architecting 2022 compensation plans. In collaboration with my good friend Jody Thelander of J. Thelander Consulting, a leading private company compensation consultant, a review of the data she has collected offers insights into emerging compensation themes. And there were some quite unexpected insights that revealed themselves.
“I was most struck by how stable the data were and the impact of the amount of capital raised has on overall compensation” observed Thelander, who tracks nearly 1,300 private companies, half of which are technology companies. The extensive database aggregates all reporting companies by number of employees, title, sector, and amount of capital raised: all of which directly inform the composition and size of incentive plans. Against the obvious pressure to retain talent, one might expect a dramatic increase in annual compensation – that is not the case. In fact, Founder CEO 2021 levels were either flat or slightly lower than 2020 levels (see chart below).
The narrative for public companies is similar. The Conference Board analyzed CEO salaries for both the S&P 500 and Russell 3000 indices from 2018 – 2020 and observed modest reductions, likely one-time, heading into the pandemic in early 2020. Notably, public CEO compensation is 2x – 3x that of later stage private company CEOs, and not at all unexpectedly, 5x – 6x that of early stage CEOs. Somewhat surprisingly though, public company CEO median salary for the Consumer Staples sector was twice that of the Health Care sector. The Conference Board data also highlight that CEO salaries often decreased to a much greater degree than other members of the executive leadership team, often as a sign of solidarity to the rank-and-file employees.
The Thelander data also compared CEO compensation by sector and stage. The more capital raised, the greater the compensation. The greater the prevalence of advanced graduate degrees, the greater the compensation. Later stage biotech companies reported meaningfully higher compensation across all executive positions; Founder CEO median compensation for later stage biotech companies was nearly $500k and 60% greater than later stage technology CEOs.
Founders tended to receive lower cash compensation but enjoyed significantly greater equity ownership positions. For companies that had raised less than $14.9 million, the median Founder CEO ownership level was 24.0% versus 5.9% for non-Founder CEOs; median cash compensation was $200.0k (Founder) versus $218.5k (non-Founder). Similar story for later stage companies that have raised more than $70.0 million: Founder versus non-Founder median compensation and equity ownership were $400.0k versus $444.0k and 8.0% versus 4.6%, respectively.
One other quite surprising finding in the Thelander data involved geography. There is clearly a “coastal premium” paid to CEOs of biotech companies on both coasts, perhaps reflecting the relative concentration of the life sciences sector in certain key locales such as Boston, San Francisco, and San Diego. The reverse was true for the technology sector – there appears to be a modest premium paid in geographies in secondary venture capital regions. This will merit further analysis with Covid-inspired virtual workforces.
Given the obvious implication on wealth creation and shareholder alignment, most of the attention in compensation schemes is focused on equity. A recent Harvard Business School study concluded that companies with widely held equity were more likely to be successful. The Thelander data show that 78% of companies use Incentive Stock Options (ISO) versus only 11% with Restricted Stock Units (RSU), which is more prevalent with public companies. Not surprisingly, 94% of respondents have vesting with 83% using time-based vesting versus a mere 1% using only performance-based vesting – the remaining 16% have a hybrid vesting approach. Nearly 79% of those companies reporting have four-year vesting schedules, while 12% have three-year schedules (3% have one-year vesting and only 1% have more than five-year vesting). One-year cliff vesting was indicated for over 90% of companies.
The distribution of ownership by stage is tricker to discern across various cohorts given differences in the number of companies reporting but yet certain patterns do emerge. An enduring rule-of-thumb for early stage companies is that the employees receive up to 20% of the fully diluted ownership via the option pool. Initial Founder ownership levels are significant and absent further investments, will be meaningfully diluted. Companies in the Thelander database that have raised more than $90.0 million show Founder ownership levels of 4%, 8%, and 22% by quartile, respectively, as compared to initial early stage ownership stakes of 20%, 34%, and 47% (see below). Importantly, the employee ownership level remains relatively constant as companies raise additional capital, highlighting the necessity to “re-fresh” the option pool with each successive financing.
The impact of equity on overall executive compensation is most startling for public company CEOs. Base cash compensation accounted for only 22% of overall pay for CEOs of the Russell 30000 and only 10% for S&P 500 CEOs. Not surprisingly, the compensation levels for CEOs has tracked the public equity markets (see below), until very recently. The full effect of the dramatic increase in the stock market over the last three years has not yet been fully reflected in CEO compensation, as hard as that is to believe.
Source: Economic Policy Institute
And size matters – in 2020 the top 350 CEOs averaged $24.2 million in total compensation, an increase of 18.9% over the 2020 level, while the broader S&P 500 cohort earned on average $15.5 million according to Thrive. The Conference Board analyzed CEO compensation for public companies by aggregate revenue, and perhaps not surprisingly, determined that has companies scale, so did CEO compensation. It is true – bigger is actually better.
The size of CEO compensation packages has become a visible and highly charged topic, bordering on perfidy in some circles. The Financial Times recently cited a London Business School survey of public equity investors that determined 75% felt that compensation was too high while only 18% supported high pay to “recruit and retain” leadership talent. Critics of executive compensation have focused on the relative compensation of CEOs as compared to the average employee. The Economic Policy Institute calculates that the current ratio sits at 351:1, an increase from 307:1 in 2019 and a mere 21:1 in 1965. Aptiv Plc tops the leader board at 5,291:1.
Source: Economic Policy Institute
At the risk of wading into a public policy debate, executive compensation is under an even brighter spotlight now that three federal unemployment insurance programs are set to expire. This will cause up to seven million Americans to lose a variety of unemployment benefits while another three million people will see their $300 weekly payments come to an end. Somewhat unexpectedly, the U.S. is at a record low in the poverty level at 9.1% of Americans living poverty, down from 11.8% in 2019. This is largely due to the social safety net programs that were unfurled since the onset of the pandemic. Were it not for this government support, the effective poverty rate would be 11.4%, according to a recent Columbia University study. Due to the Great Recession a dozen years ago, the poverty rate hit 16.1% in 2011.
The U.S. Census Bureau reported that 11.7 million Americans were lifted out of poverty while another 10.3 million were kept from falling into poverty by the stimulus programs over the past 18 months. In 2020, median household income declined 2.9% to $68k. If one was able to keep his/her job during the pandemic, their effective income increased 6.9%. These inequities have caused many policy makers to craft proposals to attack the “corporate greed” associated with equity compensation. One recent proposal was to aggressively tax share buybacks which, if enacted, might influence senior executive compensation plans. In 2018, the S&P 500 reported $806 billion of share buybacks as a way, in part some would argue, to prop up stock prices.
To come full circle, what will be the lasting impact of Covid 19 on compensation plans? As Thelander highlighted, the impact on executive compensation over the last 18 months has been fairly muted. Of the respondents to a recent Thelander survey, 91% of companies do not expect to modify current compensation frameworks for employees who have relocated away from company headquarters, although 87% expect to adjust cash levels based on that new location. Notably, only 10% expect to require a return to the office, while 59% expect to institute a “flexible” hybrid arrangement (only 12% expect to stay fully virtual through year-end 2021, with nearly half of those respondents already concluding that it will be permanent). Of those utilizing a hybrid approach, 72% expect that less than 50% of the workforce will be fully remote.
All of this will be closely tracked and analyzed by Jody, and you can take that to the bank…