Executive pay adaptations in a transforming tech sector

Few sectors have experienced the up-and-down market movement felt by the technology sector in the years since the COVID-19 pandemic. For tech investors, profits during the midst of the pandemic were followed by a sector-wide contraction in the equity market. Coming off the highs of those pandemic-era years, many tech companies underwent significant reductions in force as the economic outlook dimmed.

However, it now appears that technology companies have entered a new era as the adoption of AI and automation have become front-and-center topics globally. The labor market has settled down from the hyper-competitiveness experienced three years ago, but recruiting the right talent for key roles in technology remains a concern.

To help in this effort, Grant Thornton analyzed executive pay levels and practices among 80 technology companies in the Russell 2000 Index between 2021 and 2023. Among our key findings are:

• Technology CEO total pay decreased for the second straight year in 2023.
• This multi-year decline in CEO pay levels is driven largely by the value of CEO equity grants, which decreased by 28% between 2022 and 2023.
• CEO cash compensation (inclusive of salary and bonus), by contrast, has increased modestly in the last two years.
• Despite the overall decline in actual compensation for CEOs, equity incentive reserves are shrinking, and equity dilution continues to rise.

As tech companies assess their position in a transforming market, they are taking a closer look at the role of executive compensation in igniting long-term, sustainable growth.

Declining executive pay

A central challenge faced by compensation committees in the last few years has been calibrating executive compensation programs in response to a rapidly changing business environment. With 2021 and 2022 being the first two fiscal years after the primary business shocks of the pandemic in 2020, many compensation committees approved executive pay increases then to recognize the extraordinary efforts of returning business to normal. Because of this unique circumstance, pay levels in 2023 and 2024 likely are a better representation of “true” compensation levels, as any elevated pay levels and interim strategies from post-COVID years have fallen to the wayside.

For many of the companies included in the sample, share prices decreased by roughly 30% between the beginning of 2021 to the beginning of 2023 (i.e., when pay decisions were being made). This broader decline in stock prices contributed to lower compensation levels as a means of aligning pay and performance.

Retaining the right people

Talent retention for technology companies is as important as ever. “While the broader technology labor market has cooled in the last two years, tech company compensation committees still face challenges related to attracting, retaining and motivating their executive teams. Changing business strategies necessitate potential changes to pay strategies to ensure proper alignment,” said Andrea Schulz, Grant Thornton’s National Managing Principal for Technology. Compensation for chief technology and chief revenue/commercial officer roles has become of particular interest to compensation committees more recently. Technology companies that have shifted to focus on AI, automation and cloud computing are challenged when trying to find leaders from a relatively small talent pool of those who can develop and commercialize these growing products.

As tech companies modify their business strategies, it is important that compensation committees look at individual executive roles and their importance in advancing the enterprise. Understanding the market competitiveness of existing pay levels and practices for these roles is a crucial aspect of this talent assessment. Median total direct compensation (inclusive of salary, bonus, and equity awards) for top technology and chief revenue officer roles was about $2.5 million and $2.7 million, respectively, based on 2023 proxy statement filings by the tech companies included in the sample. Tech companies are taking a closer look at pay competitiveness for these roles through benchmarking exercises to take a pulse on the current market.

Evolving incentive compensation

Perhaps the most significant modification to tech company compensation practices made between 2021 and 2023 was related to equity vehicle usage. Time-based restricted stock units (RSUs) increased in prevalence, moving from 76% to 82% after a slight dip in 2022. Performance-based RSUs also increased substantially, moving from 28% in 2021 to 44% in 2023. The use of stock options, conversely, decreased by 3%.

This increased reliance on RSUs and performance-based RSUs and decreased use of stock options suggests that companies have adjusted pay practices in response to declining share prices in the sector. Appreciation-only awards such as stock options have offered less retentive power (due to declining share prices and reduced upside potential) in the last couple years compared to full-value awards such as RSUs and performance-based RSUs.

Many compensation committees have also been faced with equity dilution concerns as share prices decline. Each of these factors has necessitated a de-emphasis on stock options, which tend to be more dilutive to shareholders than RSUs and Performance-based RSUs.

Moving into 2025, we are likely to see performance-based RSUs become more widely adopted as companies engage with proxy advisors and institutional shareholders, tighten the alignment between their compensation and business strategies, and look for the ability to deliver outsized payouts for above-market performance. These trends suggest that the time is ripe for tech companies to determine whether their existing short-term and long-term incentive plans are equipped to support the direction the business is moving, or if legacy practices from pandemic-era years (or before) present misalignment concerns.

Equity dilution on the rise

Equity usage has remained elevated in the years since the onset of COVID-19. Equity overhang, which measures outstanding equity awards in relation to common shares outstanding, has trended upwards in each of the last two years among tech companies in the sample. Declining share prices and unmet performance goals have driven up the number of underwater stock options and unvested PSUs granted by tech companies. Lower share prices mean that tech companies must grant more shares to deliver the same accounting value as in prior years when prices were stronger. This puts pressure on incentive plan equity reserves and creates a dilemma for compensation committees.

“The key for tech companies is being able to strike a balance between paying competitively to support executive retention while also being prudent with equity usage. Compensation committees want to continue to deliver market-competitive compensation to executives, but shrinking equity reserves, lower share prices, and pushback from proxy advisors have required more creative thinking in the boardroom about equity grant practices,” said Eric Gonzaga, Grant Thornton’s National Managing Principal for Compensation Solutions. The equity dilution trend being observed is a key reason why many tech companies have shifted their equity vehicle preferences.

Keeping the board engaged

Just as companies seek to draw executive talent from a relatively small market, the same is true of board recruiting. Independent director turnover and refreshment have increased in recent years and tech companies are actively working to identify the right board candidates to support business plans and growth trajectories.

Compensation committees are tasked not only with oversight of executive pay, but also the compensation of independent directors. As board seat vacancies occur, it’s important that tech companies ensure that board retainers are appropriately and competitively set to give the company an advantage when recruiting potential board members. Boards tend to review their own compensation less frequently than they do executive pay, but the tech sector’s rapid evolution suggests that more regular market assessments are warranted (e.g. at least once every two years).