incentive plan series - decusoft · ¨ incentives paid subject to shareholder approved plan ¨...

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INCENTIVE PLAN SERIES

Annual Incentive Plans

Joseph Sorrentino, Managing Director

Steven Hall Jr., Managing Director

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• Compensation earned and paid based upon achievement of performance goals over a one-year period

• Motivate performance and align executives with company’s short-term performance objectives– In a well designed program, annual incentive targets support the company’s long-term

business plan/strategy

• Opportunities for senior executives are most often defined as a percentage of base salary– Targets are reflective of

¨ Market opportunity for the position¨ Internal pay equity considerations

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• What defines a well-designed incentive program?– Pay opportunities tightly aligned with responsible performance– Balanced approach to delivering compensation

¨ Don’t want all your eggs in one basket– Mitigates risk– Reflects environment

¨ Internal− What will attract, motivate and retain executives?− What will drive corporate performance and the achievement of strategic

objectives?¨ External

− Comparators− Shareholders− Other Stakeholders

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• Philosophy on performance metrics– Performance measures should be aligned with business strategy– Reflect the key drivers of corporate and shareholder value– Create clear line of sight for key employees that focuses their efforts and maps their

accountability– Goals should be realistic and motivational and represent sustainable performance

relative to benchmarks¨ Historical performance and volatility¨ Future prospects / market expectations

– Ability to forecast future performance – how strong is the budgeting / business planning process?

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Fixed13%

Annual Incentive19%

Long-Term Incentive

68%

Variable87%

Source: SH&P 2017 Incentive Plan Study

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Target Annual IncentiveDollar % of Target Annual Incentive RangeValue Salary Threshold - Maximum

Average $2,711,896 187% $853,712 - $5,707,167

Median $2,343,333 164% $737,400 - $4,800,000

25th Percentile $1,818,960 150% $300,434 - $3,600,000

75th Percentile $2,838,500 200% $1,100,000 - $6,125,200

Source: SH&P 2017 Incentive Plan Study

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Annual Incentive Range Annual Incentive RangeAs a % of Target As a % of Salary

Threshold - Maximum Threshold - Maximum

Average 34% - 215% 60% - 401%

Median 38% - 200% 50% - 340%

25th Percentile 20% - 200% 30% - 300%

75th Percentile 50% - 200% 88% - 400%

Source: SH&P 2017 Incentive Plan Study

Actual Annual Incentive PayoutDollar % ofValue Target

Average $2,758,045 107%

Median $2,509,213 106%

25th Percentile $1,413,223 80%

75th Percentile $3,727,575 135%

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- 9 -

10%

17%

26%

16%

8%10%

5% 2% 2%4%

1 2 3 4 5 6 7 8 9 10+

Source: SH&P 2017 Incentive Plan Study

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3

4

6

54

3 3

4 4

9

ConsumerDiscretionary

ConsumerStaples

Energy Financials Health Care Industrials InformationTechnology

Materials Telecomm.Services

Utilities

Source: SH&P 2017 Incentive Plan Study

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78%

101%108% 105% 110%

117%

1 2 3 4 5 6+

Source: SH&P 2017 Incentive Plan Study

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• Types of performance metrics– Financials

¨ Earnings− Net income, EPS, Operating income

¨ Revenues/Sales¨ Cash Flow

− Free cash flow, Cash from operations

¨ Returns− Return on assets, Return on equity,

Return on invested capital

¨ Ratios− Operating income margin, EBIT margin,

Efficiency ratio

¨ Costs/Expenses

– Non-Financial¨ MBOs / KPIs

− Management by Objectives, Key Performance Indicators

¨ Individual¨ Strategic Goals¨ Health, Safety & Environmental¨ Customer Satisfaction/Experience

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85%

40%32%

26%21% 19% 18% 17% 12% 12%

10% 8%2%

Source: SH&P 2017 Incentive Plan Study

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50%

25% 25% 25% 25% 23% 21% 20% 20%15% 15% 14%

10%

Source: SH&P 2017 Incentive Plan Study

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• Goal-setting challenges– Goal setting under increasing scrutiny from shareholders and proxy advisory firms

¨ AIP performance targets will be examined in various ways. Comparisons to− Estimates provided to Wall St.− Last year’s results− Industry averages and direct competitors

– Inability to forecast performance¨ Take more than 90 days if needed¨ Use of “stub” plans

– Projecting a decline in year-over-year results

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• Achieved 9 out of 10 years (90%)

Minimum / Threshold

• Achieved 1 out of 10 years (10%)

Maximum

• Remaining eight years performance should range on the continuum between threshold and max, with a tendency to cluster around target

Target

Probability of attainment – rule of thumb

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Incentive payout curve

Payoutas a % of Target

Performance as a % of Target

ThesholdPayout

Target Payout

Maximum Payout

A very common payout curve

0

50

100

150

200

80 90 100 110 120

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Alternative incentive payout curves

Payoutas a % of Target

Performance as a % of Target

Target Payout

Alternatives for difficult goal setting1 ‐ flatter curve around  target2 ‐ stretch the curve

0

50

100

150

200

80 90 100 110 120

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• Section 162(m)– Most annual incentive programs at public companies are structured to comply with IRC

Section 162(m)– Requirements include

¨ Incentives paid subject to shareholder approved plan¨ Payment determined through objective performance criteria established by a

committee of outside, independent directors¨ Compensation Committee certifies in writing the amounts paid and the goals

achieved¨ Negative discretion only – Compensation Committee can decrease the payment

but cannot increase based on discretion¨ Plan must be re-approved every 5 years, unless it is a formula-based plan

– Proposed Tax Cuts and Jobs Act may eliminate performance exclusion under Section 162(m)

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• Risk– Too much of a good thing can be a bad thing– Trend towards de-leveraging some elements of compensation program as a way to

further mitigate risk largely implemented– Greater attention paid to reasonableness of performance targets – Are they attainable? Sustainable? How do they compare with investor guidance?– Balance and alignment

¨ Between fixed and variable, short- and long-term pay¨ Complementary performance metrics

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• Impact of non-recurring events on bonus program– Restructuring charges– Loss or gain on sale of assets– Acquisitions/transaction costs– Litigation expenses– Changes in accounting or tax rules– Exchange rate volatility

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• Discretion– Enhanced disclosure requirements caused a shift away from discretionary plans towards

more formulaic “cookie-cutter” approaches– Discretion takes courage– Can be difficult to describe and rationalize / defend publicly

¨ Viewed negatively by ISS– Adjustments / modifications to established plan viewed as moving the goal posts – Companies and Committees are returning to the concept

¨ Economic volatility and associated challenges with setting performance targets¨ Discretion is a valuable risk mitigation tool

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• Currency Fluctuations– Size of recent currency fluctuations have impacted corporations with global operations– Committees now focused on the extent to which management should be held

accountable for a factor largely outside their control– Companies have adopted several approaches to adjustment:

¨ No adjustments¨ Corridor approach (exclude impact outside of a pre-determined range, i.e. ±10/15%)¨ Fully neutralize¨ Board discretion

− Adjustments determined on a case-by-case basis– Some companies have moved more explicitly to constant currency disclosure in CD&A

and other IR documents

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• Sharing Ratios – How much of the profits should you be giving away?– An alternative way that measures bonus program design elements by analyzing slope of

payout curve, threshold, target and maximum payout levels– Another way to assess pay for performance alignment

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

Threshold Target Maximum

Sharing Ra

tio ‐Proxy Officers

Performance / Payout Level

S&P MidCap 400 Top 200 Companies

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• Succession Planning– Using the annual incentive plan to support succession planning goals

¨ For the current CEO¨ For highly regarded talent

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• Disconnect between short-term results and stock price– What to do when annual program pays out at target or above, but TSR is negative?

¨ Risk of the dreaded “pay for performance disconnect”

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Joseph SorrentinoManaging Director

jsorrentino@shallpartners.com

Steven Hall Jr.Managing Director

sehall@shallpartners.com www.shallpartners.com