2013 CBIA Conference: Optimizing Executive Incentive Plans

Transcription

2 Today s Session Objectives How We Think About Incentive Plans: Background and Context for the Discussion 7 Common Mistakes To Avoid Question and Answer Copyright 2013 by The Segal Group, Inc., parent of The Segal Company and its Sibson Consulting Division. All Rights Reserved

3 Role of Incentives Motivation: The incentives engage employees to drive the intended business results, and reward and differentiate employees fairly for the value they create Success Sharing: A successful incentive system is aligned with the key business priorities and proposes a meaningful value exchange for the employee 2

4 Key Inputs to Incentive Plan Design While an accumulated knowledge of market best practices may be helpful, one size does not fit all. It is important to take a balanced perspective that captures all the key inputs including your business strategy and priorities as well as the implied value proposition for your employees. KEY INPUTS TO INCENTIVE DESIGN Business Strategy and Operations Employee Value Exchange Market Trends and Best Practices Sound Analysis (Quantitative and Qualitative) SUSTAINABLE INCENTIVE DESIGN SOLUTIONS 3

5 An effective incentive design process answers the following questions What is the purpose of the plan? How does it support business performance? What is the focus of the plan individual, team? How are award decisions reviewed and calibrated across the division/ organization? Who will manage the day-to-day aspects of the plan? How will participants learn about the program? How will individual awards be communicated? SIBSON INCENTIVE DESIGN PROCESS Purpose and Type Participation & Eligibility Governance and Administration Incentives Communication Modeling & Implementation Payout Mechanics What criteria must be met to participate in the plan (e.g., business impact, internal equity, market practice)? Measures & Performance Targets Funding What metrics are best indictors of overall company success (leading vs. lagging)? Through what process are goals established? What is the best funding approach budgeted, self-funded, discretionary, blended? How are funding schedules aligned with the economics of the business? What are the range of funding scenarios and performance requirements? Is there a need for a pilot program? What is the target award opportunity and upside potential? How is the award determined? 4

6 However, Many Companies Make Mistakes Along the Way 5

7 Common Mistakes When Developing Compensation Plans There are both Design and Implementation issues 1. Complexity 2. Metric Madness 3. Mechanics 4. Modeling / Testing 5. Governance: 6. Goal Setting and Alignment 7. Communications Participants do not know how the plan works and/or understand what is expected of them Sub-optimal plan metrics Key plan provisions do not reflect the company s philosophy or market characteristics Poor scenario modeling and/or forecasting of potential plan results Unclear program rules and guideline for making adjustment mid-cycle; Illdefined and/or unclear roles and responsibilities for program administration Performance targets are unreasonable and goals do not cascade appropriately Plans are not properly communicated 6

8 1. Complexity: Participants do not understand how the plan works Most Common Complexity Issues: 1. Metrics: No more than three performance metrics No metric weighted < 20% of the target incentive No metric weighted < 5% of base pay 2. Payout Drivers: Confusion on role/impact of organizational vs. individual performance 3. Recall / Play Back: Participants should be able to describe the plan in elevator ride 4. Formulas: Too many kinks / steps in the payout curve 5. Discretion: Too much discretion without defined parameters leads to inconsistency 6. Performance Management: Forced linkages to performance management system / differences in language and tone 7

9 2. Metric Madness: Sub-optimal plan metrics and goal setting Incentive measure selection involves a number of considerations. 1. Nature What specific results should be measured? 5. Standard How should performance targets be established? Performance Measures 2. Hardness Will these results be assessed on a quantitative or qualitative basis? 4. Timing 3. Level Over what timeframe should results be measured? At what organization level should results be measured? 8

10 Identifying appropriate metrics begins with analyzing aspects of the revenue stream Capital People Make Sell Product Service Commodity Specialized Product or Service Low Margin High Margin High Volume Low Volume 9

11 Incentive metrics can be identified as a function of capital requirements and product/service orientation People Intensive (Retail; Software) Revenue Growth Margins Market Share Inventory Turns (Professional Services) Revenue Growth Margins Utilization Capital Intensive (Automotive) Revenue Growth Margins EV ROCE Plant Utilization (Airlines; Telecomm.) Revenue Growth Profit per Passenger Revenue Mile Equipment Utilization ROA Product Service 10

12 A company s business strategy can also help isolate incentive measures... Brand Imaging Market Share Profit per Brand Margins Product Mix Product Leadership Margin Progression Percentage of Revenues from New Products ROI Return on R&D Operational Excellence Margins Inventory Turns ROA EBITDA Growth Customer Intimacy Revenue Growth Account Penetration and Retention Margins Profit per Account 11

13 Best practices to keep in mind when selecting metrics Ensure measures are relevant to the business situation (i.e., not just the fad of the day) and can be tracked Ensure consistency with messages being sent through other processes Balance absolute and relative performance Look beyond the short-term Goals should be appropriate for the measurement period Consider shareholder transparency Communicate with and educate participants Evaluate unintended (as well as intended) consequences 12

14 Be careful of the following pitfalls Easily managed metrics Shortsightedness (i.e., ignoring longer-term measures) Incenting wrong behaviors Excessive award formulas without caps or gotcha provisions 13

15 3. Mechanics: Key plan provisions do not reflect the company s philosophy or market characteristics Introduction to Decision Frameworks An organization s specific circumstances within its industry, its talent profile, and rewards principles will drive the structure of its pay programs The following pages show three frameworks that we use to help ascertain the optimal structure of a company s incentive plan The concepts within these frameworks are used in consultation with management teams, Compensation Committees, and Human Resources They are not meant to be completed as an exercise to determine the right answers nor are they prescriptive. Instead, they are meant to facilitate discussion on market influences and management strategy to determine how best to implement compensation schemes that can have the most impact 14

16 Approach to Leverage/Upside Potential AMOUNT OF LEVERAGE Low High Predictability of Results Predictable Unpredictable Availability of Talent Abundant Scarce Phase in Business Cycle Start up Growth Company Position Lead the market Lag the market Prominence of Incentives in Total Pay Package Not prominent Highly prominent Pay Positioning vs. Peers Above market Below market Degree of Stretch in Performance Targets Conservative Aggressive 15

17 Approach to Determining Incentive Payouts INCENTIVE PAYOUT More Formulaic More Discretionary Manager s Skill/Proficiency Low High Performance Distribution Normal Skewed Nature of Work Performed Importance of Internal Equity Centralization of Administration Routinized, easily quantifiable, task oriented, measurable, objective Highly important Centralized within HR Strategic Less important Decentralized in the field Measurement Level Corporate/team Individual Basis for Compensation Performance only Multiple factors (i.e., performance and market positioning, career trajectory, etc.) 16

18 Approach to Measurement and Funding INCENTIVE PAYOUT Corporate Unit/Team/Individual Size of Company Small/Single Line of Business Large/Diversified Purpose of Incentive Plan Corporate affiliation Unit/team/individual affiliation/differentiation Decision Autonomy Low High Shared Resources High Low Plan Participation Narrow Broad Coordination Across Units High Low Companies can use formulaic approaches and then consider discretionary adjustments to pay amounts. 17

19 4. Modeling/Testing: Poor scenario modeling and/or forecasting of potential plan results Required Analytics: Avoiding A Nasty Surprise Sharing Ratio Market Competitiveness Incumbent Displacement Analysis Pay Mix 18

20 Sharing Ratio Exhibit Incentive Payout Percent 200% 150% 100% 50% Threshold With Discretionary Pool Target Maximum 0% 60% 80% 100% 120% Percent of Performance Target CORPORATE EXECUTIVES Level EBITDA % of Target % Payout Payout $ Sharing % Incremental Sharing % Pre-Incentive EBITDA Threshold $20,000,000 80% 50% $154, % N/A $20,154,292 Target $25,000, % 100% $308, % 3.1% $25,308,583 Maximum $30,000, % 150% $462, % 3.1% $30,462,875 WITH DISCRETIONARY POOL Threshold $20,000,000 N/A N/A $244, % N/A $20,244,909 Target $25,000,000 N/A N/A $489, % 4.9% $25,489,818 Maximum $30,000,000 N/A N/A $737, % 4.9% $30,734,728 19

21 Sample Market Competitiveness Analysis Incentive as % of Base Salary Total Cash Competitiveness (TCC) With Latest Incentive Individual Competitiveness Range With Fixed $ Target Min Max Level Avg. Salary Fixed $ Target Min Max C-Suite $365.7 $ % 29% 83% 87% 72% 98% Executive 1 $235.5 $ % 22% 92% 101% 71% 146% Executive 2 $195.7 $50.0 6% 22% 99% 106% 58% 155% Executive 3 $154.4 $35.0 6% 14% 101% 108% 91% 168% 20

22 Incumbent Displacement Analysis 100% 75% % Change from Current 50% 25% 0% -25% -50% -75% -100% $0K $50K $100K $150K $200K $250K $300K $350K $400K Forecasted Earnings 21

23 Pay Mix Comparisons by Level TARGET PAY MIX FOR TOP EXECUTIVES 1 All Levels 55% 5% 40% Market 50th 48% 25% 37% 0% 20% 40% 60% 80% 100% TARGET PAY MIX FOR SECOND LEVEL EXECUTIVES Second Level 71% 2 27% Market 50th 77% 11% 13% 0% 20% 40% 60% 80% 100% Base Salary Annual Incentives Long-Term Incentives 1 Percentages may not add up to 100% due to rounding. 22

24 5. Plan Governance: Ill-defined program administration roles; unclear rules for making adjustment mid-cycle Decision Rights Framework: The RACI framework helps to clarify the different roles in the plan design, implementation, and execution. RACI Framework R recommend Develops alternative solutions and recommends direction and associated rationale A approve Has final approval authority over decisions C consulted Consulted by those responsible for the task. Provides expert opinions. I informed Kept up to date on progress. 23

25 RACI AIP Illustration Board CEO Business Unit Lead Managers HR Eligibility N/A Inform Consult Recom. Approve Plan design / changes Inform Approve Consult Inform Recom. Annual performance goals and targets Approve Recom. Consult Consult Inform Participant payout guidelines (employees) Inform Approve Consult Inform Recom. Mid-cycle goal adjustments Approve Recom. Consult Inform Consult. Broad employee payout recommendations N/A Inform Approve Recom. Consult Executive payout recommendations Approve Recom. N/A N/A Consult CEO payout recommendations Recom. Approve NA. N/A N/A N/A 24

26 Plan Provisions Key provisions and decision makers should be clarified upfront: Illustrative Example Guidelines for Changes in Goal Setting Adjust Do Not Adjust Consider Adjustment KEY EVENTS New Hires Death, disability, retirement Promotions Transfers Goal Adjustments Change-of-control M&A activity Accounting rule change Board-directed strategic change Recession Material change in ability to measure stated goal Extraordinary competitor actions Legal action affecting operating income by >50% Significant operational restructuring (e.g., major IT conversion, etc.) Changes in currency exchange rates Interest rate shifts Planning errors Poor publicity 25

27 Plan Governance Roles and Responsibilities SAMPLE ROLES AND RESPONSIBILITIES Senior Leadership Human Resources Managers Beginning Middle End Sets organizational objectives Approves metrics and plan design Champions plan design and communication Recommends plan design Oversees goal setting process Performs scenario modeling Provides training to Managers Understand and communicate plan details to employees Conduct goal setting with employees Evaluates year to date organizational performance Links employee communication about year to date organizational performance to incentive plan Sets and monitors process for interim reviews of goals/performance Develops messages about year to date performance Conduct interim review of goals/performance with employees Delivers messages about year to date performance Evaluates organizational year end performance against metrics Approves individual award recommendations Manages process for determining individual incentive awards Reviews award recommendations and processes pay outs Conducts individual performance evaluations Communicates award decisions to employees 26

28 6. Goal Setting and Alignment; Performance targets are unreasonable; goals do not cascade throughout the organizations Approach Advantages Disadvantages Budget GOAL SETTING APPROACHES Commits management to achieving budgets May bias the budgeting process, requires history Milestone Historical Relative to peer group Year-over-year improvement Share ratio Focus on critical objectives; does not need complex measurement systems Reflects actual performance Implicitly recognizes changing business conditions Simple; avoids the need to rely on set budget (eliminates sandbagging) Simple; easy to demonstrate economic proof Undermines the budget process Assumes past is predictive of the future performance May generate rewards despite weak returns if industry performance is weak Requires the need to factor in the changing business conditions Does not recognize changing business conditions Goal setting alternatives present certain strengths and limitations. Chosen method(s) should fit with the company objectives and business dynamics. 27

29 Actual performance targets may be influenced by a combination of approaches Measure Product Returns (Percent of units) COGS per Sales Dollars Cycle Time for Order to Delivery Historical Company Performance Top Unit in Company Average Competitor Performance Best-in-Class Competitor Performance Planning Estimate 8.5% 4.3% 6.0% 4.0% 5.0% 65% 55% 60% 55% 60% 15 days 10 days 12 days 8 days 10 days 28

30 Link Organizational, Department, and Individual Goals Individual goal setting should be driven by the organization and department priorities and plans. President/ CEO and Leadership Team Vertical cascade should be part of the business calendar Horizontal alignment calibration for stretch Departments and Divisions Division/department plans and objectives in support of organization objectives Supervisors and Staff Annual objectives linked to division/department objectives: Clearly articulate what to achieve (job responsibilities and objectives) Clearly articulate how success will be measured 29

31 7. Communication: Plans are not properly communicated When implementing incentive plans, many organizations overlook key tenets of effective plan communications: Do not underestimate the value of a comprehensive communications strategy and the time required to develop communication tools. Sample tools include Brochures Interactive calculators Personalized statements Mid-year updates / progress reports Sensitivity analyses (i.e., the impact of incremental improvements / declines) Post incentive plan messaging A direct and straightforward conversation with the executive manager A data dump does not constitute dialogue surface and manage resistance publicly raise the water cooler issues Without a thoughtful and effective communication plan, even the best designed plans can fail. 30

32 Communication The Checklist Execs should be able to answer the following questions: 1. What are the metrics and how are they measured? 2. How do the metrics link to organization, department, and/or individual strategic objectives? 3. How they can directly impact the metrics? 4. How does performance on the metrics impact the incentive award? 5. How is individual target incentive determined? 6. What level of performance will pay out the target level of incentive? What level of performance pays out below or above the target incentive? 7. When are metrics set, metrics measured, and incentives awarded? 31

33 Wrap Up- Effective Executive Incentive Compensation Design Guidelines: Control / Line of Sight Participants should have ability to affect measures in the incentive plan Differentiation Top performers should earn significantly more than bottom performers Simplicity A plan should be as clear and simple as possible Pay for Results Pay for business results. Manage activities Rule of 20% An incentive plan should have no measure worth less than 20% of target incentive Rule of 5% Rule of Three Scope / Prominence Timeliness Any one incentive measure should be no less than 5% of base salary An incentive plan should focus on no more than 3 measures Target opportunity levels should be based on scope and prominence of the roles Incentive payments close to the achievement of results 32 32

34 Further Questions and Discussion Jason Adwin Vice President (o) (c) 33