Watson Wyatt’s 2007/2008 Report on Executive Pay, Debunking Executive Compensation Myths, demonstrates the overall effectiveness of the U.S. executive pay model by finding that CEOs’ realizable pay and corporate performance are highly correlated. It also confirms that executive stock ownership and stock options create strong alignment with shareholder interests and provide powerful incentives to maximize shareholder value.

This year’s study finds that companies continue to implement changes in broad-based equity compensation strategies to reduce dilution and compensation expense. In fact, annual equity usage is about 33 percent lower than it was just two years ago. In combination with the finding that pay and performance are aligned, reduced shareholder dilution suggests that recent changes in compensation strategy are improving corporate governance and serving the interests of shareholders.

Overall, we believe that the U.S. executive pay model is working. So well, in fact, that corporate counterparts globally are adopting U.S. pay practices in their efforts to attract and retain top executive talent and to maximize investor returns.

Key Findings

• At most companies pay and performance are aligned. In fact, CEOs of high-performing companies typically earn 75 percent more realizable pay than CEOs of low-performing companies.
• Despite being cut, options continue to play a strong role in creating alignment between shareholders and executives:
  • CEOs at typical high-performing companies (cumulative total returns to shareholders of 28 percent) gained $4.2 million in the intrinsic value of their stock options, from $6.6 million in 2005 to $10.8 million in 2006 (a 63 percent increase).
  • CEOs at typical low-performing companies (cumulative total returns to shareholders of negative 3 percent) lost $3.3 million in the intrinsic value of their stock options, from $8.8 million in 2005 to $5.5 million in 2006 (a 38 percent decrease).
• Targeting long-term incentive (LTI) opportunity above the market may cause companies to deliver above-market realizable LTI for below-market performance, which is not a shareholder-friendly outcome.
• Companies with greater executive stock ownership generate higher shareholder returns than companies with lower executive ownership levels.
• A CEO’s pay increases and decreases in relation to company performance. CEOs at low-performing companies experienced a 3 percent decrease in realizable total direct compensation compared with a 13 percent increase for their counterparts at high-performing companies.
• Companies continue to reduce equity usage under broad-based plans. In fact, the number of option shares granted in 2006 fell 23 percent from 2005 and 33 percent from 2004.