Picture this: During a discussion about leadership succession with your board’s compensation and HR committee, your CEO mentions that she plans to retire in about three years. While not entirely unexpected, this announcement and your CEO’s expected timeframe causes you to start thinking about what this means for her compensation — especially equity compensation — in her final years with the company.
Currently, your CEO receives annual equity compensation grants that are 50% performance share units (PSUs), 30% stock options and 20% restricted stock units (RSUs). With a view toward retirement, how should the committee approach her outstanding equity awards and future grants in her remaining tenure? And, how soon do you need to begin addressing these questions?
Most organizations don’t consider these equity compensation-related questions long before CEOs retire. However, with the average retirement age among CEOs on the decline, not considering the long-term incentive (LTI) strategy far enough in advance can limit your opportunities to appropriately plan and change course. Inaction also can reduce LTI value that could have been realized in equity compensation grants made during the CEO’s final years in office.
Even organizations that consider this topic early can find themselves unable to address potential lost value at the CEO’s retirement. This outcome can be caused by equity award provisions that require a degree of award truncation rather than providing for full vesting.
WTW’s Global Executive Compensation Analysis Team (GECAT) reviewed five years of pay history among 42 CEOs who retired from S&P 500 companies in the past five years. Unsurprisingly, more than half of the companies made no change to their CEO’s LTI compensation delivery. There were no changes to vehicle mix or vesting schedules in the years leading up to retirement. And, during their retirement year, only 10% of retiring CEOs had a change to their LTI mix, while about 25% of retiring CEOs did not receive any LTI grant.
Once your CEO has announced an intent to retire, you can take initial steps that will help optimize compensation in those final years. Consider the following guidance and questions.
Consider what you want to reward the CEO for and be creative with how you design and deliver your final grants. But remember: Equity awards should reward long-term performance and support shareholder alignment. If you address any lost value for the retiring CEO, also consider if this will set a precedent for other retiring executives and employees.
Revisiting our example-CEO scenario with these considerations in mind, think about the CEO’s equity LTI mix during those final three years. For example, with stock options making up 30% of the annual award mix:
By definition and design, equity LTI awards are intended to reward long-term performance while supporting shareholder interests. So, when planning for a CEO’s retirement, it helps to reassess what “long term” means when considering remaining tenure and equity LTI design and delivery. How can these awards support the actions and performance you want to see from your retiring CEO?
Be proactive and thorough in ensuring your approach is aligned with your organization’s objectives and intentions for what you pay your CEO in their final years in the role. In turn, your organization will likely continue to flourish, your CEO will know their pay continues to align with stakeholder interests, and executives can smoothly transition while continuing to focus on the key dimensions of corporate stewardship during the final years of your CEO’s tenure.
A version of this article appeared in Workspan on November 21, 2024. All rights reserved, reprinted with permission.
