One of the most important ingredients when designing short- and long-term incentives is determining the right plan metrics that make the most sense for your business. Think of it as adding salt to a recipe — without it, you’d be left with something bland and, frankly, not as rewarding.
Now that you’re hungry (for metrics), here’s a snapshot of how your peers are leveraging metrics, and we’ve even broken it down by industry. For this piece, we’re using the CG Pro database, our comprehensive database of proxy filings from the Russell 3000 and their peers to examine the usage of short-term and long-term performance metrics among S&P 1500 companies.
Different Types of Metrics/Measures Used By Companies
We’ve divided the types of metrics into seven broad categories: balance sheet measures, cash flow measures, income statement measures, profit measures, return measures, stock price, and miscellaneous measures. First, let’s look at short-term incentives.
We looked at the number of metrics used across various industries and sub-industries. You’ll notice in Figure 1 below that the average number of metrics used by S&P 1500 companies is 3.6, with companies in the Energy (4.7) and Utility (4.9) industries using the most, and Retail (2.7) using the fewest.
More than half of Energy and Utility companies use five or more metrics in their short-term incentive plan. Almost all the industries use multiple measures; however, 29% of the Retail industry companies use only one metric.
Looking at company size, large companies, defined as the S&P 500, generally use more measures than mid-sized (S&P 400) or smaller companies (S&P 600). On average, companies in the S&P 500 use 4.1 metrics whereas companies in the S&P 400 indices use 3.6 metrics in their short-term incentive plan and S&P 600 companies use 3.2 metrics.
Although there is wide variance in the metrics used by companies in their short-term incentive plans, profit measures (EPS, net income, etc.) are the most common in all industries except Energy, where cash flow measures are most common. Income statement measures (predominately revenue, but also inclusive of expense measures) is next most common followed by cash flow measures. Balance sheet and stock price related measures are uncommon in short-term incentive plans.
There are some significant industry differences as well beyond the use of cash flow measures in the Energy industry. Banks and Insurance companies are significantly more likely to use return measures (e.g., ROE and ROA) than other industries. Conversely, they are less likely to use cash flow measures. Utilities are the most frequent users of profitability measures. Banks are the least likely to use income statement measures.
Individual performance is used by 43% of the companies, but less often among Retailers and more often among Diversified Financials and Banks.
Safety is used by 9% of companies, but by a majority of Utility (63%) and Energy (59%) companies.
In general, large companies tend to use more metrics than mid-sized and smaller companies. Now, let’s do a deep dive of metrics used for long-term incentives.
The number of metrics used in long-term incentive plans (average of 2.1 metrics) is lower than in short-term incentive plans (average of 3.6 metrics).
Across all industries, except Energy, the most common design uses two metrics. One-half of Energy companies, and roughly one-third of all companies, use a single measure and it’s typically relative Total Shareholder Return (rTSR). On the other end of the spectrum, utility companies are more likely to use five or more metrics.
Large companies are more likely to use 3 or 4 metrics compared to mid-sized and smaller companies who typically use one or two measures in their long-term incentive plans.
The popularity of stock price-based measures, in particular relative Total Shareholder Return, can be seen in the table below. A majority of companies (56%) report using a stock price-based measure in their long-term incentive plan. Among Utility (96%) and Energy (88%) companies the use is almost universal. Conversely, use among Retail companies is much lower than average (23%).
However, despite its popularity, stock price is not always the most common measure in every industry. Both Retailers and Fast Moving Consumer Goods (FMCG) companies use a profit measure most often. FMCG companies are also more likely to use an income statement measure (e.g., revenue) than other companies. Banks (74%) and Insurance (44%) companies are more likely to use Return measures than other companies. Even with the increase in popularity of Return measures over the last few years, it still is only the third most popular (31%) metric category after Stock Price and Profit measures.
Metrics usage is relatively similar across company size. Large companies are slightly more likely to use Profit and Stock Price measures compared to smaller companies.
A Final Word
When determining the right metrics for your incentive plans, the most important consideration is looking at the unique circumstances of your own business and industry and choosing measures that support your business strategy. Using an industry peer group to benchmark your incentive plan provides an internal perspective on what your peers are doing.
We used Aon’s Compensation and Governance Pro tool to conduct this analysis, and you can too. CG Pro provides a portfolio of tools to review peer metrics and their usage, include our Pay and Performance Curves reports. If you have any questions for our executive compensation experts or would like to know how Aon and CG Pro can help your organization design better incentive plans, please contact us.