How should a CEO's individual performance be assessed and rewarded? To what extent can a CEO’s individual performance, and therefore compensation, differ from broader organizational outcomes? These are critical questions faced by every board and compensation committee. Although there is no definitive answer, we present a summary of North American market practices for annual incentive plans and a framework that our clients find valuable when addressing these questions
To evaluate and reward CEO performance, 52% of the companies within the S&P 500 and 50% of the S&P / TSX 60 incorporate an individual weighting or modifier in their annual incentive plans. A weighted approach assigns part of the overall score to individual performance. On average, the weighting is 26% in the US and 29% in Canada for CEOs. A modifier on the other hand is applied to the overall enterprise performance to adjust the annual incentive payout up or down based on individual performance (typical modifiers are +/- 10% to 25%). Among S&P 500 companies, modifiers are slightly more common than weighted components. However, 80% of those S&P/TSX 60 companies noted above use a weighted approach.
So, how did CEOs perform relative to their corporate scorecards in 2023? In short, better.
168 US S&P 500 companies disclosed weighted scores for both corporate and individual performance
223 Canadian S&P/TSX 60 companies disclosed weighted scores for both corporate and individual performance
In addition to higher average annual incentive scores, individual CEO outcomes were much less likely to be scored below target or, for performance modifiers, to decrease CEO outcomes:
Although the use of individual components in annual incentive plans for CEOs is evenly split in North America, high-performing organizations typically possess well-defined CEO performance appraisal processes, fostering a shared understanding of performance expectations and outcomes. Whether such CEO performance appraisal should be formalized in the annual bonus depends on how each company views the following cases for and against:
Rationale for an individual CEO component:
Rationale against an individual CEO component:
How should we interpret these results? Are CEOs being over-rewarded or evaluated less strictly? We do not believe this is the case.
We believe the key question is whether a CEO’s personal contributions are accurately reflected in the annual incentive plan. Companies with bonus plans that focus mainly on financial performance and less on other metrics benefit from including an individual component which helps hold CEOs accountable for overall operational performance. In contrast, companies with a more balanced annual scorecard gain less from having an individual component.
Enhancing the link between executive pay and performance is a core focus of WTW’s Executive Compensation and Board Advisory Practice. For expert assistance, please connect with your local WTW consultant or contact one of the authors below.
A version of this article appeared in Workspan on December 19, 2024. All rights reserved, reprinted with permission.