Performance equity global-gilead-20100627


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This presentation provides a look at Performance-based Equity from three angles: Design, Legal issues (provided by Jennifer George at Orrick) and Administration concerns (provided by Paz Dizon of Gilead). The administrative concerns is especially interesting since Paz drills deep into some of the difficulties and how she handled them.

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Performance equity global-gilead-20100627

  1. 1. Design, Legal and Administration Domestic and International Realities of Our Future June 27, 2010
  2. 2. Paz Dizon, CEP Associate Mgr, Stock Administration Jennifer George Partner Dan Walter, CEP President and CEO
  3. 3. Multi Trigger, Multi Measurement Period, Multiple Payout Levels Three-year performance measurement period Performance Metrics are: Relative TSR (Goal 1) and Revenue Growth (Goal 2) Goal 1, Relative TSR (each year): Threshold - 50th Percentile, Target - 75th Percentile, Maximum - 90th Percentile Goal 2, Combined Score of Revenue and Cost Reduction (based on internal scoring system) Year 1: Score 85, Target 87, Maximum 90 Year 2: Threshold 87, Target 90, Maximum 92 Year 3: Threshold 90, Target 92, Maximum 95 Goal 1 threshold must be met each year before Goal 2 performance is allowed to payout. Payout is based on: Threshold = 50%, Target = 100%, Maximum = 200% 50% of awarded units are subject to Goal 1, 50% of awarded units are subject to Goal 2 If Goal 2 performance is met in a year when Goal 1 threshold is not: Earned Goal 2 units will be carried forward into future measurement periods and paid out if Goal 1 is met in the future
  4. 4. Multi Trigger, Multi Measurement Period, Multiple Payout Levels – Continued Dividend Equivalents are calculated when regular dividends are paid and converted into child units which are paid out relative to earned units, if and when they vest Retired Employees are paid out when: Most recent measured performance as of retirement date Actual term of service during the life of the award as a percentage of the total term of the award All unvested units are forfeited upon earlier of termination or end of performance measurement period Earned shares vest over three years, annually Dividends in cash with no restrictions relative to vesting
  5. 5. Royal Dutch Shell – 2008 Annual Report Long-Term Incentive Plan and Performance Share Plan In July 2005, Royal Dutch Shell adopted an amended Long-term Incentive Plan (LTIP). When awards are made under the LTIP other than to the Executive Directors the plan is called the Performance Share Plan (PSP). On the award date conditional awards are made of Royal Dutch Shell shares. To date for the LTIP, the actual amount of shares that may vest, which can be between 0 – 200% of the conditional award, depends on the total shareholder return (TSR) of Royal Dutch Shell versus four of its main competitors over a three-year performance period. For the PSP awards made in 2005 and 2006, the extent to which the awards vest depends on the TSR of Royal Dutch Shell compared with four of its main competitors over a specific measurement period.
  6. 6. Royal Dutch Shell – 2008 Annual Report, continued For the PSP awards made in 2007 onwards, the extent to which the awards vest will be determined by two performance conditions. The relative TSR measure over the measurement period will be used to determine the vesting of half the award and the other half of the award will be linked to the declared Business Performance Factor (Shell scorecard results). For the shares granted in 2008, the measurement period is three years from January 1, 2008 (for the shares granted in 2006 and 2007, the measurement period is three years from January 1, 2006 and January 1, 2007 respectively). Awards made in 2007 and 2008 under the LTIP and PSP to individuals employed in the Netherlands at the time of the award will be cash-settled. None of the awards will result in beneficial ownership until the shares are released.
  7. 7. !! 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
  8. 8. !! TSR – Total Shareholder return !! Absolute – your company’s number !! Relative – compared against peer group(s) !! Financial Goals !! Revenue !! ROIC !! EBITDA !! Cost !! Other !! Risk !! Staff Retention !! Innovation / Product Development !! HRIS !! Performance Appraisal / Human Capital Management score !! About a million others
  9. 9. !! As a stand-alone goal it may not !! Provide line of sight to staff below C-Suite !! Link corporate long-term success to plan !! Pay evenly. Peer groups can differ widely, skewing results !! Reflect risk or other factors in today’s payout !! Companies are starting to combine it with other metrics !! Create a balance using Financial, HRIS and Project goals – Total Compensation Intelligence™ !! Multiple Independent goals !! Co-Dependent goals – Usually must meet TSR threshold to be eligible for other goals
  10. 10. !! The National Association of Pension Funds (NAPF) and Association of British Insurers (ABI) have issued guidelines on equity plans: !! Share Schemes as Remuneration !! …It is a fundamental requirement that exercise of executive share options should be subject to some realistic measure of management performance. The difficulties of prescribing one single measurement of long term sustained performance - which will be regarded as appropriate for all situations - is recognised. It is generally acknowledged, however, that linking the exercise of options to sustained underlying financial performance is in the best interest of the company and long term investors. Such linkage requires sustained results before any benefit can be taken by an option holder and creates a community of interest between corporate management and the shareholder. !! It is expected that the rules of any executive scheme should include prudent limits concerning the level of share option grant to any individual and concerning the timing or phasing of such grants. !! Although, by law, companies are permitted to issue executive options at a discount to the share's market price in certain circumstances, companies should note that this is viewed as undesirable. !! summary: link to performance and have prudent limits
  11. 11. !! Remuneration Committee !! Any company proposing a share scheme should note, therefore, that support for the proposals is unlikely to be forthcoming unless the company has in existence a properly constituted Remuneration Committee which has formal responsibility for the scheme. Such a Committee will be fully aware of the circumstances of the company in question and it follows that it should, therefore, be in the best position to determine the most relevant and effective performance criteria. !! It is important that shareholders understand the basis on which the chosen criteria have been set. Full details of the criteria which are felt appropriate should, therefore, be disclosed both when the scheme is put forward for approval by shareholders and annually thereafter. !! summary: use effective performance criteria and explain the basis of why they were used
  12. 12. !! Remuneration Committee, continued !! The ABI and the NAPF are agreed that the aim of any formula should be to produce significant and sustained improvement in the underlying financial performance of the concern in question. Both will expect the formula to be based, therefore, on criteria which genuinely reflect the effort and achievement of the management in question. !! Safeguards must be incorporated by the Remuneration Committee to ensure that measures chosen are appropriate to the circumstances of the company and are used consistently. Furthermore, they must not be capable of manipulation nor must they be influenced by the particular accounting treatment of various items. !! summary: base formula on effort and achievement and incorporate safeguards to prevent manipulation and influence from accounting treatment
  13. 13. !! Outside the US, performance is the 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
  14. 14. All the same tax and legal issues as for non performance awards plus –!Additional labor law risk/considerations and –!Unique tax considerations 14
  15. 15. –!More involvement from local entity/employer if awards or vesting of awards based on individual performance or local entity performance –!Performance is more easily tied to employment as compared to broad-based grants with time-based vesting 15
  16. 16. Acquired rights/entitlements —!employee may not have to forfeit award upon termination —!may be more difficult to stop making grants in the future More likely to be considered part of local compensation especially if targets tied to individual performance —!Termination/severance indemnities —!local bonuses/benefit plans —!Social insurance contributions due? Work Councils? 16 Translations?
  17. 17. Taxable event may be an earlier date than expected if after the performance period, the employee does not have to do anything else to receive benefit, but benefit is not paid until later (usually comes up for RSUs) —!Comes up if want terminated employees to get portion of pay-out —!Comes up if don’t require continued employment through pay-out/ settlement date Don’t overlook tax qualified program availability – could work for certain performance awards in some countries 17
  18. 18. Australia: Be careful with new tax rules that will tax at point in time where no longer a substantial risk of forfeiture (even for options) Canada: If RSUs can be settled in cash or shares and the performance period and vesting period added together is more than 3 years, tax may be due at grant (deferred compensation rules) Denmark: Performance conditions can help to defer taxable event from grant for RSUs 18
  19. 19. 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 19
  20. 20. !! Type of plan !! PSUs for annual merit awards for VPs and above !! PSUs with individual, non-market based performance milestones for new hire VPs !! Initially Rolled out !! First PSUs issued in January 2007 !! Number of participants !! 45 VPs and above are eligible
  21. 21. !! Goals, Metrics, Earning Period, Vesting Period and Payout Period !! 3-year performance period, vest and release is in March of the year following the end of the 3rd year !! Combination of 2 goals – (1) relative TSR (against Amex Bio Pharma Index) and (2) Revenue Growth !! 0% - 200%, based on matrix designed to arrive at a combined attainment percentile level of the two goals
  22. 22. !! What can be automated and how? !! Valuation of awards with one or more market-based conditions will have to be derived or computed using a custom lattice model or Monte Carlo simulation. These models consider all possible outcomes or scenarios so that these are baked into the grant-date fair value of the award !! Once you have the valuation per share, some service providers have developed modules to properly allocate and amortize the expense over the expected service period !! In prior years, tracking of expense associated with performance shares has been entirely manual using excel, and painstaking
  23. 23. !! What is manual and why? !! What will always be manual is the monitoring of the probability of achievement of goals that are non-market based. Someone will have to periodically assess and somehow build this into the expense accrual for these awards to properly reflect the costs attributed to that particular period
  24. 24. !! How is your job different than when you only had time-based vesting? !! Managing performance shares is quite different from managing awards with time-based vesting – there’s a whole other dimension to managing these types of awards !! With time based vesting, you just need to make sure that these are correctly entered into the database with the correct vesting dates, valuation is simply fair market value on grant date x number of shares, and shares are released at specific points in time, and service periods are explicit so you now exactly over what period to allocate expense !! With performance shares, you have to understand and analyze the goals associated with each tranche of shares in order to know how to allocate the expense; you need to monitor probabilities if valuation is not calculated using a lattice model or Monte Carlo simulation; and achievement of milestones that trigger vesting needs to be communicated timely to Stock Admin
  25. 25. !! How does interaction with other stakeholders differ from basic time-based awards? !! With time-based awards, we get the list approved by the comp committee, we enter them in the system, prepare grant agreements, send out pre- vesting communication, process releases and send tax info to Payroll, and then send out confirmations – almost no interaction with stakeholders !! With performance-based awards, we do all of the above, plus we have to meet with HR and Legal prior to issuing the annual awards to discuss goals and metrics, external counsel will draft new agreements specific to this new batch of grants. Accounting and HR need to confirm the probability of achievement for grants with performance milestones, and communicate the same to Stock Admin. Stock Admin should receive prior notice when the BOD is asked to approve achievement of milestones, and confirm with Stock Admin once the BOD does confirm. !! In managing performance shares all lines of communication have to be open and information must flow to Stock Admin timely – time is of the essence!
  26. 26. !! How is their job different? !! Whereas Stock Admin used to be an “afterthought” in many instances, it has become apparent that we need to be included in the planning and preparation of board resolutions !! We learned this the hard way – there have been recent instances when we didn’t know that there was a telephonic BOD meeting where the attainment of personal milestones was approved and PSUs should have vested, and they “forgot” to tell us, so there was a big re-do of 10K documents and payroll tax withholding statements
  27. 27. !! How is everything communicated? !! Currently we have been doing everything by e-mail, because we need to act long before Board minutes are finalized. !! What would make your life easier? !! My life will be easier when we are able to have a seamless path of communication, from number of shares approved for grant by the board, confirmation from Legal or HR of the goals and metrics, to the approval of the number of shares vesting and lastly, any decisions regarding stock should immediately be forwarded to Stock Admin
  28. 28. !! If Say on Pay doesn’t happen: !! Slow march toward these plans. With 5 years 50-70% of companies will have performance equity for C-suite !! Some surveys suggest performance is already at these levels !! A limited number of aggressive companies will continue to expand performance programs broader populations !! If Say on Pay happens: !! Within 5 years nearly every public company will have performance-based equity !! Performance programs will evolve as companies work to remain different that their competitors, especially in the Silicon Valley !! Performance shares and units will become “normal” and performance will start being added to other program types
  29. 29. !! RTSR/TSR has been used more than 10 years outside the US. !! Academic studies are already showing where and how it works and where and how it fails !! Multiple TSR peer groups are already happening at large companies !! Beyond RTSR !! Companies will first expand financial metrics as goals !! Already measured and reported !! Already linked in company performance !! Companies will move to Total Compensation Intelligence™ programs !! Link of HRIS, Compensation and Financial Data into more complex and dynamic goals !! Reflection of the individual, group and company in long-term success
  30. 30. !! The Basics !! Types of plans and awards !! Who is working on this TODAY at your company !! International !! Which countries have a concentration of senior staff !! Where in the world does performance equity make you MORE competitive for desired talent !! Administration !! Limitations and Features of your Stock Admin system and providers !! Delivery schedule for new performance features and specifics of those features
  31. 31. !! Stock Administrators become more strategic by determining how to measure true effectiveness of plan !! Link equity implementation, communication, vesting events and value to past and future corporate performance !! Understand what your participants truly understand about equity to better plan for rolling out these more complex plans !! Stock Administrators must learn the principles of performance in the same we all had to learn the principles of ownership !! You may want to start with: !! “Pay for Results”, by Mercer !! “Pay without Performance” by Lucien Bebchuck and Jesse Fried
  32. 32. Paz Dizon, CEP +1-650-522-5517 Jennifer George +1-415-773-5640 Dan Walter, CEP +1-917-734-4649