Say on Pays #1 — The basics of executive pay
Lifting the lid on executive pay packages and how CEOs actually get paid.
Large CEO pay packages often make headlines, with annual “highest-paid lists” enjoying particular attention. Hint: in 2021 it’s $296.25 million, received by the CEO of Expedia Group Peter Kern.
But take a closer look, and the jargon-filled multi-million-pound packages are nearly impossible to understand.
In the first of this two-part series, we’ll look at the different parts that make up a typical executive pay package.
What makes up a pay package?
Companies’ pay arrangements are all different, but most pay packages can be broken down into three main parts:
- A base salary and benefits.
- An annual bonus.
- Long-term incentives.
Base salary and benefits
An executive’s base salary and benefits (which include pension), are often collectively referred to as “fixed pay”. They are mainly paid in cash and are not tied to any performance targets.
Annual bonus
Annual bonuses are also commonly called “short-term incentives” or “cash-based incentives”. They fall under the category of “variable pay” or “performance-based pay”.
There are two main things to note:
- They are often paid in cash, but executives may be required to invest some of the cash in company shares; a practice referred to as “deferred share bonus plan”.
- They are conditional on the achievement of yearly performance targets.
Long-term incentives
Long-term incentives (or LTIs, as they’re fondly called in remuneration reports) are designed to ensure executives protect shareholder interests. The strategy? Putting executives in shareholders’ shoes.
They are exclusively share-based and are granted either as share awards or share options (read about the difference here). The gist is that if executives are paid in shares, they will be motivated to grow the share price — hence benefitting shareholders.
The best way to understand LTIs is to understand how they work. A common scenario is as below:
i. An executive is granted an LTI, be it as share awards or options.
ii. Those shares are conditional on the company’s performance over several [three to four] years.
iii. Based on the company’s performance, all or a proportion of those shares will be paid out.
iv. In some instances, executives are required to hold those shares for another few years before being able to cash in on them; a holding period.
[break to take your breath]
LTIs are often complex and technical, so be prepared to sift through some finance lingo. Common ones you may encounter include grant date (the time when you’re given share-based incentives), vest (pay out), and become exercisable (when your share options can be bought).
Recap
A typical CEO pay package can be broken down into three parts:
- A base salary and benefits.
- An annual bonus.
- Long-term incentives.
The key differences between these parts could be whether they’re fixed or variable, performance-based or not, and whether they’re paid in cash or shares.
In the second part of the Say on Pays series, we’ll explore what experts look out for when evaluating pay packages, and how Say on Pay votes work.
