Executive Decisions: Considering CEO Comp in Pre-Retirement Years

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?

Start Planning Now

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.

When CEO Retirement Appears on the Horizon

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.

Project the timeframe. How much time remains before the CEO retires? Is it short enough that you need to prioritize planning at once? Or, do you have time to thoughtfully and carefully develop and execute a tailored approach?
Review existing equity compensation provisions. Study current plan documents and award agreements to understand how they define retirement and how outstanding equity grants are treated upon retirement. Ensure that the current treatment aligns with your organization’s aims as well as views of fairness held by the committee and your retiring leader. Also, take current market practices into consideration and decide whether retirement-related provisions should be changed for equity grants yet to be made.
Estimate the value of in-flight awards that would be prorated or truncated. Based on the expected retirement date, does the potential realizable value of these awards correspond with the committee’s intention for CEO pay? Is the value enough to reward the CEO’s expected leadership and decision-making during their final years in the role?
Explore unique alternatives for grants to be made in the CEO’s final years. For example:
- A larger final equity grant made two or three years before retirement could continue to align your CEO’s pay with their final-years performance while effectively avoiding proration, truncation and/or lost value.
- A change to the equity pay mix and/or vesting period could help to do the same.
- A special performance-based grant could help to underscore and celebrate achievements toward the end of the CEO’s successful tenure.

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:

Stock options with a typical 10-year exercise term (or even a shorter seven-year term) would be out of sync with the remaining tenure. Should stock options continue to be part of the mix — perhaps with a shorter exercise term and/or tailored post-retirement exercise window — or should they be removed from the mix?
It would be reasonable to grant no more stock options to the retiring CEO, while delivering final grants via PSUs and/or RSUs (e.g., 100% PSUs, 100% RSUs or a mix of both).
Suspending stock option grants in those final three years would enable the compensation committee to reduce the amount of truncated post-retirement exercise periods for vested but unexercised stock options.
Meanwhile, PSUs and/or RSUs that continue vesting into your CEO’s retirement will help align the CEO’s interests with those of the organization and shareholders for a reasonable time after she retires.

Redefining ‘Long Term’

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.

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