Current Trends and New Directions in Variable Pay

Transcription

1 Current Trends and New Directions in Variable Pay September 18, 2013 Jim Hudner Managing Director Kristine Oliver Vice President

2 Session Overview Introduction Definition and Types of Variable Pay Evolution of Variable Pay Developing Clarity on Variable Pay Objectives Plan Design Alternatives: Current Trends A Word About Long-term Incentives Assessing Risk Common Pitfalls Outlook for Variable Pay Final Thoughts and Questions 1

3 About Pearl Meyer & Partners Pearl Meyer & Partners (PM&P) is a leading compensation consulting firm serving as trusted advisor to Directors, Senior Management and Human Resources in the areas of compensation governance, strategy development and program design. Founded in 1989, PM&P works with a wide range of clients - from start up to Fortune 500 firms. The firm maintains offices in New York, Atlanta, Boston, Charlotte, Chicago, Houston, Los Angeles San Francisco, San Jose and London. Please visit www pearlmeyer.com - Our Services - Upcoming Events Our Br oad-based Em ployee Com pensat ion Consult ing Ser vices Include: Def in it io n o f Co m p en sat io n Ph ilo so p h ies an d St r at egies Co m p et it ive An alyses an d Assessm en t o f Em p lo yee Pay Pr o gr am s Design in g, Cr eat in g, an d Im p lem en t in g Salar y St r uct ur es an d Rew ar d s Syst em s Co st in g An alyses o f Cur r en t an d Pr o sp ect ive Pay Pr o gr am s Co m p en sat io n Plan Aud it s - Our Surveys - Client Alerts - Comment Letters - Research Reports - Articles & Presentations - Advisor Blog Var iab le Pay Pr o gr am s In cen t ive Plan Design an d Evaluat io n Im p lem en t at io n an d Co m m un icat io n To o ls 2

4 Definition of Variable Pay Compensation that is contingent on discretion, performance or results achieved Pay At Risk Source: 3

5 Types of Variable Pay Approaches Short-Term Incentives Rewards based on the attainment of short-term results of 12 months of less Annual Bonus Lump-sum payment which is not based on predetermined performance criteria or standards VARIABLE PAY Compensation that is contingent on discretion, performance or results achieved Pay At Risk Long-Term Incentives Focuses and rewards performance over a period longer than one year 4 Recognition Awards Rewards employee contributions after the fact, usually on a discretionary basis

6 Evolution of Variable Pay Early Stages (60s 80s) Focused primarily on executives / management At individual contributor levels» Gainsharing» Individual incentives Growing Stages (90s 00s) Increasing levels of eligibility and award levels Greater variety of plans / programs LTI is king Today (2013) Fulfilling two primary objectives» Managing fixed costs» Rewarding performance Greater focus on alignment and ROI 5

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8 Managing the Growth of Salaries Has Had an Impact on the Role of Variable Pay 6% Salary Budget (Exempt Salaried) 5% 4% 3% 2% 1% 0% % 95% 90% 85% 80% 75% 70% % of Employees Receiving Salary Increases (Exempt Salaried) Source: World@Work (ACA) Salary Budget Surveys 7

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10 Variable Pay Has Evolved to Have a Larger Role in Total Compensation 14% 12% 10% 8% 6% 4% 2% Avg Percent Paid Amount (as % of Salaries) 0% Avg % of Eligible Employees Actually Paid 90% 85% 80% 75% 70% 65% 60% 55% 50% Source: World@Work (ACA) Salary Budget Surveys 9

11 A Key Driver in Variable Pay: Adjusting Pay Mix Based on recent and projected trends, pay mixes are likely to continue shifting in a way that helps to manage fixed costs Percent of Total Compensation 100% 90% 80% 70% 60% 50% 40% Base Salary STI Base Salary as a % of Total Compensation LTI (as a % of Total Compensation) LTI 30% 20% 10% 0% Non-Exempt Professional Mid Mgmt. Sr. Mgmt Executive 10

12 A Continued Shift in Pay Mix is Likely Shifting the pay mix to include more variable pay will place more risk with the employee, but create greater leverage and expense control Percent of Total Compensation 100% 90% 80% 70% 60% 50% 40% STI Base Salary as a % of Total Compensation LTI 30% 20% 10% 0% Non-Exempt Professional Mid Mgmt. Sr. Mgmt Executive 11

13 Selecting the Right Approach. It All Starts With Your Compensation Philosophy Money Level of Compensation Who does the organization compare itself to? Who are your comparative labor market/peers? What is the desired competitive posture? Mix Total Compensation What is each element of compensation that is being offered? What is the desired overall mix of total compensation? How much focus should there be on performance-based pay/pay-at-risk? Messages Objectives and Goals What is the rationale of each component of total compensation? What are the compensation program(s) designed to reward? How does it attract, motivate and retain executives/employees? Different Philosophies for Executives and Staff? Different Employee Groups? Different Locations? Different Business Units / Functions? 12

14 Strategic Alignment Different Business Strategies = Different Reward Approaches Start Up Building business Opening locations Attracting talent Seeking profitability Expanding Location expansion Acquisitions Diverse businesses Established Customer service/retention Community focus Profitability Different Business Goals Conservative base salaries Limited incentives (preserving cash) Long-term incentives/equity Limited benefits We re all in this together Competitive base salaries Buying or acquiring talent (sometimes at premium) Focus on performance based pay (annual incentives and equity) Multiple reward strategies (different businesses) Competitive base salaries Incentives to reward customer service & profitability Long-term incentives/retention of executives Competitive benefits Generally common pay programs 13

15 Ensuring Clarity on Objectives It s critical to gain agreement on what variable pay is intended to achieve Motivate & Reward Compensation for Goal Achievement Compensation for Extraordinary Achievements Recognition of Team Results Token Award - Job Well Done 14

16 Variable Pay Design Common Frameworks Target & Goal-Based Plan Design Summary Key Objectives Typical Usage Funding Eligibility Participation Allocation Target & Goal-Based Predetermined awards linked to predetermined outcomes Mature firms where goals and targets can be more easily and accurately predetermined Budgeted Top management and others with ability to influence short term performance of the firm Based upon achievement of predetermined performance goals at the corporate/region/division/individual levels More formulaic based upon achievement of goals Timing Typically quarterly or annually 15

17 Variable Pay Design Common Frameworks Pool & Allocation Plan Plan Design Summary Key Objectives Pool & Allocation Plan Allocation of funds linked to financial success of the firm Typical Usage Typically firms which are more entrepreneurial Funding Award pool is generated as a function of financial success Eligibility Based on management s objectives of the plan Participation Based on success of overall corporation, division, or unit. Allocation May be per capita, pro-rata, discretionary, or any combination Timing Typically quarterly or annually 16

18 Variable Pay Design Common Frameworks Recognition Award Plan Design Summary Key Objectives Typical Usage Recognition Award Recognition of individual unplanned but significant achievements Many firms Funding Budgeted Eligibility All employees, but generally does not include executives Participation Allocation Timing Very limited, typically 5%-10% of population Generally by guidelines (i.e., $1,000-$5,000 awards without corporate approval) Coincident with achievement 17

19 Which Variable Pay Approach Makes Sense for Various Employee Groups? Sr. Level Employees Long-Term Incentive Plan Corporate Annual Incentive Plan Employee Level Divisional / Functional Annual Incentive Plan Lower Level Employees Discretionary Bonus Individual Discretionary Bonus Team Team Annual Incentive Plan Staff Function.Staff /Line...Line Function Type of Function 18

20 Four Key Elements for Variable Pay Plan Design Eligibility Performance Measures Pay Philosophy Award Opportunity Leverage 19

21 Determining Eligibility: Assessing Line-of-Sight Exec Hourl y Staff Function.Staff /Line...Line Function 20

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23 Eligibility: Stringent Threshold / Circuit Breaker Some incentive/bonus plans incorporate an overall circuit breaker based on corporate performance, but can also use a layered approach based on individual performance 95% Corporate Performance (as a % of Target) 90% 85% 80% 70% Not Incentive/Bonus Eligible Incentive/Bonus Eligible Poor Performance High Performance Individual Performance 22

24 Aligning Eligibility, Participation and Award Opportunities Feature Target and Goal Pool and Allocation Recognition Eligibility Ability to Measure Targeted Ability to Impact Broad Population Participation of Eligible Employees Driven Directly by 70% - 90% Driven by Organizational Success and Individual 70% - 90% 5% - 10% Award Opportunity Most Aggressive Market-Oriented Reflects Pay Mix Tiered Less Aggressive Market-Oriented Reflects Pay Mix Tiered Modest Timing Often annual Can be shorter Annual Event-Driven Can be Annual Drive Behavior / Results Influence Behavior / Results Recognize Behavior / Results 23

25 Assessing Leverage / Payout Range Most relevant to target and goal frameworks Important to identify relationship between threshold, target and maximum performance objectives and associated payout Performance Level %of Plan Achieved Award as % of Target Incentive Eligible Maximum > 175% 150% How challenging should this be? Target 100% 100% Target should be realistic Threshold 25% 50% Performance where awards begin Below Threshold < 25% 0% For quantifiable goals, interpolation is recommended to encourage and reward incremental performance improvement Factors determining leverage Economic, Performance, Historical, Retention 24

26 Performance Measurement Feature Target and Goal Pool Allocation Recognition Orientation Metrics Goals Events Focus Combination of Corporate, Team and Individual Primarily Individual, with Corporate Measures Impacting Pool Team and Individual Level of Discretion Limited Some Considerable 25

27 Performance Metrics: Balanced Approach The most effective incentive programs balance financial and non-financial measures of performance, as well as leading and lagging indicators Strategic Measures Operational Measures Financial Measures Leading indicators Tend to be qualitative Serve as the basis for management decisions Examples Customer satisfaction New product sales Cross-selling Market share Leading or lagging indicators Quantifiably measured with enhanced line-of-sight Reflect sub-process where focus/improvement is needed Examples Quality and Safety Factory productivity Cost reduction initiatives Working capital turnover Lagging indicators Quantifiable and indicate results/progress to date Reflect investor perspective and capture business economics Examples Revenue growth Profit (Gross, Operating, Net) Margin (Gross, Operating, Net) Return on Assets (Net, Gross) EVA Valuation measures 26

28 Strength of Relationship (R-Squared) Performance Metrics: The Value Driver Approach A Value Drive Analysis can provide input on those metrics that drive the most value over the long- and short-term Organizational Value Drivers Software & Services 100% 90% 80% 70% Earnings growth drives shareholder value over the long-term but shows weak correlation in the short term Capital return measures exhibit strong correlations to value over 1-, 3- and 5- year time periods 60% 50% 40% 30% Profit margins have little correlation to shareholder value 20% 10% 0% EBITDA Growth Net Income Growth EPS Growth Sales Growth Gross Margin EBITDA Margin Net Income Margin Cash Flow ROE ROIC ROGA EVA Spread 1-Year 3-Year 5-Year 27

29 Predominant Factors Used to Set Goals Data below was collected in PM&P s Executive Pay for Performance Survey % of Companies Reporting Factors Used to Set Performance Goals Annual budget Long-range plan or strategic plan Business unit or "bottom-up" plans Historical performance Value-sharing (e.g., X% of profits, etc.) Statistical analysis of measures and value Peer performance Variance analysis (e.g., in determining goal ranges) Implications of goals on stock price Wall St. Earnings guidance Forecasts by external analysts Very Important Somewhat Important 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Conclusion: The annual budget and long-range plan are key to goal-setting, historical and peer comparative performance are also fairly common. Advanced analytics and modeling are used much less often. 28

30 A Word About Long-Term Incentives Eligibility: Less is More Participation: Focused / Targeted Executives High Performers / High Potentials Role Below Executive Level: Achieving Clarity Retention Reward / Recognition Competitiveness Delivery Vehicles: Focus on Balance Stock Options Restricted Stock Performance Equity 29

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32 Assessing Compensation Risk: The Process Define Process, Roles & Accountability Board & Management Understand Business Risks Inventory Plans Executive & Employee Prioritize Review for Materiality Conduct Assessment (see box below)* Approvals and Certification Ongoing monitoring, analyses & reporting START NOW * Conducting the Assessment: Review risks resulting from employee function/role Understand the time horizon over which risks may be realized Assess controls, processes, policies, governance practices and plan design features that may lead to increased risk taking or mitigate risk taking Identify changes to policies, controls, incentive plans as appropriate 31

33 Assessing Incentive Design Features - EXAMPLES LOWER RISK HIGHER RISK MIX At least half of compensation in base salary Most of compensation paid based longterm, sustained performance Majority of compensation in incentive pay Most of compensation paid based on annual, short-term results MEASURES Balance of performance measures: Financial, operational, quality Short and long-term Company and Individual Absolute and relative Formula and discretion 1 (or few) performance measures 1 (or few) performance perspectives (e.g. all top line metrics without accounting for quality) Same performance measures used for short and long-term incentives DESIGN FEATURES Cap/maximum payout Appropriate performance-payout curve Multi-year performance period (or hold back/deferral if focus on short-term) Discretion allowed Clawback Ownership/holding requirements No cap/unlimited upside Threshold/target set too high Quarterly or single year performance without some focus on longer-term Formulaic calculation No clawback No ownership/holding requirements 32

34 Common Pitfalls with Variable Pay Programs You re measuring and rewarding for the wrong things! Money isn t everything Relationships are hurt or silo mentality is created Lack of clarity Overly complex Not well understood Awards become an expectation or a guarantee Two Hardest Aspects: Choosing the Right Metrics and Setting Goals Appropriately! 33

35 Outlook for Variable Pay It is here to stay and then some! Organizations will find the right balance between performance metrics and discretion Pay delivery vehicles will evolve Greater emphasis on variable pay along with constrained salary growth may challenge conventions on rewarding the what and the how Current Paradigm Evolving Paradigm? Base = Market plus Performance (e.g., How) Base = Market Variable Pay = Results (e.g., What) Variable Pay = Results (e.g., What) + Performance (e.g., How) 34

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37 Final Thoughts. 36

38 Variable Pay Programs Can Work If Variable Pay Programs Can Work If Target & Goal Pool & Allocation Recognition Criteria for Eligibility, Participation and Awards is Clear Performance Measures Reward Right Things Target Performance Raises the Bar, but Realistic Balance and Simplicity in Plan Design Payouts / Awards Vary Careful Use of Triggers / Circuit Breakers Entitlement is Avoided 37

39 In Summary Variable Pay Programs Can Work If Objectives and rationale are clear Sound business judgment is used in plan design and administration There is sufficient leverage and variability in awards SUCCESS!! There is clarity and consistency in communications and implementation 38

40 Questions? 39

41 Jim Hudner Jim Hudner, a Managing Director in the Boston office, has consulted for over 25 years on a broad range of compensation issues. He advises clients in total compensation strategy, compensation planning, base salary management, incentive plan design, executive compensation and performance management. Prior to joining Pearl Meyer & Partners, Mr. Hudner held leadership roles at two international consulting firms. He has expertise in developing integrated compensation programs in support of mergers and acquisitions, and has experience in a range of industry sectors. Over his career, Mr. Hudner s primary focus has been on the assessment, design, implementation and communication of compensation programs covering broad-based employee populations. Mr. Hudner earned a bachelor s degree from Boston College and an MBA with a concentration in human resources and finance from Babson College in Massachusetts. In addition to being a member of WorldatWork, he is an experienced speaker on a variety of compensation topics and has contributed to several industry publications [email protected]

42 Kristine Oliver Kristine Oliver is a Vice President with Pearl Meyer & Partners. Kristine s areas of expertise include broad-based compensation design and administration for employees at all levels, competitive analysis, performance management, base pay structure development, compensation audits, incentive plan design, executive and board compensation and compensation communication. Ms. Oliver has consulted to companies in various sectors over the past 10 years, but with a particular emphasis in banking. Prior to joining Pearl Meyer & Partners, Kristine held positions in compensation at Pearson Education and Schering Plough Pharmaceuticals. Ms. Oliver holds an MA in Human Resources Management from Rutgers University and a Bachelor of Arts from Denison University. In addition to being a member of WorldatWork, she is an experienced speaker on a variety of compensation topics and has authored and/or co-authored the following articles: The Top Five Questions About Communicating Compensation ; Workspan Magazine (Cover article: February 2013) Getting The Most Out of Salary Surveys: Seven Tips for Success ; Workspan Magazine (Cover article: February 2011) 10 Steps to Paying for Real Performance ; e-version Workspan Magazine (May 2010) [email protected]