Paying for Performance: Priority #1 - Towers Watson

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New Towers Watson research spotlights the continuing evolution in pay for performance, emerging trends in talent management and rewards, and how companies are maximizing the return on their incentive compensation investments.

And, with new disclosures on how CEO pay aligns with company performance on the horizon, getting pay for performance right is an organizational imperative today for employees at all levels -- from the top of the house to the bottom.

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Paying for Performance: Priority #1 - Towers Watson

  1. 1. Paying for Performance: Priority #1 The Changing Landscape of Total RewardsLaura Sejen and David SeitzDecember 8, 2011© 2011 Towers Watson. All rights reserved.
  2. 2.  Getting Pay for Performance Right: A Business Imperative for Employees at All Levelstowerswatson.com 2 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  3. 3. The market: Economic uncertainty continuesMerit pay remains relatively flat U.S. Merit Budget Increases* Nonexempt Nonexempt Year Executive Management Exempt Salaried Hourly 2008 3.7% 3.5% 3.5% 3.5% 3.4% 2009 3.3% 2.9% 2.8% 2.8% 2.8% 2010 3.0% 2.8% 2.8% 2.7% 2.7% Salary increases 2011P 3.0% 3.0% 3.0% 2.9% 2.8% still well below 2012F 3.0% 3.0% 3.0% 3.0% 3.0% 2008 levels Canada Merit Budget Increases* Administrative/ Year Executive Management Professional Support Hourly 2008 3.5% 3.4% 3.3% 3.2% 3.0% 2009 3.2% 2.9% 2.8% 2.8% 2.8% 2010 2.5% 2.5% 2.7% 2.6% 2.5% 2011P 3.0% 3.0% 3.0% 3.0% 2.9% 2012F 3.0% 3.0% 3.0% 3.0% 3.0%*Data represents median merit increases. Includes participants providing no merit increases. P: Projected for 2011/F: Forecast for 2012. Source: Towers Watson Data Services.towerswatson.com 3 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  4. 4. The market: Economic volatility continuesShort-term incentive funding expected to drop from 2010 to 2011 After an improvement from the lows of 2007 – 2009, funding exceeded 100% last year, but is expected to drop this year 2005 2006 2007 2008 2009 2010 2011P Average Funding 91% 102% 78% 82% 88% 111% 101% (as a Percent of Target)Source: Towers Watson 2011 Talent Management and Rewards Survey. P = Projected.towerswatson.com 4 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  5. 5. The market: Changing conditions and working hoursEmployees are working more 65% of employers think employees have been working more hours than normal over the past three years 53% expect this to continue over the next three years This is especially true for senior managers and professionals Employees Have Employees Have Employees Will Be Been Using Less of Been Working More Expected to Work Their Vacation Days Hours Than Normal More Hours Than or Personal Time Off Over the Past Three Normal Over the Over the Past Three Years Next Three Years Years Employers 65% 53% 31% Employees Senior and middle managers 57% 47% 44% First-line supervisors and team leaders 35% 32% 27% Professional individual contributors 46% 40% 30% Administrative/clerical/manual 37% 33% 24% Exempt 50% 43% 33% Non-exempt 35% 31% 25%Source: Towers Watson 2011 Talent Management and Rewards Survey.towerswatson.com 5 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  6. 6. Attraction drivers among broad-based employeesThe role of compensation Employers underestimate the importance of “fundamentals” to attracting employees — even top talent All Employees High-Potential Employees Rank Employers Employees Rank Employers Employees 1 Base pay Job security 1 Challenging work Job security 2 Organization’s mission, Base pay 2 Career development Base pay vision and values opportunities 3 Organization’s Health care benefits 3 Organization’s mission, Career development reputation as a great vision and values opportunities place to work 4 Career development Length of commute 4 Base pay Promotion opportunities opportunity 5 Challenging work Vacation/PTO 5 Organization’s financial Health care benefits performanceSource: Towers Watson 2011 Talent Management and Rewards Survey.towerswatson.com 6 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  7. 7. Retention drivers among broad-based employeesThe role of compensation Employers do not completely understand what would cause employees to leave — especially the best employees All Employees Top Performing Employees Rank Employers Employees Rank Employers Employees 1 Base pay Work-related 1 Promotion opportunity Work-related stress stress 2 Promotion opportunity Base pay 2 Career development Promotion opportunities opportunity 3 Relationship w/ Promotion opportunity 3 Base pay Base pay supervisor 4 Career Trust/confidence in 4 Relationship w/ Trust/confidence in development management supervisor management opportunities 5 Work-related Incentive pay 5 Incentive pay Length of commute stress opportunity opportunitySource: Towers Watson 2011 Talent Management and Rewards Survey.towerswatson.com 7 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  8. 8. Segmentation opportunityDifferentiating talent management and reward programs Organizations that invest more resources on targeted groups than other groups Not Critical-Skill Program Differentiated Employees High-Potentials Top Performers Base pay 34% 45% 39% 57% Short-term incentives 47% 26% 27% 49% Long-term incentives 53% 25% 29% 37% Coaching or mentoring 42% 15% 55% 29% Recognition programs 74% 9% 11% 24% Recruiting and selection 50% 46% 23% 17% Career pathing and planning 47% 19% 51% 32% Employee learning and development 58% 21% 37% 27% Leadership development 31% 16% 65% 40% Succession management 30% 26% 65% 44%Source: Towers Watson 2011 Talent Management and Rewards Survey. Numbers in bold indicated differentiated strategy for identified group.towerswatson.com 8 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  9. 9. Merit pay differentiationRoom for improvement Given the importance of the fundamental forms of reward, pay differentiation is one mechanism to segment high performers Organizations are differentiating merit pay increases based on performance What Is the Average Merit Increase as a Percentage of High-Performing Low-Performing Salary for Each Employee Group at Your Organization: Organizations Organizations Employees who did not meet expectations 0.0% 0.0% Employees who partially met expectations 1.0% 0.7% Employees who met expectations 2.8% 2.5% Employees who exceeded expectations 4.0% 3.1% Employees who far exceed expectations 5.0% 4.5%Source: Towers Watson 2011 Talent Management and Rewards Survey.towerswatson.com 9 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  10. 10. Short-term incentive differentiationRoom for improvement Organizations are differentiating short-term incentive payouts on individual employee performance relative to target funding levels — but there is still opportunity to do more Target Funding Actual Funding Employees who did not meet expectations 0% 0% Employees who partially met expectations 60% 74% Employees who met expectations 100% 100% Employees who exceeded expectations 112% 112% Employees who far exceed expectations 133% 128% Differentiation* 2.2 1.7 Although organizations target payouts so that top performers will receive 120% more than employees who only partially meet expectations, they typically only get about 70% more*The ratio of payouts to employees who far exceed expectations relative to those who partially met expectations. Source: Towers Watson 2011 Talent Management and Rewards Survey. towerswatson.com 10 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  11. 11. Segmentation and differentiationExecution is critical The importance of segmentation and differentiation needs to be socialized throughout the organization Employees already recognize their organizations’ failure to execute these programs well In the current market, employers cannot be all things to all people: achieving more meaningful differentials in increases will require that companies raise their game in terms of segmenting the workforce and executing on differentiation Fewer than half of all employees report that high- performing employees are rewarded for their performanceSource: Towers Watson 2011 Talent Management and Rewards Survey.towerswatson.com 11 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  12. 12. Execution is criticalThe role of the manager Managers are the front line in delivering most programs or changes Managers have limited flexibility to adjust programs and apply policies to create a compelling employee experience Organizations are very mixed in their views on managerial effectiveness in executing reward and talent programs Managers Execute Program Well % of Companies That Agree Base pay 43% Short-term incentives 49% Long-term incentives 32% Sales force compensation 59% Recognition 35% Competencies 40% Career management 14%Source: Towers Watson 2011 Talent Management and Rewards Survey.towerswatson.com 12 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  13. 13. Execution is criticalMonitoring program effectiveness Among Rewards programs, organizations are focused on monitoring STI and base pay programs, followed by sales force compensation, LTI and recognition Organization Monitors Program Implementation to Ensure Consistency with Program Objectives and Guidelines % of Companies That Agree Base pay 72% Short-term incentives 75% Long-term incentives 54% Sales force compensation 64% Recognition 46% Leadership development 77% Competencies 54% Career management 26% Learning and development 49% Formally monitoring the effectiveness of reward and talent programs supports data-driven adjustments to their design or implementationSource: Towers Watson 2011 Talent Management and Rewards Survey.towerswatson.com 13 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  14. 14. Making differentiation and segmentation more meaningfulFive steps your organization can take1. Clearly communicate your compensation philosophy to both managers and employees2. Review rewards plan objectives and design to ensure they align with your pay-for-performance philosophy3. Reinforce effective performance management practices — these are critical to significantly differentiating pay based on performance4. Issue guidance on base pay increases and STI awards for specific results achieved5. Monitor programs: Ensure managers realize desired differentiation relative to performancetowerswatson.com 14 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  15. 15.  Why Effective Pay-for-Performance Programs Are Critical for Senior Leaderstowerswatson.com 15 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  16. 16. Pay-for-performance alignment is likely to be the issue inexecutive compensation in 2012 Despite the fact that 98% of companies received majority support for their pay programs in 2011 say-on-pay votes…  Many compensation committees are concerned that shareholder support for pay programs might fall below an 80% support level  There is a looming concern that lawsuits may proliferate against directors whose companies fail say-on-pay votes  Forthcoming SEC rules under Dodd-Frank are likely to bring added scrutiny to the issue  Possible disconnect between corporate earnings and stock performance may add fuel to the fire Companies are continuing to proactively plan for year two of say- on-pay and are enhancing their processes, and not just where shareholder support was lacking or less than anticipated in 2011towerswatson.com 16 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  17. 17. Shareholder concerns about pay for performance wereapparent in this year’s say-on-pay votes 37 companies failed to get majority support for their say-on-pay proposals  Pay-for-performance disconnect provoked highest opposition Key Concerns Raised by Institutional Shareholder Services (ISS) at Companies that Received Majority Votes Against Say-on-Pay Proposals Pay-for-Performance Disconnect 78% 19% 3% Compensation Committee 19% 46% 35%Communication and Effectiveness Non-Performance-Based Pay 13% 11% 76% Severance/CIC Arrangements 8% 60% 32% Peer Group Benchmarking 8% 14% 51% High Concern Medium Concern Low ConcernNote: Based on Towers Watson’s review of ISS reports; categories and ratings are as designated by ISS when making voterecommendation for say-on-pay proposals.towerswatson.com 17 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  18. 18. The total pay mix for senior executives continues toevolve toward more performance-based plans Median Total Direct Compensation (TDC) for CEOs TDC Levels Mix of TDC Base Target Salary Bonus Long-Term Incentive 16% 18% Opportunity $4.3 million 84% Variable PFPTarget Bonus 66% Long-Term $1.2 million Incentive Base Salary Opportunity $1.0 millionSource: Towers Watson 2011 Compensation Data Bank; median revenue = $5 billion.towerswatson.com 18 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  19. 19. Forthcoming SEC rules are likely to bring even morescrutiny Proposed regulations under Section 953 of Dodd-Frank were expected to be published in 2011  SEC delay makes it unlikely the rules will take effect for the 2012 proxy season  Proposed rules will provide guidance on where the SEC is headed Key issues  Will a particular disclosure be mandated, such as pay compared to one-year total shareholder return (TSR)?  Will compensation “actually paid” be defined as the Total Compensation reported in the proxy, or something else? To prepare for this new disclosure, companies may want to perform analyses on their own approach to defining pay, performance metrics and a time frame for measuring performancetowerswatson.com 19 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  20. 20. The issue could take on greater urgency if marketvolatility triggers a disconnect with shareholder returns Year-to-Date Earnings Growth vs. Total Shareholder Return (S&P 500) 25th Percentile Median 75th Percentile EPS Growth 7% 21% 54% TSR -13% 1% 12%towerswatson.com 20 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  21. 21. To ensure proper design and alignment, companies needto look at pay and performance from multiple dimensions Performance Perspective Summary Performance Against Plan Annual incentive plan Long-term incentive plan Trend Analysis Plan payouts over time Performance over time: incentive plan metrics Performance over time: other relevant metrics Alignment Analysis Actual performance vs. market standards Goals vs. market standards Pay outcome vs. performance outcome Other Considerations Favorable Strategic achievements Neutral Disclosure/proxy advisor concerns Caution Nonrecurring impacts Overall Assessment Concerntowerswatson.com 21 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  22. 22. Pay/performance monitoring — A continuum ofapproaches Less More complex complex Monitor Relate Measure historical historical historical pay incentive payouts to and performance payouts historical performancetowerswatson.com 22 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  23. 23. Analyzing historical incentive payouts — Is our variablepay plan really variable? Company A: Low-Risk Incentive Company B: High-Risk Incentive Incentive Payouts (% of Target) Incentive Payouts (% of Target) 150% 100% 100% 100% 100% 100% 100% 50% 0% 0% 06 07 08 09 10 06 07 08 09 10 Year Yeartowerswatson.com 23 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  24. 24. Another way of looking at it — Incentive payouts in relation to company financial performance Incentive Payouts Annual Incentives as a Percentage of Pretax Income(% of Pretax Income) 20% 15% 15% 15% 14% 14% 12% 10% 10% 9% 9% 8% 8% 5% 0% 01 1 02 2 03 3 04 4 05 5 06 6 07 7 08 8 09 9 10 10 Year Year-Over-Year Change Year Pretax Income Incentive Pool 1 +12% +8% 2 +10% +9% 3 -10% +8% towerswatson.com 24 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  25. 25. Some companies are now measuring historical pay andperformanceBut, conventional measurement approaches are often a mismatch 2008 2009 2010 2011 2012 2013 Historical Performance Future Pay OpportunityA better approach compares pay actually delivered to actual performance Pay 2008 2009 2010  How much pay has been delivered? Performance 2008 2009 2010  How has the company performed?towerswatson.com 25 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  26. 26. Some companies also look at realizable pay incomparison to relative total shareholder return (TSR) WMT ABC Top Five 100% Executives CVS XYZ 90% GPS KR 80% XYZ TGT Top 5 Total Realizable Pay Percentile Rank 70% LTD SPLS XYZ 60% HD BBY 50% XYZ COST 40% SVU JCP XYZ 30% SWY KSS 20% LOW XYZ WAG 10% ODP XYZ SHLD 0% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 3 Year TSR Percentile Ranktowerswatson.com 26 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  27. 27. A thoughtful process for selecting performance metricsis critical, for both annual and long-term incentives Performance metrics used vary significantly by company size and industry Performance Metrics in Long-Term Plans — Percent Used Overall 35% 22% 18% 17% 10% 9% 8% TSR EPS Revenue ROIC Net Income EBIT CashflowSource: Towers Watson 2011 CDB – LTI Database.towerswatson.com 27 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  28. 28. Key issues to consider in evaluating pay-for-performancealignmentHistorical Perspective Are we prepared for the increased scrutiny?  What are we doing today to measure and monitor our pay-for-performance alignment?  Are we certain that we have the correct alignment today? Are management and the compensation committee comfortable with the process and outcomes?  How will we disclose our pay-for-performance alignment in the proxy to help shareholders understand the key links?Looking ahead (incentive plan design perspective) Have we considered the key incentive plan design issues?  Are we using the right performance measures?  Do our performance targets have the appropriate degree of stretch?  Is the plan leverage appropriate for our industry and historical performance patterns?towerswatson.com 28 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
  29. 29. Questions?Laura Sejenlaura.sejen@towerswatson.comDavid Seitzdavid.seitz@towerswatson.com For more information, visit our new blog at www.towerswatson.com/newsletters/executive-pay-matterstowerswatson.com 29 © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
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