Simplify Executive Compensation With Must-Know Insights on Incentive Plan Design

December 6, 2018 Scott Allen and Michael Garcia

As companies begin to develop incentive plan performance targets and ranges for the next cycle, it is important to recognize that aligning incentive plan payouts with a range of performance measures requires extensive and thoughtful analysis. As part of the preparation, it is helpful to assess how your company’s performance range (i.e., threshold, target, maximum) compares with that of similar industries and peers, in addition to the broader market.

To understand the ranges around incentive plan performance targets and payouts, we analyzed the disclosure of these levels for all companies in the S&P 500. This analysis was conducted using Aon’s Compensation and Governance Professional (CG Pro) database, a comprehensive database of proxy filings from the Russell 3000.

We categorized all companies in the S&P 500 by 11 industries based on the Global Industry Classification Standard (GICS) and researched the performance and payout levels as a percentage of target for threshold and maximum levels disclosed in companies’ annual incentive plans using CG Pro’s Pay and Performance Curve reports. The metrics, performance ranges and payouts are based on the annual and long-term incentive plans for each company’s CEO. For all companies’ CEO plans, we also reviewed the actual bonus as a percentage of target for companies disclosing a payout.

The performance and payout ranges are based on the median range disclosed for all metrics. It should be noted that it is typical for incentive plans to have more than one metric in either incentive plan. Short-term incentive plans may have one to two metrics, while long-term incentive plans tend to have more than two metrics. Further delineation of performance and payout ranges can be established for each individual metric to evaluate the differences in performance ranges across metrics. CG Pro can report on the overall plan as well as any performance and payout range by each metric as disclosed in companies’ proxy statements.

Short-Term Incentive Performance and Payout Ranges

Based on median results for the full S&P 500 (primarily fiscal year 2017), the median actual performance as a percentage of target is 102%, with a threshold of 89% of target to a maximum of 110% of target. For the incentive payouts, the median actual as a percentage of target bonus is 120%. The median payout range has a threshold of 30% of target bonus to a maximum of 200% of target bonus.

Overall, actual payouts as a percentage of target performance levels are aligned. The financials sector has the highest actual as a percentage of target performance of 105%. For this same sector, the actual payout as a percentage of target bonus of 131%, which is the second-highest payout level across the sectors. The consumer staples sector has the lowest actual as a percentage of target performance of 100%, while the actual as a percentage of target payout is 103%, which is the lowest level across the sectors. 

The financials, energy and communication services sectors have the widest performance ranges, while the utilities and real estate sectors have the narrowest performance ranges.

The energy, industrials, consumer discretionary and consumer staples sectors have the widest payout ranges while the financials, utilities, real estate and health care sectors have the narrowest payout ranges.

Long-Term Incentive Performance and Payout Ranges

For the full S&P 500, the median actual long-term incentive performance as a percentage of target is 103%, with a threshold of 67% of target to a maximum of 136% of target. For the payout levels, the median actual as a percentage of target long-term incentive is 119%. The median payout range has a threshold of 38% of target to a maximum of 200% of target.

As with short-term incentives, actual performance as a percentage of target is closely aligned with payout levels. The materials sector has the highest level of actual as a percentage of target performance of 117% and the actual as a percentage of target long-term incentive is 163%, which is the second-highest level across sectors. The real estate sector has the lowest level of actual as a percentage of target performance of 90%, with an actual as a percentage of target long-term incentive payout of 106%, which is the third-lowest payout across the sectors. 

The financial, energy and real estate sectors have the widest performance ranges, while the information technology, consumer discretionary and health care sectors have the narrowest performance ranges.

The materials, consumer staples, energy and utilities sectors have the widest payout ranges, while the financials, information technology, communication services and real estate sectors have the narrowest payout ranges.

Implications

Overall, performance are above target levels, with very few sectors producing below-target levels.

The performance ranges across industry sectors exhibit varying amounts of stretch. The size of the range from threshold to maximum is highly dependent on several key factors, including industry sector, business life cycle and the types of performance metrics used. For establishing company-specific incentive plan performance targets, several approaches can be used to supplement the budget and planning process. While these approaches range from simple to complex, companies should ensure that a rigorous process for target-setting is employed that balances the right amount internal vs. external perspectives.

Reviewing industry and peer performance and payout ranges is an important step in understanding threshold and maximum levels. With Aon’s CG Pro, a variety of tools to analyze pay and performance curves are available to conduct this review and provide key insights from a market perspective. The detail this database provides in terms of capturing the full threshold, target and maximum performance and payout levels by metric allows us to focus more on the added complexities in the design and development of pay and performance curves.

Next Steps

Two critical incentive plan design steps are metric selection and leverage. Whether it’s a short-term or long-term incentive plan, we often look to understand what metrics our peers are using and where they are setting threshold and maximum for those metrics. Historically, this has been a time-consuming manual process that requires hours of digging through proxy filings, but the CG Pro suite of tools can help you accomplish this faster.

The CG Pro Pay and Performance Curve reports collect the metrics used in the incentive plans, the metric goals at threshold, target and maximum, the actual metric performance, payout opportunities at threshold, target and maximum and actual payouts. Information can be looked at for the plan or by individual metric.

Do you have specific questions for our executive compensation experts? Contact us now to understand how CG Pro can meet your compensation and governance needs and to see a pay and performance curves demo for yourself.

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