Why Performance Matters

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  1. 1. Why Performance Matters The reality of performance in the world of equity Presented byDan Walter, Performensation Consulting Peter Djokovich, Strategix 20/20
  2. 2. The foundation of measuring performance Why Create certainty in the workplace Drive corporate, group and individual performance Achieve defensibility and legitimacy in compensation Who Start at the top, but properly designed programs can be effective at all levels When Communicate as frequently as you can provide accurate information Where Common in much of Europe and Australia Growing in US and Canada Interest in Asia
  3. 3. The foundation of measuring performance What KPI - Key Performance Indicators Can be any measurable factor Must be understood, communicated and transparent Separate drivers of performance from results How Single-trigger KPI Interdependent KPI Measurement Date vs. Vesting Date vs. Payout Date Multilevel Measurement Threshold/Minimum Target/Expectation Maximum Equity vehicle
  4. 4. The biggest problem with performance today is that it is often based on luck not science Imprecise and clumsy goals can work too well, or not at all Use an axe when you need a scalpel What gets measured gets done True only if what is measured is communicated and managed Relevance is the key to performance effectiveness Results-only goals can lead to manipulation or abject failure Underlying drivers must be communicated when results are communicated When goals are too single-minded all focus is aimed in only one direction. Goals may be met at the expense of success Complex goals are hard, but so is sustained corporate performance
  5. 5. Using performance to drive business success and compensation Define Mission, Goals and Objectives Through and Across The Organization Relevance Align All Employee Business Processes Align All Human Resource Strategies Align Business Processes and Enabling Technologies Employee Segmentation Train and Develop Skills and Expertise Establish Individual and Team Performance Expectations Measure and Report Performance Results Keep It Simple Incent For What Can Be Controlled Pay For Quantifiable Performance Improvements Recognize and Reward Individuals for Events, and Teams for Processes Avoid Unnecessary Competition Between Participants Incentives & Recognition Should Not Be a Proxy For Leadership
  6. 6. 11 types of performance-based equity Performance Awarded Shares Performance Awarded Units Performance Leveraged Units Performance Earned Units Performance Accelerated Units Performance Priced Units Indexed Options Performance Granted Options Performance Accelerated Options Premium Priced Options Performance Earned Options
  7. 7. Common KPI for Equity Relative TSR Total Shareholder Return as compared against a group of peer companies Revenue Growth Operating Income Share Price Net Income EBITDA - (Earnings Before Interest, Taxes, Depreciation and Amortization) EBIT (Earnings Before Interest and Taxes) Turnover/Retention Reduced Expense (usually for large companies) ROI (Return on Investment) (usually for small companies) Reduced Risk Profile (recent addition to the mix) Other (reserve of outstanding inventory, customer satisfaction rating, project delivery etc...)
  8. 8. Examples of some common types of Performance-based Equity Either stock or stock options that are tied to performance metrics Type A: Awarding of shares is triggered by the performance metrics May have vesting of shares in addition to trigger Type B: Vesting, or lapse of restrictions, is triggered by the performancemetrics Multiple triggers may be layered to create more nuancedawards
  9. 9. Type A - Ex. 1: Performance Shares without Vesting (Performance Awarded Shares) Company A wants to incent share price growth Awards 1,000 potential Performance Shares to CEO Establishes KPI of Relative TSR against S&P 500 Earning of shares is based on following levels Minimum Payout (50% of 1,000 shares) at 50th percentile Target Payout (100% of 1,000 shares) at 75th percentile Maximum Payout (150% of 1,000) at 95th percentile Payouts between each level is based on a straight-line interpolation At the end of the year the metric has either been achieved or not If met, award is made and fully vested
  10. 10. Type A - Ex. 2: Performance Awarded Units with Vesting Similar to Example 1, but with time-based vesting after award In Example 2 the trigger for the award of units to the CEO is the out-performance of the S&P 500 for one year. At the end of the one year either it has been achieved or not However, once triggered the actual shares vest at 33% per year. This is often used to promote retention of the executive as well as drive specific performance
  11. 11. Type B - Ex. 3: Performance with Multi-year, Multi-goal triggers and goal interdependency Complex structure representing a small percentage of current programs Company wants to reduce expense and while maintaining performance compared to peer companies Awards 1,000 units with vesting contingent upon layered metrics Threshold - Target - Maximum structure Threshold = absolute minimum Target = stretch, but expected goal Maximum = ultimate out performance
  12. 12. Type B - Ex. 3: Performance With multi-year, multi-goal triggers (cont.) Certain goals are be required to be met before others can be triggered Goal 1: TSR metrics are 50th percentile for Threshold, 75thpercentile for Target and 90th Percentile for Maximum Goal 2: Expense Reduction is 2% for Threshold, 4% for Target, 7%growth for Max Require: Goal 1 MUST be met before Goal is triggered These goals can be layered for multiple years and metrics on a single award Goal measurements can vary from year to year
  13. 13. Performance Share Stats Over 40% of large US public companies plan to implement performance-based equity by the end of 2009 There is some dispute to the % of companies actually utilizing theseplans At least 150 of the FTSE 350 utilize TSR-based performance equity Highest growth of any equity plan type over the past two years
  14. 14. Pros and Cons of Performance Equity Pros ConsMotivates employees to drive specific Motivates employees to drive specific performance performance Can be used as a retention tool May become a demotivatorFlexible structureMay need crystal ball in structuring multi- year approach
  15. 15. Common Pitfalls and Issues Too many metrics, too complex BUT - Rare that one metric will predict success of a company Multiple year metrics in non-mature or unpredictable companies Guaranteed metrics in mature, predictable companies Acquisitions or divestures Both within the company and at peer group companies Variable Accounting Either mark-to-market, variable Fair Value accounting or Variable probability, fixed Fair Value accounting Limited Administration, Communication and Reporting tools Poorly communicated and understood, (especially in the period between award and measurement date)
  16. 16. Potential Work-Arounds or Ways to Game the Plan Sand bag numbers for easy targets Make award subject to Board approval Reset targets if necessary Forgive missed goals and allow for re-measurement Set metrics off industry standards instead of company-specific goals
  17. 17. Performance Shares: Mature Vs. Non-Mature CompaniesMatureNon-MatureCan determine meaningful target metrics Hard to make meaningful financial targets due to lack of predictability (recruitment, innovation and product delivery can be measured)Minimal Acquisition Activity? May be Acquisitive? This depends largely on industry and current market conditionsHarder to manufacture false Executives can manufacture results, but performance, but easier to create difficult to guarantee results guaranteed results
  18. 18. Key elements to managing and communicating performance Understand your KPI How were they chosen? What are the underlying components? How does a participant impact them? How does the market impact them? Know where you stand Communicate interim performance regularly Show trending and historical comparisons Communicate what need to be done, rather than just what has been done Focus on percentages and measurement levels rather than payout amounts Use performance programs as the foundation for communication, instead of an afterthought
  19. 19. Impact of performance on the administration of equity compensation plans Requires systems to be more nimble and flexible Lack of fixed dates, fixed prices and fixed numbers of shares significantlyincreases system complexity Accounting Systems are catching up to the most common plan designs Valuation Market-based goals require more complex valuation that can beautomatically offered by software Additional cost and timing of using valuation professionals as frequently asevery quarter
  20. 20. Impact of performance on the administration of equity compensation plans Communication Most current websites are very limited in their ability to provide performancedetails Risk of providing incorrect information if there is a limited ability to drill downor model System Interaction Data must be updated regularly and often comes from multiple sources External TSR tracking Data from financial systems Annual Review systems Compensation Planning systems General Ledger Sales Tracking and Commission tools
  21. 21. Conclusion Performance-based equity is the next wave of evolution in equity compensation Your plan must be as unique as your company, but still be comparable to your peers Strong communication is becomes a basic requirement rather than a valued addition Administration and accounting systems are improving and even the most complex plans can be handled well
  22. 22. QuestionsFor more information or to discuss this topic in more detail:Dan Walter, Perfo