Hewitt's survey of more than 115 large U.S. companies reveals that nearly three-fourths (71 percent) are revising or plan to revise their long-term incentive program design in anticipation of mandatory stock option expensing(a). Many organizations are shifting a portion of their long-term incentive mix from stock options to restricted stock (43 percent) and performance-based shares/units (33 percent). What's more, 35 percent of companies are limiting the number of employees eligible for long-term incentive plans.

"As corporate boards come under increasing scrutiny from shareholders and regulators, they're shifting more executive pay to performance-based equity, which has a greater focus on long-term results," said Tracy Davis, senior consultant for Hewitt Associates. "Moving forward, we expect this to have a major impact on executive earning potential, as a growing portion of their pay will be determined by their success in achieving long-term business goals and how well they meet shareholder expectations."

Hewitt's study also shows that many companies (42 percent) aren't fully replacing stock option grant values as they move to other forms of equity incentives. In fact, approximately 40 percent of companies are using a 3-to-1 value ratio when converting to restricted stock, and a 4-to-1 ratio when converting to performance-based shares. Only a minority of companies are fully replacing stock option values in shifting to other forms of incentive compensation.

"Stock option expensing and today's corporate governance climate have companies moving toward a greater balance in delivering long-term incentives," said Davis. "However, the challenge is determining the appropriate amount of equity, considering the various performance requirements and time-based vesting triggers, as well as tax and cost implications. We're advising organizations to design a total compensation plan that's in line with their pay philosophy and business strategy."

Hewitt's study reveals that 2005 executive base pay increases are consistent with last year, with more than 70 percent of companies awarding increases of less than 4 percent (median of 3.5 percent).

"Economic conditions are keeping executive base pay increases stable," said Davis. "However, even as the economy improves, we still anticipate seeing salary increases of less than 4 percent, as companies develop pay packages that are more focused on long-term incentives."

As for executive bonuses, more companies (68 percent) are awarding at or above target this year (for 2004 performance), compared with last year (46 percent). Specifically, 47 percent of organizations are paying between 100 percent and 149 percent, and 21 percent of companies are paying 150 percent or more of targeted bonus.

Hewitt's "Hot Topics in Executive Compensation" study is based on 117 companies with a median market cap of more than $11 billion. More than half of these companies are members of the Fortune 500.