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Everything about Performance Equity Compensation (or as much as fits into an hour presentation)
 

Everything about Performance Equity Compensation (or as much as fits into an hour presentation)

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The use of performance-based equity is on the rise. This presentation discusses how to select metrics, set goals,and design a plan. It also covers communication, accounting and administrative ...

The use of performance-based equity is on the rise. This presentation discusses how to select metrics, set goals,and design a plan. It also covers communication, accounting and administrative concerns.

Presented to BACA (Bay Area Compensation Association 10/21/2010)

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    Everything about Performance Equity Compensation (or as much as fits into an hour presentation) Everything about Performance Equity Compensation (or as much as fits into an hour presentation) Presentation Transcript

    • Everything You Wanted to Know About Performance Equity (well as much as can fit into a 1 hour presentation)Presented to the Bay Area Compensation Association Oct. 21, 2010
      Dan Walter
      President and CEO
      Performensation
      © 2010 – Performensation – all rights reserved
      10/21/10
      1
    • DAN WALTER, CEP
      Dan Walter CEP, is the President of Performensation (www.performensation.com). For more than 15 years, Dan has assisted companies with equity and performance-based compensation issues. Dan has extensive experience with both executive and broad-based programs. A unique focus is the design and management of performance share and units.Dan provides end-to-end solutions for private and public companies based in both the United States and abroad. Dan is a popular speaker on topics involving equity compensation and success growth. His extensive work with both very small and very large companies provides his clients with a unique perspective. He creates effective, company-specific solutions paired with post-consultation support. Dan’s expertise includes diagnosis of issues, plan design, communication, administration and reporting solutions.  
       
      WWW.PERFORMENSATION.COM
      © 2010 – Performensation – all rights reserved
      10/21/10
      2
    • Learning Objectives
      Definition
      Popularity
      Purposes
      Common Uses
      Participants
      Metrics
      Equity Instruments
      Comparison to Time-based Equity
      Administrative Issues
      Communication
      A bit of Accounting
      Conclusions
      © 2010 – Performensation – all rights reserved
      10/21/10
      3
    • "Some men give up their designs when they have almost reached the goal; while others, on the contrary, obtain a victory by exerting, at the last moment, more vigorous efforts than before.”-Herodotus
      © 2010 – Performensation – all rights reserved
      10/21/10
      4
    • Performance Equity, Defined
      Award is given for meeting goals
      Vesting is accelerated for meeting goals
      Vesting occurs after a period of time AND goals are met
      Vesting occurs ONLY when goals are met
      Shares are earned, but not vested, when goals are met
      Payout may be separate from earning and vesting
      © 2010 – Performensation – all rights reserved
      10/21/10
      5
    • 11 types of Performance Equity
      Performance Awarded Shares
      Performance Awarded Units
      Performance Leveraged Units
      Performance Earned Units
      Performance Accelerated Units
      Performance Priced Units
      Indexed Options
      Performance Granted Options
      Performance Accelerated Options
      Premium Priced Options
      Performance Earned Options
      © 2010 – Performensation – all rights reserved
      10/21/10
      6
    • The Popularity of Performance Equity
      Most surveys shows that 50% of US companies now have some form of performance equity program.
      Outside Directors and Employees agree that there should be a link between equity compensation and relative, absolute and strategic metrics (Pearl Meyer & Partners, 2010)
      © 2010 – Performensation – all rights reserved
      10/21/10
      7
    • The Popularity of Performance Equity
      Most surveys shows that 50% of US Risk Metrics and Glass Lewis have increased emphasis on performance equity
      Dodd-Frank includes provision that requires companies to explain link between performance and compensation.
      Say-on-Pay becomes mandatory in 2011. Other countries show direct link between this and performance equity.
      © 2010 – Performensation – all rights reserved
      10/21/10
      8
    • The Purposes of Performance Equity
      Drive corporate performance
      Align compensation to shareholder expectations
      Improve “media worthiness” of equity compensation
      Limit impact of volatile market movements on value of equity
      © 2010 – Performensation – all rights reserved
      10/21/10
      9
    • Intended consequences
      Increase shareholder value
      Better align participants goals with those of investors
      Reduce “lottery” aspect of equity compensation
      Focus participants on those metrics which best support corporate success
      Obtain shareholder buy-in for current and future share usage
      © 2010 – Performensation – all rights reserved
      10/21/10
      10
    • Unintended Consequences
      Pay executives well when company is cutting pay or reducing headcount
      Disengage participants via unreachable goals, misunderstood or poorly communicated plan details
      Orient participants on specific goals at the risk of others
      Losing retentive value due to early payout
      Magnified payout when short-term and long-term goals are too similar
      © 2010 – Performensation – all rights reserved
      10/21/10
      11
    • Historic Pitfalls
      Too many metrics, too complex
      Multiple year metrics in young or unpredictable companies
      “Guaranteed” metrics in mature, predictable companies
      Acquisitions or divestitures (internal and peers)
      Variable Accounting
      Limited Administration, Communication and Reporting tools
      Poorly communicated and understood, (especially in the period between award and measurement date)
      © 2010 – Performensation – all rights reserved
      10/21/10
      12
    • “If you can measure that of which you speak and can express it by a number, you know something of your subject; but if you cannot measure it, your knowledge ismeager and unsatisfactory."
      ~LORD KELVIN
      Or, in today’s vernacular
      "What gets measured , gets done ."
      ~TOM PETERS
      © 2010 – Performensation – all rights reserved
      10/21/10
      13
    • How Companies Use Performance Equity
      Most common for Restricted Stock Units (Performance Units)
      Most common for Executive Management
      Mid and Upper management use is growing
      © 2010 – Performensation – all rights reserved
      10/21/10
      14
    • How Companies Use Performance Equity
      Common Metrics
      TSR – Total Shareholder return
      Absolute – your company’s number
      Relative – compared against peer group(s)
      Financial Goals
      Revenue
      ROIC
      EBITDA / EBIT
      Cost
      Share Price
      HRIS
      Performance Appraisal / Human Capital Management score
      Other
      Risk
      Staff Retention
      Innovation / Product Development
      © 2010 – Performensation – all rights reserved
      10/21/10
      15
    • How Companies Use Performance Equity
      How to shape a plan
      Successful performance programs are about details and nuances
      You must understand your data and direction
      KPIs, metrics and measurements
      Internal struggles during plan creation
      Motivation factors
      Administrative Simplicity
      Performance drivers versus performance results
      Defining the “What” Versus the “How”
      © 2010 – Performensation – all rights reserved
      10/21/10
      16
    • Plan Design Project Flow
      Corporate Philosophy and Intent
      Data Analysis
      Plan Goals
      KPI Selection
      Equity Instrument Selection
      Measurement Selection
      Plan Structure
      Review by External and Internal Stakeholders
      Plan Documentation
      Approval
      Data Integration
      Roll-out and Implementation
      * Note this entire process may take 1- 2 years
      © 2010 – Performensation – all rights reserved
      10/21/10
      17
    • The Equity Compensation Dilemma
      The Golden Decade
      © 2010 – Performensation – all rights reserved
      10/21/10
      18
      1988-1999 proved to be an anomaly.
      This period became basis for future equity compensation expectations.
      Since 2000, the market has been more volatile and is reflective of periods prior to 1988. Higher volatility may lead to higher values for time-base stock options, but it also leads to higher corporate compensation expense and greater risk of delivering no value to participants
    • The Comparison to Time-based Equity
      Properly designed, performance equity can offer MORE STABILITY than time-based equity
      Not completely dependent upon stock price
      Can factor in influence of the market volatility on peers and self
      Can provide upside leverage and downside protection
      Time to achievement based on corporate success cycles rather than the orbit of the earth around the sun
      © 2010 – Performensation – all rights reserved
      10/21/10
      19
    • The Comparison to Time-based Equity
      Even if properly designed, performance equity can offer MORE RISK than time-based equity
      Improper goal setting can occur when source data or future projections are incorrect.
      Payout based on excellent past performance, but delivered during poor current performance.
      Grants at historically low prices it can in tremendous value delivery
      Goals always seems ambitious until, and unless, they are achieved.
      © 2010 – Performensation – all rights reserved
      10/21/10
      20
    • It’s Execution, NOT Administration
      Processes
      How to fit new features and manual processes into Sarbanes-Oxley approved processes
      Responsibility
      Who is responsible for each piece? Checks an balances. From beginning to end
      Accountability
      Who can be held accountable if it goes wrong?
      Plan Evolution
      Tomorrows plan design in today’s systems
      How to augment the familiar with the unusual
      © 2010 – Performensation – all rights reserved
      10/21/10
      21
    • Impact on Administration
      Requires systems to be more nimble and flexible
      Lack of fixed dates, fixed prices and fixed numbers of shares significantly increases system complexity
      Accounting
      Systems are catching up to the most common plan designs
      Valuation
      Market-based goals require more complex valuation that can be automatically offered by software
      Additional cost and timing of using valuation professionals as frequently as every quarter
      © 2010 – Performensation – all rights reserved
      10/21/10
      22
    • Administrative Issues
      Automate Goal Tracking and Communication
      Integrate data elements from internal and external sources
      Metrics Vs Goals
      System must support What, When Why, How, Who and the type of instrument the goal applies to
      Provide access to managers and participants
      Link to financia reporting an stock administration systems
      Provide a path to drive, rather than reward, performance
      © 2010 – Performensation – all rights reserved
      10/21/10
      23
    • Administrative Issues
      Stock Administration System
      System should be able to store awards with minimum, target and maximum awards amounts
      System should allow for description of goals for each tranche of shares
      System should properly amortize expense for shares expected to vest
      System should allow for update of probabilities or vesting, metrics achieved/missed
      System should allow for shares associated with missed goals to be pushed to a later date.
      “forgiveness” or “second chance”
      © 2010 – Performensation – all rights reserved
      10/21/10
      24
    • How to Make Administration Easier
      Define a seamless path of communication
      Number of shares approved for grant by the board
      Confirmation from Legal or HR of the goals and metric
      Approval of the number of shares vesting
      Any decisions regarding stock should immediately be forwarded to Stock Admin
      (many thanks to Paz Dizon)
      © 2010 – Performensation – all rights reserved
      10/21/10
      25
    • Communicating the Not So Obvious
      Always use prices and growth rates that reflect expectations, not hopes
      Provide examples of both up and down market conditions
      Understand why and how each instrument and its goals have been designed
      Performance equity only works if you watch performance closely and regularly recognize participants for interim achievement
      Regular communications of small pieces of information are likely to be more effective than one huge communication covering “everything”
      © 2010 – Performensation – all rights reserved
      10/21/10
      26
    • Communicating the Not So Obvious
      Best practices for communicating performance-based equity?
      “Communication is the key to a successful program” – Allison McBride, International Paper
      Educate participants on how the goals drive corporate success and why they apply to the individual
      Communicate often, consistently and with enough detail for individuals to understand how they are linked to the movement of the underlying metrics
      © 2010 – Performensation – all rights reserved
      10/21/10
      27
    • Communicating the Not So Obvious
      Do employees like receiving performance-based equity?
      Results are mixed
      When alignment and line-of sight are correctly positioned and the individuals can see their role plans seem to be positively received
      When performance is low, the result can be similar to impact of underwater stock options
      For lower level staff minimums may need to be structured to ensure some value even when performance is not great
      © 2010 – Performensation – all rights reserved
      10/21/10
      28
    • Multi-National Overview
      Outside the US, performance is a main foundation of share-based compensation
      98% of FTSE 300 have performance share schemes
      More than 80% of Australian companies have performance-based share remuneration
      Say on Pay is the biggest driver of these plans
      The following countries have some version of Say on Pay rules in place
      UK, Australia, Sweden, Norway, Netherlands, Italy, Portugal, Spain, Austria, Germany, Ireland, Croatia, Hungary, Poland, Denmark, Finland, Estonia, Luxembourg, Switzerland, Belgium and more on the way
      © 2010 – Performensation – all rights reserved
      10/21/10
      29
    • Multi-National Overview
      Make sure that you obtain professional advice before rolling out a performance award program
      May need special documentation/acknowledgements from employees beyond what using for time-based awards
      Don’t assume that tax favored treatment will/will not be available for performance awards (e.g., France)
      Be prepared to make changes to program design for non- U.S. employees
      (many thanks to Jennifer George, Partner Orrick)
      © 2010 – Performensation – all rights reserved
      10/21/10
      30
    • Some Basics on Accounting / ASC 718 (FAS 123R)
      Two basic “types” of performance metrics
      Performance conditions: Requires achievement of metric that is not directly related to company stock price
      Example: ROIC, Revenue
      Is not included in Fair Value calculation
      Market conditions: Requires achievement of metric based or indexed on company stock price
      Example: TSR or Stock price
      This does get included in the Fair Value calculation
      © 2010 – Performensation – all rights reserved
      10/21/10
      31
    • Some Basics on Accounting / ASC 718 (FAS 123R)
      Fair Value: Per share amount that must be expensed as compensation (non-cash expense)
      Private companies may use “Calculated Value” that is based on a measure of past volatility, rather than implied volatility
      © 2010 – Performensation – all rights reserved
      10/21/10
      32
    • Some Basics on Accounting / ASC 718 (FAS 123R)
      Compensation for all performance equity is amortized across the Requisite Service Period
      For market conditions this is factored into the Fair Value calculation and generally does not change after the grant
      For Service and Performance conditions this is estimated at the time of award, based on the probability of achieving the metric. This is adjusted, post-award, if probability of achieve changes
      © 2010 – Performensation – all rights reserved
      10/21/10
      33
    • Accounting – The Basics are Not Enough
      Valuation cannot be performed on Market Conditions using Black-Scholes.
      Monte-Carlo modeling requires tool, expertise and experience only possessed by a true valuation professional.
      Amortization on Performance Conditions is a story with multiple possible endings.
      While the total possible expense is generally fixed, the amount accrued each quarter depends on understanding both the award structure and the influences on the underlying metrics.
      © 2010 – Performensation – all rights reserved
      10/21/10
      34
    • Conclusions
      We are on the fast track to more performance equity
      Say on Pay, Investor Concerns, Market Volatility, Media scrutiny and more will pus this quickly
      Performance equity has both the potential for more stability and more risk.
      Keys include design, communication and execution
      Accounting is not for the inexperienced
      Valuation, amortization and modifications are unlikely to ever be fully automated, but systems are getting better
      © 2010 – Performensation – all rights reserved
      10/21/10
      35
    • Questions?
      Dan Walter, CEP, PresidentPerformensation514 Precita Ave, Suite 100San Francisco, CA 94110877-803-9255 (toll free)
      415-625-3406 (office)
      917-734-4649 (mobile)
      dwalter@performensation.com
      www.performensation.com
      Twitter: www.twitter.com/performensation
      LinkedIn: www.linkedin.com/in/danwalter
      © 2010 – Performensation – all rights reserved
      10/21/10
      36