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Paying for Performance - February 2019
The document summarizes a study on CEO incentive compensation plans among 600 large, mid-size, and small U.S. companies. Key findings include: 1) Larger companies have a higher percentage of variable pay, with CEOs of top 200 companies having an average of 87% of target pay in variable compensation. Performance-based long-term incentives represent the largest portion of long-term incentive value across all company sizes. 2) Earnings metrics are the most commonly used and heavily weighted performance metric in annual incentive plans, present in over 85% of plans across all company sizes. Larger companies tend to include more performance metrics in their plans. 3) Usage of environmental, social, and
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Paying for Performance - February 2019
- 1. Copyright © 2019Steven Hall & Partners. All rights reserved. A review of CEO Incentive Compensation Plans among U.S. Companies Steven Hall Jr. Devin Reilly William Fiske Paying for Performance
- 2. 2 • What definesa 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 Paying for Performance Introduction
- 3. 3 Section 162(m) -the $1 million deductibility cap - overhauled by the 2017 Tax Cuts and Jobs Act • The “performance-based compensation” exclusion is gone • Covered employees –Now five or more executive officers, not four –CFO is in, not out –Interim and departed CEO/CFOs are in –No requirement that executive be serving at year end • The new “once in-always in” rule for covered employees –Limits deductions for post-termination compensation • “Grandfathering” rules apply (are you good at puzzles)? Paying for Performance Trends in Incentive Compensation
- 4. 4 • Continued refinementof incentive plan performance metrics –Relative vs. absolute metrics –Evolving use of relative TSR • Environmental, Social & Governance (ESG) metrics • 2nd year of CEO Pay Ratio disclosure –Year over year comparisons • Continued shareholder outreach and engagement Paying for Performance Trends in Incentive Compensation
- 5. 5 Fixed 26% Fixed 20% Fixed 13% Variable 74% Variable 80% Variable 87% Small 200 Mid 200 Top200 CEO Average Target Pay Mix Annual 24% Long- Term 50% Annual 21% Long- Term 59% Annual 19% Long- Term 68% Steven Hall & Partners reviewed CEO incentive compensation plans among 600 US companies • Top 200 – Largest US companies by revenue • Mid 200 – Included in the S&P Mid Cap 400 • Small 200 – Included in the S&P Small Cap 600 Paying for Performance Incentive Compensation Study
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- 7. 7 • CEO targetannual incentives correlated with company size • Target bonus –Between 100% and 167% of base salary –Between $750,000 and $2.38 million • Payout range –Threshold – between 25% and 50% of target –Maximum – 200% of target for all groups Annual Incentive Plans CEO Target Annual Incentive Top 200 Target Annual Incentive Dollar % of Target Annual Incentive Range Value Salary Threshold - Maximum Average $2,723,015 190% 25% - 210% Median $2,381,250 167% 25% - 200% 25th Percentile $1,875,000 150% 0% - 200% 75th Percentile $2,828,211 200% 50% - 200% Mid 200 Target Annual Incentive Dollar % of Target Annual Incentive Range Value Salary Threshold - Maximum Average $1,183,164 129% 31% - 199% Median $1,079,009 120% 40% - 200% 25th Percentile $875,182 100% 0% - 180% 75th Percentile $1,312,500 130% 50% - 200% Small 200 Target Annual Incentive Dollar % of Target Annual Incentive Range Value Salary Threshold - Maximum Average $801,597 110% 36% - 189% Median $750,000 100% 50% - 200% 25th Percentile $592,401 98% 17% - 150% 75th Percentile $946,619 120% 50% - 200%
- 8. 8 • CEOs atlarger companies earned larger bonuses as % of target –Payouts ranged from 92% to 115% of target –$624,000 - $2.7 million Annual Incentive Plans CEO Annual Incentive Payout Top 200 Actual Annual Incentive Payout Dollar % of Value Target Average $3,047,349 111% Median $2,675,124 115% 25th Percentile $1,603,943 78% 75th Percentile $4,011,465 147% Mid 200 Actual Annual Incentive Payout Dollar % of Value Target Average $1,259,864 105% Median $1,022,199 100% 25th Percentile $592,455 74% 75th Percentile $1,557,843 140% Small 200 Actual Annual Incentive Payout Dollar % of Value Target Average $724,422 88% Median $623,875 92% 25th Percentile $75,310 37% 75th Percentile $1,044,412 126%
- 9. 9 • Philosophy onperformance 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? Annual Incentive Plans Performance Metrics
- 10. 10 • Majority ofannual incentive plans utilize two or three performance metrics • Larger companies include more metrics/complexity • Smaller companies utilize fewer metrics Performance Metrics 13% 21% 27% 17% 7% 15% 13% 27% 26% 13% 11% 10% 23% 28% 21% 12% 8% 8% 1 2 3 4 5 6+ Number of Performance Metrics in CEO AIP Top 200 Mid 200 Small 200 Annual Incentive Plans
- 11. 11 –Non-Financial – MBOs /KPIs – Management by Objectives, Key Performance Indicators – Individual – Strategic Goals – Health, Safety & Environmental – Customer Satisfaction/Experience –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 Annual Incentive Plans Performance Metrics
- 12. 12 • Annual incentivepayouts largely tied to earnings performance Annual Incentive Plans Performance Metric Prevalence 88% 39% 34% 29% 85% 37% 30% 23% 85% 34% 29% 10% Earnings Revenues Individual Cash Flow CEO AIP Performance Metric Prevalence Top 200 Mid 200 Small 200
- 13. 13 • Earnings metricsare also the most heavily weighted in annual incentive plans Annual Incentive Plans Performance Metric Weightings 50% 25% 20% 25% 50% 35% 20% 22% 70% 30% 20% 25% Earnings Revenues Individual Cash Flow Median CEO AIP Performance Metric Weightings Top 200 Mid 200 Small 200
- 14. 14 • Shareholders focusedon Environmental, Social & Governance (ESG) metrics • Adoption of ESG metrics has been slow • How should ESG be incorporated in incentive plans? –Short-term plan vs. long-term plan –Which executives? –What is the proper weighting? –Are the metrics quantifiable? –Absolute vs. relative metrics Annual Incentive Plans ESG Performance Metrics 29% 23% 15% Top 200 Mid 200 Small 200 Prevalence of ESG Metrics
- 15. 15 • SH&P identifiedseveral common groups of ESG metrics • Talent & Diversity metrics most common Annual Incentive Plans ESG Performance Metrics 77% 42% 30% 5% 12% 50% 48% 24% 2% 11% 72% 31% 3% 7% 7% Talent & Diversity Health & Safety Environmental & Sustainability Community Impact Regulatory & Compliance ESG Metric Prevalence Among Companies Disclosing the Use of 1 or More ESG Metrics Top 200 Mid 200 Small 200
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- 17. 17 • Long-term incentivesare awards earned and paid based upon achievement of goals over a period exceeding one year –Goals may be based on stock price or business performance –Typically equity-based, but a small number of firms use cash Long-Term Incentives Long- Term Incentive Objectives Align executive / shareholder interests Attract, retain and motivate Focus participants on critical performance criteria Provide competitive pay opportunities based on performance Create wealth
- 18. 18 Long-Term Incentives Vehicle Types AppreciationVehicles • Stock options • Stock appreciation rights Service-Vested Full Value vehicles • Restricted stock • Restricted stock units Performance Vehicles • Performance shares • Performance share units • Performance cash plans • Performance-vested options (rare)
- 19. 19 • Majority ofcompanies use a portfolio approach to long-term incentives –Grant two or more long-term vehicles –In each group, a small percentage of companies did not grant LTI awards to the CEO Long-Term Incentives Number of Vehicles 15% 57% 25% 4%22% 51% 25% 2%18% 62% 16% 5% 1 2 3+ 0 Number of LTI Vehicles Granted Top 200 Mid 200 Small 200
- 20. 20 • Performance-based LTIawards are the most prevalent vehicle among all three groups • In general, the usage of full-value service-based restricted stock increases as the revenue scope of companies decreases Long-Term Incentives Vehicle Prevalence 54% 56% 92% 43% 68% 88% 35% 78% 79% Stock Options Service-Vested Restricted Stock Performance-Vested Awards LTI Vehicle Prevalence Top 200 Mid 200 Small 200
- 21. 21 • Performance-based LTIawards represent the largest portion of LTI value mix for each of the three groups • Portion of LTI value granted as service-based awards increases as company size decreases Long-Term Incentives Vehicle Mix 20% 17% 16% 20% 28% 35% 60% 55% 49% Average CEO LTI Mix Stock Options Service-Vested Restricted Stock Performance-Vested Awards Top 200 Small 200 Mid 200
- 22. 22 Cons • Not viewedas performance-based by some • Not tied explicitly to company financial performance • Dilution; stock-settled SARs are less dilutive than options • Expense recognized even if option expires worthless Pros • Alignment w/ shareholders • Easy to communicate • Leverage • Fixed expense Long-Term Incentives Stock Options
- 23. 23 • Stock optionsare generally granted with –Three-year step vesting schedule –Ten-year term Long-Term Incentives Stock Options 1% 14% 39% 45% 1% 9% 34% 56% 1% 1% 8% 32% 59% 6+ 5 4 3 2 Years Options Vesting Schedule Top 200 Mid 200 Small 200 78% 72% 90% 4% 2% 1% 12% 22% 7% 1% 1% 4% 2% 2% Small 200 Mid 200 Top 200 Options Term Schedule 10 Years 8 Years 7 Years 6 Years 5 Years
- 24. 24 Cons • Viewed negativelyas “pay for pulse” • Not tied explicitly to company financial performance • No leverage Pros • Strong retention value and popular with employees • Alignment with shareholders • Less dilutive • Easy to communicate • Fixed expense Long-Term Incentives Service-Vested Restricted Stock
- 25. 25 • Service-based restrictedstock awards are generally granted with a three-year step vesting schedule Long-Term Incentives Service-Vested Restricted Stock 1% 9% 25% 65% 4% 27% 68% 1% 10% 19% 69% 1% 1% 6+ 5 4 3 2 1 Immediate Years Restricted Stock Vesting Schedule Top 200 Mid 200 Small 200 82% 70% 70% 18% 30% 30% Small 200 Mid 200 Top 200 Restricted Stock Vesting Type Step Cliff
- 26. 26 Cons • Challenges insetting performance criteria • Poor goal setting may lead to perception that they are less valuable • Reversal of expense is not possible for awards earned based on market conditions (stock price/TSR) Pros • Strong focus on performance • Alignment with shareholders; popular with advisory firms • Fixed expense may be subject to reversal if performance goals are not met • May be less dilutive Long-Term Incentives Performance-Based Awards
- 27. 27 • Performance-based awardsare generally –Based on a three-year performance period –Payout in shares of company stock Long-Term Incentives Performance-Based Awards 4% 75% 21% 4% 83% 13% 6% 89% 5% 4+ 3 1 - 2 Years Performance Period Length Top 200 Mid 200 Small 200 90% 87% 83% 6% 7% 6% 1% 4% 9% 1% 1% 2% 2% 1% Small 200 Mid 200 Top 200 Payout Type Stock Cash Cash & Stock Options Stock & Options
- 28. 28 • Majority ofTop 200 and Mid 200 performance-based awards utilize two or more performance metrics • Majority of Small 200 companies use only one performance metric Long-Term Incentives Performance Metrics 27% 42% 22% 6% 4% 43% 38% 14% 2% 3% 51% 32% 13% 2% 2% 1 2 3 4 5+ Number of Performance Metrics in LTIP Top 200 Mid 200 Small 200
- 29. 29 • The twomost common performance metrics were total shareholder return (TSR) and earnings Long-Term Incentives Metric Prevalence 54% 54% 42% 18% 17% 50% 45% 25% 7% 17% 38% 41% 22% 3% 17% TSR Earnings Returns Cash Flow Revenues LTIP Performance Metric Prevalence Top 200 Mid 200 Small 200
- 30. 30 • On average,CEO performance-based payouts for the most recently completed performance cycle were at the target level –Indicates that goal setting is generally balanced Long-Term Incentives CEO Performance-Based Payouts 106% 96% 101% Top 200 Mid 200 Small 200 CEO LTIP Payout as a % of Target Top 200 Mid 200 Small 200
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- 32. 32 • Follow thebusiness plan – Well-designed incentive plans should be aligned with your organization’s strategic plan in order to focus and reward executives for accomplishing objectives that will drive long-term shareholder value. The mix of vehicles and performance metrics selected should provide an appropriate and balanced focus on achievement of key strategic objectives and retention of executive talent. • Periodically reconsider the program – Incentive programs need not remain static over time. Instead, companies should periodically reevaluate programs to ensure that they continue to support the organization’s strategic objectives. Companies should periodically evaluate their mix to ensure that the program continues to make sense. • Understand the ramifications of change – If you are making substantial modifications to your incentive plans, make sure you understand all the legal and accounting ramifications of the changes. Nothing upsets executives, directors and shareholders more than surprises. Things to Consider
- 33. 33 • Mitigate excessiverisk-taking – Make sure performance targets are attainable and fair to both executives and shareholders. Establish maximum performance goals and payout levels that will challenge executives, but won’t encourage them to take on excess risk. Performance metrics should also be thoughtfully selected to ensure that they are complementary with other goals used in both the short-term and long-term plans. • Communication is paramount – All stakeholders should understand how the plan works and what performance will drive payouts under the plan. Ascertaining the views of significant shareholders on essential program design issues is a key part of ongoing shareholder outreach. Additionally, regular communications to participants about the status of awards can go a long way towards ensuring continued focus on desired objectives and reinforcing the potential value of awards if performance goals are achieved. • Do the right thing – If your company faces a unique situation, the incentive plans should be reflective of and responsive to that situation. Don’t automatically shy away from vehicles or metrics that are unpopular with shareholder advisory services or governance experts if they support your specific strategic objectives. Make sure your shareholders understand the choice and why it ultimately aligns executive interests with theirs. Things to Consider
- 34. 34 Questions? Steven Hall Jr. ManagingDirector sehall@shallpartners.com www.shallpartners.com Devin Reilly Consultant dreilly@shallpartners.com William Fiske Analyst wfiske@shallpartners.com
Editor's Notes
- #6 Explain Methodology for picking incumbents 200 Largest Revenues Random Samples taken from MidCap and SmallCap Indices Explain Pay Mix Fixed = Base + All Other Comp (Perqs & Benefits) Variable = Annual Incentive/Bonus + Long-Term Incentive Awards (Cash & Equity) Data collected as disclosed in the CD&A or based on Target/Annualized Amounts (Annual Salary, Annual Target Bonus, Grant Date FV of equity awards, All Other Comp values taken from SCT
- #8 Target Bonus generally disclosed as either a percent of Base Salary or a specific dollar amount Target amounts are positively correlated with the size of a company (both as a % of base and dollar value wise) Maximum Payouts are fairly consistent across all three groups Identical max payouts as a % of target at median for the three groups It is more common for larger companies to have max payouts of 200% of target or more Threshold payouts as a percent of target are lower at the largest companies and higher at the smallest companies Larger companies have a wider “performance range”
- #9 At Median: Top 200 companies paid out above target Mid 200 companies awarded target payouts Small 200 companies paid out below target Implies that larger companies are generally out-performing targets while smaller companies are struggling to meet their annual goals Should larger companies make targets tougher? Do smaller companies need to be cautious of setting unattainable goals?
- #11 Smaller companies are more likely to use less metrics in their annual incentive programs than their larger counterparts Additional Industry Data not shown, but available in All 600 Company Excel File For the entire 600 company group, companies in the Consumer Discretionary and IT industries are the most likely to have more than three metrics in their annual incentive plans For the Top 200 and Mid 200, Energy companies are the most likely to have more than three performance metrics in their AIP Companies from the Utility industry are the most likely to have more than three performance metrics in their AIP for the Small 200
- #12 SH&P analyzed the performance metrics contained in annual incentive plans and bucketed each one accordingly Looked at Financial and Non-Financial measures 6 financial buckets plus one “Other Financial” bucket 5 non-financial buckets plus one “Other Non-Financial bucket “Other” buckets represent metrics that are contained in incentive plans that do not fit into any of the pre-established buckets (i.e. market share growth, product inventory measures, quality, and pipeline innovation) Looked at metric weightings and absolute vs. relative measures We also further analyzed the non-financial metrics from our Strategic Goals, HS&E, MBOs/KPIs, and Individual Performance buckets to determine which companies incorporate Environmental, Social & Governance issues into their AIP
- #13 Slide only displays the top 6 most prevalent metric buckets The prevalence of different metrics is generally uniform regardless of the size of a company or which group it belongs to Additional Industry Data not shown, but available in All 600 Company Excel File Financial companies rely most heavily on return metrics IT companies rely most heavily on revenue metrics Earnings metrics are most prevalent at: Companies in the Consumer Discretionary industry for the Top 200 Companies in the Consumer Discretionary & IT industries for the Mid 200 Companies in the Industrial industry for the Small 200
- #14 Earnings weights are higher for the small cap companies because these metrics are used at roughly the same proportion of companies compared to the Top & Mid groups, but Small 200 companies generally use a lesser number of metrics This forces the earnings metrics used at Small 200 companies to have greater weights compared to companies in the larger groups The remaining 5 metric buckets out of the top 6 are all weighted between 20% and 35% at median for all three groups
- #16 Explain bucket categories Talent & Diversity A Health & Safety B Environmental & Sustainability C Community Impact D Regulatory & Compliance E
- #30 Median LTIP Metric Weightings: TSR: Top 200 – 50% Mid 200 – 88% Small 200 – 100% Earnings: Top 200 – 50% Mid 200 – 55% Small 200 – 63%
- #31 Payouts for most recently completed award cycle: Top 200 Mid 200 Small 200 Average: 106% 96% 101% Median: 105% 100% 99% These payouts indicate that overall performance objectives are being met at target levels and that goal setting is generally balanced (not too easy but not too hard)