The TEXPERS Blog

Looking for impact in CEO compensation

Graphic: iStock/Natali_Mis

By Katherine Collins and Stephanie Henderson,

Guest Columnists

One powerful element to consider across all sectors is capital stewardship. While company management doesn’t directly control the performance of their stock, especially in the short term, the CEO has direct responsibility for the stewardship of a company’s capital. Additionally, analysis of incentive compensation measures reveals a lot about internal company priorities: Sometimes incentive structures amplify the company’s stated mission, and sometimes they contradict it. 

For investors concerned about corporate governance issues, the structure of management incentive compensation has become a prominent consideration. Still, we do not have a complete understanding of the linkages between pay structures and company performance. While many companies have moved to incorporate total shareholder return (TSR, or stock price appreciation plus dividends) into their incentive metrics, the use of this metric alone does not necessarily ensure alignment between management and shareholders.

First, consider the growing importance of incentives. More than 80 percent of companies in the S&P 500 used performance awards as recently as 2015, linking a part of their executives’ annual compensation to performance goals; this compares with about 50 percent of companies in 2009, according to a report from Stanford Graduate School of Business. Performance-based pay, in fact, accounts for the majority of CEO compensation for the average S&P 500 company. More than 60 percent of total compensation is from long-term incentives such as stock and option awards, the Stanford report shows.

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TSR is the most popular metric in incentive plans.  According to the Stanford study, 57 percent of companies in the S&P 500 used it in incentive pay. However, there is little empirical evidence showing a relationship between TSR-based incentive plans and company performance.

While it’s tempting to think that stock performance and management performance are one and the same, there is often a disconnect. A recent MSCI study from October 2017 shows that there is little relationship between CEO pay and shareholder returns, even over a 10-year period. There are several possible explanations for this, involving a mix of external factors, CEO performance, and luck.

The disconnect between long-term total CEO pay and long-term shareholder return indicates that important questions remain. As compensation measures become more complicated, the assessments have turned increasingly interesting and nuanced. For example, a metric that works for an industrial company may not be tied to value creation in a technology company. 

The power of incentives becomes even more apparent over the long term. Viewing executive compensation in this light can help us to identify organizations that are best aligned with true long-term value creation for their investors and other stakeholders.

The views expressed do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Putnam Investments or TEXPERS.

Katherine Collins

About the Authors

Katherine Collins is head of sustainable investing at Putnam Investments. She is responsible for leading the firm's investment research, strategy implementation, and thought leadership on environmental, social and governance principles. Collins collaborates with portfolio managers and analysts on ESG integration, assessing the fundamental relevance of ESG issues at a security level, and the potential for alpha generation and risk mitigation at a portfolio level. In addition, she is the portfolio manager for two ESG-focused separately managed accounts, specifically managed for institutional clients. 

Stephanie Henderson

Stephanie Henderson is a portfolio manager and an analyst in Putnam Investment's Equity Research group, which specializes in sustainable investing strategies. Henderson is responsible for conducting fundamental analysis and valuation of companies, evaluating their performance across environmental, social and governance factor and identifying potential risks and opportunities related to these factors.