Why Performance Matters

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A presentation presented to the Global Equity Organization covering strategic aspects of performance-base equity programs.

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  • TSR - (common in US, VERY common in UK and Australia) (peer group may be as small as 5 or as large as several hundred, or an entire index. Most companies use a peer groups of 25-40 companies)* Most commonly company needs to be in a minimum percentile to earn anything (below that nothing vests). There are breakpoints at multiple percentiales above the minimum. Usually paying betwen 25% and 200% of the total awarded shares. Payout level between the breakpoints can be linear, stepped or absolute.
  • Why Performance Matters

    1. 1. Why Performance Matters The reality of performance in the world of equity Presented by Dan Walter, Performensation Consulting Peter Djokovich, Strategix 20/20
    2. 2. The foundation of measuring performance  Why  Create certainty in the workplace  Drive corporate, group and individual performance  Achieve defensibility and legitimacy in compensation  Who  Start at the top, but properly designed programs can be effective at all levels  When  Communicate as frequently as you can provide accurate information  Where  Common in much of Europe and Australia  Growing in US and Canada  Interest in Asia
    3. 3. The foundation of measuring performance  What  KPI - Key Performance Indicators  Can be any measurable factor  Must be understood, communicated and transparent  Separate drivers of performance from results  How  Single-trigger KPI  Interdependent KPI  Measurement Date vs. Vesting Date vs. Payout Date  Multilevel Measurement  Threshold/Minimum  Target/Expectation  Maximum  Equity vehicle
    4. 4. The biggest problem with performance today is that it is often based on luck not science  Imprecise and clumsy goals can work too well, or not at all  Use an axe when you need a scalpel  What gets measured gets done  True only if what is measured is communicated and managed  Relevance is the key to performance effectiveness  Results-only goals can lead to manipulation or abject failure  Underlying drivers must be communicated when results are communicated  When goals are too single-minded all focus is aimed in only one direction. Goals may be met at the expense of success  Complex goals are hard, but so is sustained corporate performance
    5. 5. Using performance to drive business success and compensation § Define Mission, Goals and Objectives Through and Across The Organization § Relevance  Align All Employee Business Processes  Align All Human Resource Strategies  Align Business Processes and Enabling Technologies § Employee Segmentation § Train and Develop Skills and Expertise § Establish Individual and Team Performance Expectations § Measure and Report Performance Results § Keep It Simple § Incent For What Can Be Controlled  Pay For Quantifiable Performance Improvements § Recognize and Reward Individuals for Events, and Teams for Processes  Avoid Unnecessary Competition Between Participants § Incentives & Recognition Should Not Be a Proxy For Leadership
    6. 6. 11 types of performance-based 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
    7. 7. Common KPI for Equity  Relative TSR  Total Shareholder Return as compared against a group of peer companies  Revenue Growth  Operating Income  Share Price  Net Income  EBITDA - (Earnings Before Interest, Taxes, Depreciation and Amortization)  EBIT (Earnings Before Interest and Taxes)  Turnover/Retention  Reduced Expense (usually for large companies)  ROI (Return on Investment) (usually for small companies)  Reduced Risk Profile (recent addition to the mix)  Other (reserve of outstanding inventory, customer satisfaction rating, project delivery etc...)
    8. 8. Examples of some common types of Performance-based Equity  Either stock or stock options that are tied to performance metrics  Type A:  Awarding of shares is triggered by the performance metrics  May have vesting of shares in addition to trigger  Type B:  Vesting, or lapse of restrictions, is triggered by the performance metrics  Multiple triggers may be layered to create more nuanced awards
    9. 9. Type A - Ex. 1: Performance Shares without Vesting (Performance Awarded Shares)  Company A wants to incent share price growth  Awards 1,000 potential Performance Shares to CEO  Establishes KPI of Relative TSR against S&P 500  Earning of shares is based on following levels  Minimum Payout (50% of 1,000 shares) at 50th percentile  Target Payout (100% of 1,000 shares) at 75th percentile  Maximum Payout (150% of 1,000) at 95th percentile  Payouts between each level is based on a straight-line interpolation  At the end of the year the metric has either been achieved or not  If met, award is made and fully vested
    10. 10. Type A - Ex. 2: Performance Awarded Units with Vesting  Similar to Example 1, but with time-based vesting after award  In Example 2 the trigger for the award of units to the CEO is the out-performance of the S&P 500 for one year. At the end of the one year either it has been achieved or not  However, once triggered the actual shares vest at 33% per year. This is often used to promote retention of the executive as well as drive specific performance
    11. 11. Type B - Ex. 3: Performance with Multi-year, Multi-goal triggers and goal interdependency  Complex structure representing a small percentage of current programs  Company wants to reduce expense and while maintaining performance compared to peer companies  Awards 1,000 units with vesting contingent upon layered metrics  Threshold - Target - Maximum structure  Threshold = absolute minimum  Target = stretch, but expected goal  Maximum = ultimate out performance
    12. 12. Type B - Ex. 3: Performance With multi-year, multi-goal triggers (cont.)  Certain goals are be required to be met before others can be triggered  Goal 1: TSR metrics are 50th percentile for Threshold, 75th percentile for Target and 90th Percentile for Maximum  Goal 2: Expense Reduction is 2% for Threshold, 4% for Target, 7% growth for Max  Require: Goal 1 MUST be met before Goal is triggered  These goals can be layered for multiple years and metrics on a single award  Goal measurements can vary from year to year
    13. 13. Performance Share Stats  Over 40% of large US public companies plan to implement performance-based equity by the end of 2009  There is some dispute to the % of companies actually utilizing these plans  At least 150 of the FTSE 350 utilize TSR-based performance equity  Highest growth of any equity plan type over the past two years
    14. 14. Pros and Cons of Performance Equity Pros Cons Motivates employees to drive specific Motivates employees to drive specific performance performance Can be used as a retention tool May become a demotivator Flexible structure May need crystal ball in structuring multi- year approach
    15. 15. Common Pitfalls and Issues  Too many metrics, too complex  BUT - Rare that one metric will predict success of a company  Multiple year metrics in non-mature or unpredictable companies  “Guaranteed” metrics in mature, predictable companies  Acquisitions or divestures  Both within the company and at peer group companies  Variable Accounting  Either mark-to-market, variable Fair Value accounting or  Variable probability, fixed Fair Value accounting  Limited Administration, Communication and Reporting tools  Poorly communicated and understood, (especially in the period between award and measurement date)
    16. 16. Potential Work-Arounds or Ways to “Game the Plan”  Sand bag numbers for easy targets  Make award subject to Board approval  Reset targets if necessary  Forgive missed goals and allow for re-measurement  Set metrics off industry standards instead of company-specific goals
    17. 17. Performance Shares: Mature Vs. Non-Mature Companies Mature Non-Mature Can determine meaningful target metrics Hard to make meaningful financial targets due to lack of predictability (recruitment, innovation and product delivery can be measured) Minimal Acquisition Activity? May be Acquisitive? This depends largely on industry and current market conditions Harder to manufacture false Executives can manufacture results, but performance, but easier to create difficult to guarantee results “guaranteed” results
    18. 18. Key elements to managing and communicating performance  Understand your KPI  How were they chosen?  What are the underlying components?  How does a participant impact them?  How does the market impact them?  Know where you stand  Communicate interim performance regularly  Show trending and historical comparisons  Communicate what need to be done, rather than just what has been done  Focus on percentages and measurement levels rather than payout amounts  Use performance programs as the foundation for communication, instead of an afterthought
    19. 19. Impact of performance on the administration of equity compensation plans  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
    20. 20. Impact of performance on the administration of equity compensation plans  Communication  Most current websites are very limited in their ability to provide performance details  Risk of providing incorrect information if there is a limited ability to drill down or model  System Interaction  Data must be updated regularly and often comes from multiple sources  External TSR tracking  Data from financial systems  Annual Review systems  Compensation Planning systems  General Ledger  Sales Tracking and Commission tools
    21. 21. Conclusion  Performance-based equity is the next wave of evolution in equity compensation  Your plan must be as unique as your company, but still be comparable to your peers  Strong communication is becomes a basic requirement rather than a valued addition  Administration and accounting systems are improving and even the most complex plans can be handled well
    22. 22. Questions For more information or to discuss this topic in more detail: Dan Walter, Performensation Consulting 917-734-4649 Dwalter@performensation.com www.performensation.com

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