Making a long-term incentive work requires at least three bases 1. A well thought-through incentive design Upstream 2. A tailored approach to implementation and communication 3. A studied approach to measuring the effectiveness of offerings
'Upstream'
'Downstream' Implement design
Establish link to business strategy Segment and engage participants
Companies are increasingly emphasising alignment with business strategy
Annual Incentives
Long-term Incentives
Based on sample of 27 FTSE 100 and 37 FTSE 250 companies that altered (or planning to alter) annual incentive plans and 22 FTSE 100 and 27 FTSE 250 companies that altered (or planning to alter) LTI plans as at 1 May 2013
Stakeholder views can have a significant impact on the design
1. Alignment
With desired corporate culture i.e. company-wide remuneration With business strategy - more diverse and tailored performance metrics With shareholders - long-term investment in shares
4. Accountability
RemCos should justify how their decisions will help deliver long-term business success RemCos must have the ability to exercise judgement when determining rewards
2. Simplification
Executive pay design and disclosures
Multiplicity of awards and, in particular, share matching plans questioned Pay schemes should be simple and understandable for investors and executives
3. Strength of pay and performance linkage
Driven need for clarity on the relationship between pay, company performance and business strategy
Our research* suggests that a potentially major shift is occurring in investor views on this topic
Flows of pay governed by performance measures More generic performance measures/more prescriptive investor views on these
Acceptance of high leverage accompanied by high performance conditionality of pay
Relative performance
Leverage
Type of performance
Driven by increasing scepticism of effectiveness of incentives
Link to performance
Stocks of executive shareholdings in company/longer time horizons/other holding conditions
Tailoring of performance measures encouraged/less prescriptive views
Some preference for less leverage/allowing share price to do work of linking pay/wealth to performance
Absolute performance
* We have recently completed a study of leading investors’ views on the changing environment for executive pay in the UK. Close to 30 institutions took part, and participants included both corporate governance specialists and fund managers.
Ensuring a long-term incentive has maximum impact requires careful implementation and communication
Three key elements of the link to pay for performance are: Process Governance Line of sight In addition to these elements, pay for performance is enabled by critical drivers, which are important for maximum impact
Governance of the plan remains important and should be maintained and checked year on year
This phase is critical – do you have it right at your organisation? Participants need to feel they understand the plan’s operation Who drives goal-setting and calibration? How are award payouts are determined? When should they expect communications? Are all of these clear to your employees?
All of this promotes trust in the process and allows employees to focus more on the performance the plan is meant to drive rather than the fairness of the pay they expect to receive.
Transitioning from one plan to another at any time will typically require two things: Addressing any gap in pay created (i.e. ‘transition payments’) and Alleviating lack of understanding around the new structure (i.e. communications).
1. Transition payments
2. Communications
• •
E.g. one-off awards, phased payments or vesting of awards Need to address any loss of value
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Communicate change to all employees that participate Include training sessions for finance and HR teams who will need to put the plan in operation. Establish links to company strategy
Once implemented, continual assessment of the effectiveness of the long-term offering is required As the company changes (e.g. strategy, business maturity, etc.) – the long-term offering needs to keep pace. A review can be a combination of five questions:
1 2
Is our long-term incentive still aligned with our business strategy?
Have historic payouts reflected performance? How well do these historic payouts compare to those of our peers?
3
4 5
How sensitive is the current long-term incentive to alternative future performance scenarios? How sensitive is it to alternative performance outcomes relative to our peers?
What potential governance concerns should we be aware of prior to the next AGM?
What potential wider stakeholder concerns might the plan raise?
Case studies – what are some of the pros/cons? (1 of 3) Company
Large public company
Overview
Performance shares with five year performance period
Measures
EPS growth Absolute ROE TSR against a group of relatively similar companies Five year performance period
Points of interest
Highly leveraged: targets for maximum vesting are challenging, but large payouts are possible Long performance period links to long-term company performance
