Executive Compensation Trends

Transcription

1 Executive Compensation Trends WACABA Meeting November 20, 2014 Chris Hamilton Director and EC Practice Leader, Arlington (703) Scott Oberstaedt Senior Consultant, Executive Compensation (703) Towers Watson. All rights reserved.

2 Agenda 75 minutes Towers Watson s Principles & Elements of Effective Compensation Design ( Guiding Principles ) Long-Term Incentive Survey Results Global M&A Retention Study Results Questions & Wrap-up towerswatson.com 2014 Towers Watson. All rights reserved. 1

3 Towers Watson s Principles & Elements of Effective Compensation Design towerswatson.com 2014 Towers Watson. All rights reserved. 2

4 Executive pay continues to receive heightened media attention not the good kind! Jim Webb says CEOs make 350 times more than workers Executive pay: If you hire them, pay will come Efforts to regulate CEO pay gain traction Can CEO Pay Ever Be Reeled In? More Transparency, More Pay for CEOs How compensation consultants use data to ratchet up pay of CEOs towerswatson.com 2014 Towers Watson. All rights reserved. 3

5 The current environment is dynamic and subject to mixed messages Overall Economy Say-on-Pay Pay Irritants Slow to moderate growth but Strong markets for top talent and executive Generally high vote outcomes but Shareholders not satisfied with current state On the decline but Widespread concerns over inequality and pay excess remain Forces for Conformity are Driving Decisions Proxy advisors, market norms and so-called best practices have disproportionate influence on design but Forces for Tailored Approaches Should be Driving Decisions As company strategies, cultures, and talent differs, so should approaches to EC towerswatson.com 2014 Towers Watson. All rights reserved. 4

6 The evolution of executive compensation Sound compensation principles can help organizations make the strategic shift Dawn of Shareholder Alignment Incentive-based pay widely embraced Greater use of long-term incentives, especially stock-based Era of Exuberance Rampant growth of stockbased pay Pay what it takes for talent Lagging checks and balances Era of Compliance (Today) Formal market rules via say-on-pay and regulation Prominence of proxy advisors Dominance of market norms Considered on a narrow component-by-component basis Era of Wisdom (Future) EC that is: Holistic (for both rewards and performance) Strategy-driven Long-term oriented Tailored Dynamic enhanced over time Supports Overarching Principles of: Alignment, Purpose, Accountability and Engagement towerswatson.com 2014 Towers Watson. All rights reserved. 5

7 Scope of TW s EC Principles Six Topic Areas Governing objectives and EC philosophy Pay level reference group selection and benchmarking Performance-based pay Mix, measures and funding Targets, ranges and discretion Pay-for-performance assessment and incentive program review Governance Other terms and conditions Special circumstances 75 Principles & Elements of Effective Executive Compensation Design Four Overarching Principles Purpose: Supporting the mission, vision and values of the organization Alignment: Reflects the orientation of programs around shareholder value creation Accountability: Links pay to key areas of director, management and individual responsibility Engagement: Represents the motivational/behavioral aspects of rewards Critical development inputs included: In-depth research, EC consultant working groups and workshops, input from hundreds of Board members, pilot client discussions and presentations towerswatson.com 2014 Towers Watson. All rights reserved. 6

8 10 The Committee needs a comprehensive toolkit Executive compensation is becoming more complex The amount of information shared with Committees is increasing Key resources include: Calendar / agenda linked to charter Assessments of the committee and advisors Director education External market insights Additional analyses to validate pay outcomes Results from other executive talent management processes towerswatson.com 2014 Towers Watson. All rights reserved. 7

9 9 Discretion is a critical tool Discretion allows for a holistic assessment of sustainable performance and quality of outcomes Address issues that cannot be captured in a formulaic calculation It s a right and obligation for the Compensation Committee Discretion can be: Unstructured and determined when decisions are made This doesn t feel right, lets adjust Semi-structured with pre-defined adjustment criteria We will only adjust if Structured with a formal scorecard and adjustment range Here s exactly how we may or may not adjust Calculated Score +/- 25% Adjustment Factor Holistic assessment of specific factors: Achievement of key milestones Quality of earnings Capital management Customer/quality issues Economic factors towerswatson.com 2014 Towers Watson. All rights reserved. 8

10 8 Share ownership policies should reflect the tail risk of executive decision making Share ownership guidelines (e.g., 3.0x salary) are a must Scaled with equity compensation levels Supported by share retention requirements Based on non-performance based equity or owned equity Post-employment hold periods should be added for senior executives Time period to align with decision tails Supports the realization of decisions/actions during tenure Consider with termination/retirement provisions of LTI plans towerswatson.com 2014 Towers Watson. All rights reserved. 9

11 7 Market data is an input, not an answer Market data is: Helpful context Starting point or baseline for consideration Market data is not: Necessarily a best fit The primary factor for compensation decisions In fact, convergence around prevalent market practice could reduce a company s ability to differentiate within a competitive labor market towerswatson.com 2014 Towers Watson. All rights reserved. 10

12 7 Market data is an input, not an answer Surprisingly, data on enduring high-performing companies demonstrate a number of interesting deviations from typical market practice These companies are more likely to: Target pay above the 50 th percentile Use a single measure in the annual incentive plan Emphasize stock options versus performance plans Use other return metrics in addition to total shareholder return (TSR) Use longer equity vesting schedules towerswatson.com 2014 Towers Watson. All rights reserved. 11

13 6 Multiple peers are better than one Compensation levels should be benchmarked against multiple reference points, including: Direct competitors Industry (or comparable) peers General industry Banking Fin. Svcs. General Must clearly disclose these reference points and the rationale for their development Peer group development must be thoughtful and objective, but not-formulaic, with consideration of various factors, including: size, industry and labor market Having multiple reference points is particularly critical with small primary peer group sizes towerswatson.com 2014 Towers Watson. All rights reserved. 12

14 5 Consider pay decisions holistically Consider both the incentive multiplier and pension flow through effects of fixed pay decisions Consider the following: A CEO base pay increase of 25% =? A CEO target bonus increase from 75% to 125% =? Combined effect? Year Salary Target Bonus Pensionable Earnings Compensatory Change Benefit Obligation ,000 75% 1,470, ,000 2,724, ,000 75% 1,543, ,000 3,264,000 e.g ,100,000 75% 1,925,000 1,152,000 4,588,000 e.g , % 1,984,000 1,294,000 4,730,000 e.g ,100, % 2,475,000 2,463,000 5,899, % +45% +80% towerswatson.com 2014 Towers Watson. All rights reserved. 13

15 4 Use multiple dimensions of financial performance Incentive plan funding and design must consider multiple financial dimensions Focuses on quality of financial performance Earnings What revenue growth is required to achieve target EPS? How does EPS target link to ROCE and WACC? Cost of Capital Funding Design Revenue Growth How does EPS target align with share price expectations under different P/E multiples? Targets How does cash flow target link to earnings? Cash Flow Balance Sheet towerswatson.com 2014 Towers Watson. All rights reserved. 14

16 3 TSR is not the magic bullet Why Total Shareholder Return (TSR) matters but some inherent limitations Total Shareholder Return $400 $350 $300 $250 $200 $150 $100 Line of sight May not reflect the business' core value drivers or strategy Limited accountability for achieving specific goals Motivational? Relative comparisons Defining suitable peer group Measurement issues A snapshot point in time $50 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 towerswatson.com 2014 Towers Watson. All rights reserved. 15

17 3 TSR is not the magic bullet TSR plans get high marks for promoting shareholder alignment the same reason some investors and proxy advisors rate such plans highly 60% and 40% of Canadian and U.S. companies with PSU plans, respectively, use TSR Trend toward complementing TSR with additional measures Incentive plans and performance targets based on the business's core value drivers can be well aligned with shareholders while being more effective than TSR plans at boosting line of sight, accountability and engagement towerswatson.com 2014 Towers Watson. All rights reserved. 16

18 2 Budget does not always equal target Performance targets and ranges should be based upon: Organization s long-range forecasts Historical performance norms for the company, industry and peers Analyst/economic forecasts, and Organization s budgets The payout curve should also reflect the underlying volatility of the measure, and: Probability of achievement Affordability Payout alignment with historical and industry norms towerswatson.com 2014 Towers Watson. All rights reserved. 17

19 1 Pay-for-performance analyses are a must Review annually and when plan design changes are made Consider a holistic approach that includes the following: Include NEOs / executives More than just CEO Multi-year period Retrospective and prospective Multiple peer groups Different market perspectives Percentile ranking and sharing rates Sharing rates provide absolute pay perspective TSR and other financial measures Multiple performance definitions Earned or realizable pay Multiple pay definitions towerswatson.com 2014 Towers Watson. All rights reserved. 18

20 1 Pay-for-performance analyses are a must Why consider multiple performance measures? Client Positioning Against Peers 100% 90th 90% 80% 75th 70% 60% Median 50% 40% 30% 25th 20% 10th 10% 0% Low Cost High Cost TSR EBITDA Margin Production Growth Reserves Growth Costs per oz. Client 3-year Client Annual (Most Recent Year) towerswatson.com 2014 Towers Watson. All rights reserved. 19

21 1 Pay-for-performance analyses are a must Why consider multiple pay definitions? * * SCT = Summary Compensation Table towerswatson.com 2014 Towers Watson. All rights reserved. 20

22 Long-Term Incentive Survey Results towerswatson.com 2014 Towers Watson. All rights reserved. 21

23 2014 U.S. Report -- Long-Term Incentive Policies and Practices 900 participants Oct U.S. Long-Term Incentives Policies and Practices survey results published $5.7 Billion Median organization revenue 75% Of the 2013 participating companies repeated in ,000+ Participants expected by year end 16 Scope breaks available by revenue an d industry towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 22

24 2014 U.S. Report -- Long-Term Incentive Policies and Practices U.S. Long-Term Incentives U.S. Plan Design U.S. Participation/ Grant Process U.S. Grant Values towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 23

25 LTI plan design Restricted stock/restricted stock units (RSUs) continue to be the dominant form of long-term incentives 67% 57% Grant Prevalence (%) 45% 24% 7% Restricted Stock/Units (1) Performance Shares Stock Options Performance Cash SARs (1) May include some restricted stock/units with performance features Source: 2014 U.S. Long-Term Incentive Policies and Practices towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 24

26 LTI plan design Most companies (68%) are granting a portfolio of long-term incentives Number of LTI Awards Prevalence One LTI Award 32% Two LTI Awards 37% Three LTI Awards 30% 68% Four LTI Awards 1% Source: 2014 U.S. Long-Term Incentive Policies and Practices towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 25

27 LTI plan design Restricted stock/rsus Of the companies granting restricted stock/rsus, there are now more companies granting RSUs (69%) than restricted stock (40%) Both restricted stock and RSUs 9% Restricted stock - 40% RSUs - 69% Restricted stock only 31% RSUs only 60% Source: 2014 U.S. Long-Term Incentive Policies and Practices towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 26

28 LTI plan design Restricted stock/rsus c Companies with restricted shares are more likely to pay dividends currently (53%), while companies with RSUs tend to reinvest in shares (39%) or accrue (35%) Treatment of Dividends During Restricted Period Treatment Restricted stock RSUs Paid current 53% 26% Reinvest in shares 13% 39% Accrued No interest 30% 33% Accrued With interest 4% 2% Source: 2014 U.S. Long-Term Incentive Policies and Practices towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 27

29 LTI plan design Restricted stock/rsus Upon a change-in-control, most companies (49%) provide "double trigger" vesting of unvested restricted stock/rsu awards Unvested Restricted Shares/RSUs Vesting at CIC Vesting at CIC Market Prevalence "Double trigger": vested at termination after CIC 49% "Single trigger": vested at CIC 29% No vesting impact 13% Other 9% Source: 2014 U.S. Long-Term Incentive Policies and Practices towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 28

30 LTI plan design Performance plans Eighty percent (80%) of companies are now utilizing long-term performance plans; more companies (71%) utilize shares versus cash (29%) Mix of Performance Shares Versus Cash Cash/Units 29% Shares 71% Source: 2014 U.S. Long-Term Incentive Policies and Practices towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 29

31 LTI plan design Performance plans Relative total shareholder return (TSR) and earnings per share (EPS) are the dominant measures in long-term performance plans 40% Performance metrics vary significantly by industry Most companies use more than one measure (61%) Percent (%) Used Overall 21% 16% 15% 11% 9% 7% 7% 7% TSR EPS Revenue ROIC EBITDA ROE EBIT Cash Flow Net Income Source: 2014 U.S. Long-Term Incentive Policies and Practices towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 30

32 LTI plan design Performance plans d Relative performance measurement 49% of companies with performance plans utilize relative performance comparisons Peer Group or Index Used Industry Index 17% Other Index 17% Note: 16% of these relative plans also have an absolute performance threshold S&P 500 Index 14% Custom Peer Group 51% Russell 2000 Index 1% Note: relative performance means comparing a company s performance relative to that of a peer group or index Source: 2014 U.S. Long-Term Incentive Policies and Practices towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 31

33 LTI plan design Stock options Upon a change-in-control, most companies (49%) provide double trigger" vesting of unvested stock options Unvested Stock Options Vesting at CIC Vesting at CIC Market Prevalence "Single trigger": vested at CIC 31% "Double trigger": vested at termination after CIC 49% No vesting impact 10% Other 10% Source: 2014 U.S. Long-Term Incentive Policies and Practices towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 32

34 LTI participation and grant process s LTI eligibility for restricted shares/rsus begins at a midpoint of $119,000 versus $166,000 for performance plans Eligibility Entry Salary Level (Median) $166 $150 $143 Base Salary ($000) $119 Restricted Stock/Units SARs Stock Options Performance Plans Source: 2014 U.S. Long-Term Incentive Policies and Practices towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 33

35 LTI participation and grant process LTI grants still have a high level of individual "entitlement" 54% provide guidelines or ranges or flexibility to adjust But only 10% of managers always or frequently adjust awards Fixed/No Adjustment 46% Sometimes 54% Always 1% Adjustments Possible 18% Ranges 36% Almost Never 36% Frequently 9% Furthermore, typical management adjustments are less than 10% from the award guidelines 68% of the time. Source: 2014 U.S. Long-Term Incentive Policies and Practices towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 34

36 LTI grant Values Approach to setting annual awards most companies (70%) are targeting a specific economic value for their LTI awards No Set Approach 11% Fixed Shares 19% Target Value 70% Note: In practice, when there are dramatic swings in stock price, many companies do not provide an equivalent value Source: 2014 U.S. Long-Term Incentive Policies and Practices towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 35

37 Global M&A Retention Study Results towerswatson.com 2014 Towers Watson. All rights reserved. 36

38 About the Towers Watson 2014 M&A Retention Study The 2014 Global M&A Retention Study examines the structure, use and effectiveness of retention agreements during an acquisition or merger, with a particular focus on the financial elements of those agreements. To qualify for the survey, organizations had to have at least 500 employees (1,000 if based in the U.S.), completed either a merger or acquisition within the past two years and used employee retention agreements for at least one of those transactions. 248 respondents from 14 different countries qualified for the survey Survey participants responded in terms of one particular merger or acquisition their company had initiated and/or completed within the past two years. towerswatson.com Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only

39 2014 M&A Retention Study: Results at a glance Who is being targeted for retention? Employees ability to affect the success of the transaction is the most commonly cited factor for determining retention eligibility this criterion topped high-potential status, job function, job level, and job title. When are they asked to sign retention agreements? Just over half of senior leaders targeted for retention agreements are asked to sign at or before the initial signing whereas close to a third of other employees are asked to sign after close. What retention tactics and information are being used? Buyers most frequently turn to the seller s senior leaders (76%) and unit leaders (50%) to identify employees appropriate for retention agreements. No other source of information about who to include in the plan was seen as nearly as important. Cash bonuses (denominated as a percentage of base salary for both leaders and others) are the most common type of financial award in retention agreements for senior leaders (75%) and other employees (81%). towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only 38

40 2014 M&A Retention Study: Results at a glance (cont.) How were retention payouts budgeted, measured and awarded? The median retention budget is just under 2% of the total transaction cost and are largely borne by the buyer. US median value = 1.7% For senior leaders, retention agreements typically use a combination of pay-to-stay and pay-toperform metrics. Purely time-based agreements were most commonly used for other participants. For those with performancebased retention plans, the payouts for both senior leaders and other employees are most commonly based on the performance of the acquired company. towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only 39

41 2014 M&A Retention Study: Results at a glance (cont.) How were retention payouts set, measured and awarded? Over one-half (57%) of companies don t consider the value earned upon sale by retention program participants when setting retention awards 27% offer higher retention awards to those who earn more on the sale 16% offer lower retention awards to employees who earn more on the sale The majority of senior leaders receive far larger payouts as % of salary, and have longer required retention periods, than is the case for other employees. Median values 49% for senior leaders, 27% for others Median time frame 17 months for leaders; 14 months for others Vesting schedules vary across the board either fully vesting at the end of the retention period or prorating evenly across the retention period. towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only 40

42 2014 M&A Retention Study: Results at a glance (cont.) How long were employees actually retained? If not, why? The four most common reasons given by employees who left before the end of the retention period: 68% of employers report that they are able to retain at least 80% of targeted participants through the full retention period. However, this high retention rate is maintained by fewer than half (43%) of respondents in the year following the retention plan s conclusion. 1. Uncomfortable with the new culture 2. Aggressively pursued by competitors 3. Uncomfortable with their new role 4. Did not like acquirer s strategic direction towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only 41

43 Lessons from the Top: Six Habits of High-Retention Acquirers The fact that 88% of high-retention companies* rate their transaction as highly or mostly successful in terms of meeting their strategic objectives, compared to 67% of low-retention companies, points to the critical impact that talent retention can have on deal success. High-retention companies behave differently from others in six critical ways They are more likely than others to identify eligible employees for retention based on their ability to affect the success of the transaction (73% for high-retention firms versus 33% for low-retention firms). They are more likely to tap into the target s senior leadership for information about which employees to keep (66% versus 27%). They are significantly more likely than low-retention companies to include management discretion (that is, the opinion of the target s leadership) in the retention-agreement selection process (32% versus 8%). *We define high-retention companies as those who reported retention rates over 60% for the full retention period. Low-retention companies are those who reported retention rates of 40% or less. towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 42

44 Lessons from the Top: Six Habits of High-Retention Acquirers (continued) 4. 6.They They focus on cash bonuses rather than other forms of retention awards. Cash bonuses (exclusively or with other forms of compensation) are more likely to be included in retention agreements used by high-retention firms (80% for senior leadership, 89% for other employees) compared to lowretention firms (50% and 55%, respectively). 5.They are less likely than low-retention companies to change the value of their retention awards if employees earned some value due to the sale of their company. 58% of high retention companies said that the values paid out to executives and employees on the sale of their company had no effect on their approach to retention award setting, vs. only 33% of lowretention companies. offer retention target value that is higher than lowretention acquirers. For senior leaders, the median value of the retention plan among high-retention companies is 60% of base salary, versus 35% for low-retention companies. A similar difference exists for retention packages offered to nonexecutives (28% versus 16%). We define high-retention companies as those who reported retention rates over 60% for the full retention period. Low-retention companies are those who reported retention rates of 40% or less. towerswatson.com 2014 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 43

45 Key Takeaways: Principles of Effective Retention Plan Design Define success before implementing What are the corporate goals for the acquisition: stand-alone business or integrated with the parent company? Top-line or bottom-line growth? Where are there opportunities for synergies or efficiencies? Are you trying to retain employees forever, or only for a select time period? A thorough participant selection process is critical to retention success High involvement of senior leaders at the acquired company to select participants is aligned with higher retention A complicated plan design, however, is likely not critical to success Complicated plan designs are not aligned with high retention simple cash bonuses are effective Earn-out plans that pay on the future success of the acquired business are often appealing to the seller, but do they align with the acquirer s definition of success? Retention plans can buy the acquirer time, but not loyalty Acquirers still need comprehensive plans for leadership development, cultural integration, and communication Use the retention time period to build loyalty and commitment to the new parent towerswatson.com Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

46 Questions? towerswatson.com 2014 Towers Watson. All rights reserved. 45