Balancing the Scales: The Critical Role of Risk Mitigators in Executive Compensation

Equity awards are the primary compensation vehicle for U.S. executives, comprising 71 percent of total CEO compensation for S&P 500 CEOs and 60 percent for Russell 3000 (excluding S&P 500). As compensation committees seek to maintain alignment of executive and shareholder interest, the use of risk mitigators in equity grants has increased over the past five years. This paper analyzes key equity compensation risk mitigating practices such as clawback policies, stock ownership guidelines, holding period requirements, and anti-hedging and pledging policies, which enhance accountability over pay and ensure that executives bear similar risks as shareholders.

KEY TAKEAWAYS

• Amidst a changing regulatory landscape promulgated by the Dodd-Frank Act, key risk mitigators are being implemented by companies to further align management and shareholder interests.
• Companies in the S&P 500 index generally are more mature and often are under heightened shareholder scrutiny. Therefore, they tend to maintain more robust risk mitigators compared to Russell 3000 companies.
• Over the past five years, the prevalence of most of the risk mitigators examined in this paper has increased and the trend is expected to continue.

Clawback Policies

In October 2022, the Securities and Exchange Commission (SEC) adopted its final rules on clawback policies. By the beginning of 2024, all companies listed on the New York Stock Exchange, or the NASDAQ were required to adopt clawback policies compliant with listing standards as described in the SEC’ rule. The rule allows companies to recoup erroneously provided incentive-based compensation from current and former executives during the three fiscal years preceding an accounting restatement or a correction to previous financial statements that proved material to the current period. [1]

Well before it became mandated, many companies started adopting clawback policies voluntarily. Not only have they become the norm, but many firms go beyond the scope of the SEC rules. As of 2024, 93.1 percent of S&P 500 companies adopted a robust clawback policy that allows for the recovery of not only performance-based equity, but time-based as well. That compares with 67.2 percent of Russell 3000 companies.

* In 2023, ISS modified its FAQ regarding clawback to clarify that clawback must cover both time- and performance-based equity compensation, while the SEC only mandates recoupment of performance-based compensation.

Although robust clawback policies tend to be common across industries there are some notable discrepancies. The Household & Personal Products industry has the highest prevalence of robust clawback policies at 95 percent. At the other end, Pharmaceuticals, Biotechnology & Life Sciences companies are least likely to adopt a robust policy, at just 42.6 percent. This low adoption rate is probably due to the high prevalence of stock options as the primary form of equity compensation. Stock options could be interpreted as falling under the definition of “incentive-based compensation” and thus could become subject to the SEC’s clawback rules . Therefore, there may be limited need to extend clawback policies to time-based equity awards such as restricted stock units. In addition, many companies in this industry are in pre-revenue stages, placing greater emphasis on the success of a drug than on financial reporting.

Stock Ownership Guidelines and Holding Period Requirements

Investors often prefer that executives receive a significant portion of compensation through equity and maintain substantive equity ownership to create a stronger alignment between executive and shareholder interests. Practices such as stock ownership guidelines and postvesting holding period requirements are often viewed favorably by investors as mechanisms to maintain meaningful ownership of the company’s equity by executives. Ownership guidelines are commonly disclosed as a multiple of base salary, number of shares, or dollar value. These practices codify the level of ownership executives should maintain in their respective companies. Holding period requirements too are intended to encourage longer-term equity ownership by dictating how long executives should hold their ownership stake in the company once the awards have vested.

A majority of S&P 500 and Russell 3000 companies maintain CEO stock ownership guidelines and the prevalence of this practice has increased over the past three years [2]. Furthermore, companies have been gradually increasing the multiple of base salary that must be held. Among S&P 500 companies, most require at least six times the base salary and the practice continues to increase in prevalence, from two-thirds in 2022 to nearly three-quarters in 2024. Within the remainder of the Russell 3000, the percentage of companies implementing stock ownership guidelines of three times or more of the base salary continues to increase as well.

However, the majority of Russell 3000 companies still have no ownership requirement. That said, those without stock ownership guidelines have been steadily decreasing among both S&P 500 and Russell 3000 companies.

While stock ownership guidelines require executives to maintain a specified level of equity ownership, post-vesting or post-exercise holding period requirements mandate that executives retain shares released from awards for a specific period of time, such as 12 months or until the end of employment. These may be imposed on all award types or only some, such as stock options or restricted stock units.

Post-vesting holding period requirements, however, are not commonly adopted by companies and those that do maintain the practice are on the decline. These additional restrictions tend to be more commonly imposed by S&P 500 companies. In both the S&P 500 and Russell 3000, it’s also more common to impose these requirements on full-value awards as opposed to options. Only 8.1 percent of companies in the S&P 500 maintain holding period requirements on options, a level that hasn’t changed in the past year. That said, these requirements have decreased in prevalence when compared to 2019 through 2020. The prevalence of these requirements on full-value awards at S&P 500 companies decreased to 10.9 percent in the past year after a slight increase in 2023. Amongst Russell 3000 companies the prevalence of either requirement has continued to decrease.

While enhanced holding period requirements are not widely prevalent amongst the indices tracked, it is interesting to note that some industries tend to adopt them more commonly than others. For instance, they are more common amongst Household & Personal Products, Insurance, and Banking companies at roughly 11 percent, compared with 8.1 percent of all S&P 500 companies and 3.5 percent of Russell 3000 companies in 2024.

Like stock options, full value-award post-vesting holding period requirements are utilized by Household & Personal Products companies more frequently than most other industries. The exceptions being companies within the Banking and Real Estate Investment Trust (REIT) industries. Currently, 14 percent of the Banking industry and 11 percent of the REIT industry employ some form of enhanced holding period requirements. The adoption of these requirements in these particular industries outpaces the rate of S&P 500 companies at 10.9 percent and the Russell 3000 at 4.8 percent in 2024. Unlike other risk mitigators discussed, holding period requirements have not become the norm in any industry.

Anti-Pledging and Anti-Hedging Policies

When executives use company stock as collateral for personal matters, it creates potential risks, such as the forced sale of shares, which could cause the stock price to drop. Additionally, highly leveraged executives may be motivated to make riskier decisions, further endangering the company and its shareholders. Therefore, it is best practice for companies to maintain a robust anti-pledging policy that allows for no exceptions or waivers, and not to have any active pledges or indirectly pledged shares.

The prevalence of robust anti-pledging policies has continued to increase over the past five years. In the S&P 500, nearly three-quarters of companies have one in place, up by more than ten percentage points from 2019. The Russell 3000 lags behind the S&P 500, but the practice has increased by nearly 15 percentage points since 2019, with a majority of companies within the index maintaining a robust policy today

In 2024, only 4 percent of the S&P 500 and 12.9 percent of the Russell 3000 did not disclose any policy, and only 2.7 percent and 3.5 percent, respectively, explicitly permitted the pledging of shares. Nevertheless, about 19.9 percent of the S&P 500 and 29.5 percent of the Russell 3000 have waivers or exemptions in their policies that may permit the pledging of shares in certain situations.

Household & Personal Products companies have the highest prevalence of robust policies at 85 percent, significantly higher than even the S&P 500 rate of 73.5 percent. This, coupled with the high prevalence of robust clawback policies and holding period requirements for appreciation awards, indicates that the Household & Personal Products industry maintains the most robust equity risk mitigators overall. Conversely, the industry with the lowest level of robust antipledging policies is Real Estate Management & Development. The prevalence for this industry is 29.2 percent, which is significantly lower than even the Russell 3000 median

Anti-hedging policies are also an important risk mitigator, as hedging against losses in a company’s shares can lead to a misalignment between the interests of shareholders and management. Hedging undermines the value of granting equity to executives in the first place as it potentially protects them from economic exposure to company stock, even while they maintain voting rights. As such, anti-hedging policies that cover a full range of speculative transactions are generally thought to further the alignment of shareholder and management interests.

The prevalence of robust anti-hedging policies has been high for quite some time and continues to increase. A robust policy is defined as prohibiting all hedging of company stock, with no waivers or exceptions, and applying to a broad group of participants. Nearly 96 percent of S&P 500 companies prohibit the hedging of stock, and Russell 3000 companies have widely adopted the risk mitigator as well, with nearly 85 percent of companies prohibiting share hedging.

At an industry level, 97.1 percent of Utilities companies have robust anti-hedging policies, compared with 63 percent of Real Estate Management & Development companies. Notably, the Real Estate Management & Development industry seems to maintain the lowest prevalence for both robust anti-hedging and anti-pledging policies.

Conclusion

The adoption of robust risk mitigators is increasing across industries, with the exception of post-vesting requirements. Shareholder pressure, the desire to conform with market norms, updated SEC requirements, and enhanced proxy advisory firm policies have all contributed to a greater emphasis on ensuring that equity awards are accompanied by robust guardrails. Looking ahead, the expectation is that the prevalence and robustness of these risk mitigators will continue to increase as alignment between executive and shareholder interests remains in the spotlight. Companies without any of these policies in place will increasingly become outliers and should expect greater scrutiny from their stakeholders.

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1Source: https://www.sec.gov/files/rules/final/2022/33-11126.pdf(go back)

2Due to ISS policy updates in 2022, data from 2019-2021 was not included as the collection methodology changed. Stock ownership guidelines that allow unexercised options or unearned performance-based awards to be counted towards the ownership goals are now not considered sufficiently robust and are not included in the number of companies with stock ownership guidelines.(go back)