As it’s the beginning of 2022, most companies have started the annual reviews of their executive compensation packages and long-term incentive plans for the new year.
This is another year marked by the persisting uncertainty caused by the COVID-19 pandemic and its impact on the workforce market. In addition, the economic, geopolitical, and social issues exacerbated by the world health crisis have come to the fore, further affecting already difficult conditions. It comes as no surprise then that already in 2019-2020 NACD’s Private Company Governance Survey), private organization directors and board members named as their top concerns the impact of business-model disruptions (59%) closely followed by the increased competition for talent (57%).
The acutely felt shortages of material risk takers and extreme competition for top figures have forced virtually every company to review their compensation packages and long-term incentive plans to make sure they are well-designed, attractive, financially sound, and up-to-date with current trends. So what exactly are those trends for executive compensation plans?
Mega grants are simply outsized, usually one-time, performance-based awards that may also be parts of the LTI plan.
Some of the notorious ones include the refresher grant for Elon Musk](https://www.sullcrom.com/siteFiles/Media/files/CEO%20Mega%20Grant%20Practices.pdf) amounting to $2.6 billion in stock options, equal to 4.9% of Tesla’s market cap, or the award to Patrick Smith, the founder and CEO of Axon Enterprise, equal to $118 million in stock options or a whooping 7.9% of the company’s capitalization, both based on the vesting period and performance criteria.
As these examples show, in recent years, they are not only becoming increasingly popular but also extremely large in value. Approximately 10% of S&P 500 companies have made extraordinarily sizable grants between 2020 and 2021. The number is relatively low since government regulations and public pressure have put a ceiling on how common such awards can become for S&P 500 companies. Interestingly, mega grants have exploded in the pre-IPO and newly public organizations sector and we expect this uptrend of high upside potential for remarkably high-value creation to continue.
Since the economic uncertainty remains extremely high, long-term revenue and earnings forecasting remain particularly difficult. In this changing environment applying absolute metrics to predicting long-range results basically becomes a guessing game.
Hence the trend we are seeing is a clear ongoing expansion to rely on relative metrics, that give the executive a higher level of control over the KPI, filtering out most of the uncontrollable factors. In such an uncertain environment, this makes payouts for performance that are simply less poor than that of the comparator sample possible.
In 2021 79% of S&P 500 companies used relative TSR to some extent in their LTIP, an increase of 7% or over 30 firms compared to 2020. In the same period, only two companies dropped rTSR as part of their performance metric system.
Performance metrics are crucial in the implementation of an effective LTIP. Indeed, much of the critique regarding the relative performance metrics concerns flaws in the design rather than the idea itself. The size and composition of the peer group are key factors. If the group is too small, minor differences in employee performance will generate large grant differences in compensation. If the group is too large, you will end up benchmarking against firms drastically different from yours in terms of their stage in the life-cycle of the company, business phase, or economic tailwinds or headwinds. To avoid that, companies increasingly utilize sector-focused reference groups.
We describe other compensation trends in the 2022 HR trends blog post.