650 Fifth Avenue, 33rd Floor, New York, New York 10019 www.shallpartners.com(212) 488-5400
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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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
Steven Hall Jr.Managing Director
[email protected] www.shallpartners.com