Financial Executives Institute October, 2014 Executive ... · Pay at risk can be evaluated based on grant/opportunity values of compensation, as well as based on realizable/realized

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Executive Compensation Trends for CFOs

Financial Executives Institute < October, 2014

FEI | EXECUTIVE COMPENSATION TRENDS FOR CFOs < OCTOBER 2014 < PAGE 2

Agenda

This session will cover the following topics:

Pay for Performance

Annual and long term incentive practices

― Practices ― Metrics ― Vehicles ― Pay Mix

Share Ownership and Post Retirement Hold Periods

Say on Pay: Impact on Executive Compensation and Disclosure


Pay for Performance


What is “Pay for Performance”?

•5 important elements

Is there enough pay at risk?

Are we using the right performance metric(s)?

Are performance goals sufficiently stretch?

Is there alignment between realizable compensation and realized performance?

How much discretion should be incorporated?


Assessing Pay at Risk •Pay at risk can be evaluated based on grant/opportunity values of compensation, as well as based on realizable/realized value. Comparisons are generally made to peer data as well as to the company’s own historical trend

15% 23%

5% 3%

15%

23%

30%

35%

15% 5%

20%

11%

Target/Opportunity Realizable/Realized

Total Compensation by Pay Component

Base Salary All Other Comp. RS/RSUs Bonus Stock Options Perf. Plan

Fixed

Variable

Fixed

Variable


Sources of Perspective on Incentive Plan Performance Measures

Peer Company Incentive Plan Measures

Capital Market Expectations

Company/Industry-Specific Circumstances

Statistical Correlations to Value

Potential Performance

Measures


Industry Analysis and Performance Measure Selection

Pioneering (e.g., early-stage tech.)

Growth (e.g., Google)

Mature Growth (e.g., Microsoft)

Mature (e.g., Kraft)

Decline (e.g., Intl. Paper)

Performance Considerations

“Pre-Revenue” “Revenue” “Revenue/ Profitability” “Profitability”

“Profitability/ Rationalization”

Milestone measures

Prototype completion dates

Financing

Market share

Revenue

Customers

Revenue

Operating cash flow

Operating income

Net income

Return measures

ROA, ROCE, ROE, etc.

Economic profit

Cash flow

“Success” measures

Sale of assets

•The nature of any performance analysis will be bounded by industry considerations

•In addition to the life cycle factors noted above, other factors include

Regulation

Economies of scale or scope

Significant first-mover advantages to established incumbents


The Theory of Value and the Cost of Capital •Value creation depends on growth potential and return on capital relative to cost of capital:

A company’s return on capital relative to its cost of capital has implications for selection of performance measures and determination of goals

Value Creation – Summary Principles

ROI<Cost of Capital

ROI≈Cost of Capital

ROI>Cost of Capital

Focus on

profitability over

growth

Strengthen

profitability with

some emphasis

on growth

Seek growth

opportunities until

returns just equal

cost of capital Re

turn

on

Ca

pit

al

Growth

Value

Creation

Value

Destruction Y

X

ROC = COC

ROC = 0


Setting Sufficiently Stretch Performance Goals

•Optimal performance goals reflect 5 perspectives:

Recent performance—Recent results provide an obvious indicator or at least context

Strategic aspirations—What constitutes long-term success and what is the trend line to get there?

Long-term performance of peers (backward looking)—Long-term peer group results provide context for a reasonable and satisfactory range of goals

Analyst/investor expectations (forward looking)—Goals set so that above-target payouts are not paid when stock price could decline due to performance below expectations

Impact on value—What is anticipated impact on value and what degree of sharing in both the financial results and value creation is reasonable?


Client Example—Long-Term Term Performance of Relevant Peers

•Important to understand what are typical annual improvements in ROIC over time

•Histogram illustrates annual improvements greater than 3-4% points in ROIC are exceptional and more than 5% points in only ≈15% of observations over last 16 years

•Annual change typically lies between 1% and 2%

•More subjectively, conservative outlook for global economy suggests improvements for mature, capital intensive industries may be more difficult

Source: Auto Parts & Equipment GICS code

3

7

45

6

9

20

23

4244

47

54

33

1817

13

8 86

76

0

10

20

30

40

50

60

-10% -9% -8% -7% -6% -5% -4% -3% -2% -1% 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

Nu

mb

er

of

Ind

ust

ry G

rou

p O

bse

rvat

ion

s

Annual Percentage Point Change in Return on Invested Capital

1-Year %-Pt. Change in ROIC 1997-2012

Among companies that improve,71% lie between 0.1% and 4%


Realizable Compensation

($ thousands)

Realizable Pay/Realized Performance Alignment

25th %ile

75th %ile

Median

(50th %ile)

Performance During

Three Year Period

Avg.

Operating

Earnings

Growth

87.3%

41.3%

-18.8%

30.0%

41st %ile

Total

Shareholder

Return

5.3%

1.1%

-2.1%

-1.6%

29th %ile

Avg.

Adj. Book

Value

Growth

15.3%

13.5%

2.9%

14.1%

59th %ile

Total Comp.

$19,000

$11,000

$8,900

$12,900

60th %ile

Annual (salary + bonus)

$4,200

$2,650

$1,800

$3,800

73rd %ile

Avg.

Operating

ROE

10.5%

2.6%

53rd %ile

7.6%

7.6%


•Same three year data is also presented in the chart below, with the performance score based on an average ranking of the four metrics covered previously, and the pay score based on total realizable compensation

0%

25%

50%

75%

100%

0% 25% 50% 75% 100%

TDC

Pe

rce

nti

le

Performance (Composite of Four Metrics) Percentile

2010-2012 Composite Perf. Percentile Rank AgainstCEO Total Direct Comp. (TDC) Percentile

Performed Worse,Paid Higher

Performed Worse,Paid Lower

Performed Better,Paid Higher

Performed Better,Paid Lower

XYZ

Realizable Pay/Realized Performance Alignment


The Role of Discretion

•Where is discretion more controversial?

When it is used to override or materially modify results obtained by incentive plan formula – to the benefit of the participants

When the incentive award is substantially determined based on subjective judgment

•Where is discretion less controversial?

When expressed as a defined component of an incentive award program that is largely determined by formula

When used to modify results based on an unexpected event that was not anticipated in the goal-setting process

When payouts go down instead of up

•Some general guidelines

Determine the set of potential adjustments to incentive plan metrics in the abstract, when there are not real dollars on the line

If discretion constitutes a significant component of the executive pay program, include a robust pay-for-performance story in the proxy circular, incorporating hard data to the extent possible

Exercise discretion where there is a clear, compelling, discloseable rationale


Share Ownership and Post-Retirement Hold Periods


Introduction

Executive Share Ownership: How much is enough?

Share Retention Requirements: To retirement and beyond

“Hold until met”

Hold following:

― Retirement

― Exercise


Executive Share Ownership

How much is enough?

• Ownership requirements are increasing

• CEO median at the TSX 60 is 4.5× salary, 3× salary for next highest

How fast do you need to get there?

• 2/3 of the TSX 60 allow 5 years to achieve ownership levels

• Balance of the TSX 60 allows 3 years to achieve ownership levels

• Caution against special awards to help meet ownership levels

What counts and how is it valued?

• Shares, RSUs and DSUs count; options and PSUs generally don’t count

• Cash RSUs are a revolving door—consider ongoing vs. one-time awards when valuing

• Generally value at the higher of cost and current market value

What happens if you do not get

there

• Committee discretion

• Hold until met requirement


Retention Requirements

This is a growing practice—and is often the only consequence to not meeting requirements

No right to sell common shares—hardship exemption sometimes

Emerging practice (Financial Institutions required by regulator for compensation risk) executives must receive a portion of annual incentive in RSUs

Invest the after tax proceeds of share based awards in common

shares—aligned with CCGG principle

“Hold until met”


Post-Exercise and Post-Retirement Hold Periods

This is a hot issue with governance advocates and

proxy advisors.

CCGG--to align the interests of long-term shareholders and

management, executives hold a significant portion of their net

worth in shares while employed and ideally after cessation of

employment

ISS--superior financial performance is associated with stock ownership and retaining

ownership after exercising options and restricted shares

for a number of years or a specified time following

retirement

Ontario Teachers--ownership requirements with a minimum one-year post-retirement hold

period of equity awards.

CPPIB--Executives should be required to own that minimum

share ownership while employed and for at least one

year after

Alberta Teachers, Alberta Pension Services

Corporation, Aimco—no stated position


Post-Exercise and Post-Retirement Hold Periods

Emerging practice

• Correlation between long-term ownership and performance

• Facilitates succession

• Expect significant pressure in Canada

U.S. practice

• Shareholder proposals—37 in U.S. in 2013—all hold until retirement, 25% to 75% of shares received under equity programs

• Voluntary adoption--Exxon 50% 5year, 50% later of 10 years and retirement

• Emerging practice—bonus paid to retired CEO post-retirement for successful transition

Migration to Canada

• ¼ of TSX 60 have post-retirement hold requirements

• Generally only for the CEO, with respect to a portion of equity and for 1-2 years after retirement

• Expect practice to significantly increase over next 3 years, as focus on long term sustainability increases


Annual and Long Term Incentive Design


Spotlight on Annual Incentive Practices

Reinforce critical business goals/budgets for the year directly linked to near-term

strategy

Goal setting is subject to more in-depth review—focus on threshold and maximum

payouts (not just target) and payout curves

Annual performance metrics are increasingly different from LTI metrics

Individual/strategic performance continues to be a component for executives

― It is common to have 70% to 80% financial/operational (quantitative) and 30% to

20% individual/strategic (qualitative) performance

Meridian comment: Many committees are also giving consideration to

annual TSR results in their overall assessment of the year and determining

bonus payouts.


Spotlight on Long-Term Incentive Practices

Proxy advisory firms prefer certain LTI structures:

― Minimum 50% of LTI “performance-based” (time-vested stock options are not considered “performance-based” by ISS)

― Performance period should be 3 years; should include a mix of absolute and relative performance metrics and multiple performance metrics; but not the annual incentive metrics (viewed as adding “risk” to incentive pay plans)

― Neither ISS nor Glass Lewis mandate relative TSR, but removing a relative TSR plan is likely to draw scrutiny

Both ISS and Glass Lewis are skeptical about performance goals—compare goals to historic performance and question (i) threshold payouts for below-median relative TSR performance, and (ii) above-target payouts in relative TSR plans when absolute TSR is negative

Meridian comment: In some industries, following the ISS preferences may

not be appropriate for alignment with strategy and shareholder value creation


Trends in Annual Incentives Performance Metrics—

While there is not a single most common model in how incentive metrics are combined, a significant majority of the largest Canadian public companies use 2 or more financial performance metrics in annual incentive plans

20%

32%

20%

28%

0%

25%

50%

1 financial performancemetric

2 financial performancemetrics

3 financial performancemetrics

> 3 financial performancemetrics

Number of Financial Performance Metrics Used

S&P/TSX 60


42%

28%

10%

0%

20%

2%

35%

2%

5%

12%

18%

0% 20% 40% 60% 80%

Income (EBIT/EBITDA/Net Income)

EPS

Operating Income Margin

Net Income Margin

ROIC/ROE

Return on Assets

Free Cash Flow

Free Cash Flow Margin

Economic Value Added

Total Shareholder Return

Sales/Revenues

Most Common Annual Incentive Performance Metrics

S&P/TSX 60

Trends in Annual Incentives Performance Metrics

Cash Flow

Measures

Return

Measures

Profit

Measures

Income / earnings metrics are prevalent in the market, used by just under half of the TSX 60.

Many companies use some form of qualitative or discretionary assessment of performance in determining final payouts


Most companies are actively using 2 or more LTI vehicles for senior executive compensation in 2014

At different executive and/or salary levels, it is common to use “tiers” of LTI awards that differ both in combination and weighting of equity-based and performance-based vehicles; and, below the senior executive level, it is most common to grant just one vehicle, most often time-vested RSUs

8%

15%

62%

15%

5%

22%

57%

17%

0%

10%

20%

30%

40%

50%

60%

70%

No LTI 1 vehicle 2 vehicles 3 vehicles

Number of LTI Vehicles Used

S&P/TSX 60 2014

S&P/TSX 60 2013

Trends in Long-Term Incentives Use of Multiple LTI Vehicles


Trends in Long-Term Incentives Allocation and Mix of LTI Award Opportunity

Shareholders and proxy advisors continue to express their strong general preference that a majority of total LTI include “performance-based” LTI (i.e., contingent on financial performance); and consequently, use of multiyear performance award plans continues to grow and these now comprise the single largest portion of the total LTI opportunity for senior leadership positions

― About one-half of total LTI value is now from performance-based vehicles

23%

31%

46%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

S&P/TSX 60

RSUs Options PSUs


3%

17%

2%

2%

23%

2%

3%

48%

2%

7%

0% 10% 20% 30% 40% 50% 60%

EBIT/EBITDA

EPS

Net Income

Operating Margin

ROIC/ROC/ROE

Stock Price

TSR

Relative TSR

Revenue

Cash Flow

Most Common Financial Performance Measures for LTIPs

S&P/TSX 60

Trends in Long-Term Incentives Performance Plan Metrics

While there is not a single most common model in how TSR performance is evaluated, it continues to be the prominent metric for LTI performance plans among the largest Canadian companies


Say on Pay: Impact on Executive Compensation and Disclosure


Say on Pay: Shareholders Speak Out

•Say on Pay

Advisory vote on executive compensation

― Voluntary in Canada—don’t have to have a vote

― If have a vote it is not binding, but informative (embarrassing)

Approval rates in Canada are high, but slightly lower than the U.S.

Creating unprecedented internal and external focus on executive pay


Say on Pay: Shareholders Speak Out

Canada—Voluntary Advisory Vote

U.S.—Compulsory Advisory Vote

Europe—Potential Mandatory vote, currently compulsory advisory vote


What Good Has Come of Say on Pay?

Say on Pay

Improved Disclosure

More attention to pay for performance

Increased shareholder engagement

Fewer poor practices


Engaging with Shareholders

•Best-in-Class Circular: Cameco

Letters from the Chair describing the business results and corporate governance

Separate sections on Cameco’s approach to governance and Board duties (including succession planning and risk)

CD&A is concise, reader-friendly, graphics-heavy, and includes understandable discussion on key considerations in determining pay

Use the Circular

• Best-in-class examples invest heavily in circular organization and design

• When taking an approach that is out of step, explain why

Investor Outreach

• Regular interactions with investors on pay issues

• The Exxon Mobil example

• Proxy advisors will defer more to companies that engage with investors

Pay for Meaningful

Performance

• Multiple perspectives on “pay” – realized, realizable, hybrids

• Make sure the story is durable from year to year

• “Table stakes” for many companies


“What We Do/

What We Don’t Do”

Table

Business Results Are Put In Context

CEO Pay in Realized/Realizable Terms

Graphical

Depiction of

Annual and

Long-Term

Plan

Mechanics

Engaging with Shareholders The Cameco Circular


Engaging with Shareholders What’s trending upward

CD&A Disclosure Length

• Word count increased by 18% over the last 5 years (Equilar)

What We Do/What We Don’t Do Tables

• Overlaps with proxy advisor “problematic pay practices”

Supplemental Methods of Calculating Compensation

• Not a lot of movement until 2012, but substantial use of realized/realizable pay since then

Pay for Performance References

• 81% of companies in 2013, up from 59% in 2009 (Equilar)

Increasing Investor Engagement

• Disclosed outreach efforts, more references to proxy advisory firms


Canadian 2014 Say on Pay Voting Results to Date

2014 proxy voting season results for Canadian public companies are similar to 2013 results

156 Canadian companies now have voluntarily adopted Say on Pay voting*

Canadian companies have received average Say on Pay support of 92.08% and median support of 95.3% through September 16th, 2014)

― Cameco’s 2014 Say on Pay advisory resolution received 92.16% support

ISS has recommended a vote “against” Say on Pay at 4.03% of Canadian companies (based on vote recommendations through Sept. 16), compared to 6.8% for all of 2013

Shareholder support has been 18.03% lower, on average, for those companies with ISS “against” vote recommendations, compared to 30.8% for 2013

• * Based on statistics provided by SHARE (Shareholder Association for Research and Education)

No Canadian companies

with say on pay have failed

to pass their 2014 Say on

Pay resolution

18.75%

81.25%

15.38%

84.62%

1.49% 2.13%

21.28%

74.47%

4.35%

28.26%

67.39%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Less than 50% 50% < 70% 70% < 90% 90% +

Level of Shareholder Support for Say on Pay Proposals

Among S&P/TSX 60 Companies

▮ n = 32 (2011)

▮ n = 39 (2012)

▮ n = 47 (2013)

▮ n = 48 (2014)


2014 Say on Pay Voting Results to Date

•This year’s Say on Pay voting season results are similar to 2013 results

S&P 500 companies* have received average Say on Pay support of 91.9% and median support of 95.6%

ISS has recommended a vote “against” Say on Pay at 8.7% of companies assessed to date, compared to 10.3% last year

Shareholder support has been, on average, 27.6% lower at companies with ISS “against” vote recommendations, down from a 3 year average of 32.5%

1.7%

8.5%

25.2%

64.6%

2.6%

8.0%

18.3%

71.1%

1.5% 6.2%

15.7%

76.6%

1.2% 4.3%

15.6%

79.1%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Less than 50% 50% < 70% 70% < 90% 90% +

Level of Shareholder Support for Say on Pay Proposals

Among S&P 500 Companies

▮ n = 480 (2011)

▮ n = 464 (2012)

▮ n = 470 (2013)

▮ n = 436 (2014)

Five S&P 500

companies have

failed Say on Pay:

• Chipotle

• Expeditors Int’l

• Hasbro

• Nabors

Industries

• Staples

Documents

Financial Executives Institute October, 2014 Executive ... · Pay at risk can be evaluated based on grant/opportunity values of compensation, as well as based on realizable/realized