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ADVANCING EXEMPLARY BOARD LEADERSHIP
The Realities of Pay-for-Performance
Alignment in 2014
Compensation Series
August 7, 2014
2
Meet The Presenters
Ryan Compaan
Vice President, Pearl Meyer & Partners
Martin Coyne (moderator)
Director, Akamai and RockTech
Simon Patterson
Managing Director, Patterson Associates, a Pearl Meyer & Partners
Practice
3
Click the buttons below to access additional resources
Housekeeping
4
Housekeeping
Click below for a copy of the slides.
Slides are also available at pearlmeyer.com/PFPUKUS
5
You will automatically receive 1 NACD skill-specific
credit for your participation.
Credit may be applied to NACD Fellowship
programs. Contact Fellowships@NACDonline.org
for more details.
The replay and slides will also be available early
next week at NACDonline.org/webinars and
pearlmeyer.com
Housekeeping
Pay for performance in the news
In the UK
6
Barclays boss Antony Jenkins:
‘We pay for performance’
Gap widens between UK
executive pay and results
Extravagant CEO pay doesn’t reflect
performance – it’s all about status
…and in the US
7
‘Pay for Performance’ No Longer a Punchline
Shift Highlights Growing Role of Investors in Shaping Compensation
Pay for Performance? It Depends on the Measuring Stick
Misleading CEO Pay-for-Performance
Numbers Target of SEC
‘Atlantic gap opens in bank chiefs pay’
8
“If one banker epitomises the new period of modesty among
European lenders, it is Ross McEwan. Last year, the New
Zealand-born chief executive of Royal Bank of Scotland
received a fifth of an almost $20m pay package earned by
Lloyd Blankfein, his counterpart at Goldman Sachs.”
The New York Times published its
annual league table of chief executive
pay at the US’s top 100 publicly quoted
companies in April.
The average has now climbed to $13.9m (£8.3m)
That is nearly twice the average of £4.4m for CEOs within Britain's top 100
America's top 100 companies however are, on average, around three times
larger in terms of turnover than Britain’s
A KPMG survey found…
• A majority of FTSE 350 companies are paying
CEOs at least 60% of their maximum
allowable bonus
• This comes despite a quarter of companies
reporting a fall in profits.
• One third of companies paid their CEO a bonus of
80% of the maximum value
• Only 10% of FTSE 100 and 7% of FTSE 250
CEOs did not receive a bonus in 2013
9Source: KPMG’s Guide to Directors’ Remuneration 2013, Nov 2013
Recent studies even ask: is high pay inversely
related to performance?
• The US study found excess CEO pay is negatively related to future stock
returns
• Firms that paid their CEOs in the top 10% of “excess pay” earned negative abnormal
returns over the next three years of approximately -8%
• Stock options most negative result
• Hypothesis
• Effect stronger for CEOs who receive high incentive pay relative to peers
• Study suggests overconfident CEOs accept large amounts of incentive pay and
consequently engage in value destroying activities that translate into future reductions
in returns and firm performance
10
Source: Performance for pay? The relation between CEO incentive compensation and future stock price performance,
Jan 2013, by MICHAEL J. COOPER, University of Utah, HUSEYIN GULEN, Purdue University, & P. RAGHAVENDRA RAU, University of Cambridge.
Data: Execucomp, S&P1500,1994-2011. ‘Excess incentive pay’ is defined as payment of restricted stock, options and other forms of long-term
compensation in excess of the median pay to peer firms in the same industry and size group.
Does the use of restricted stock, options and long-term incentive payouts
necessarily translate into higher future returns for shareholders? A University
of Utah study thinks not...
US Proxy Season Trends
• 2014 Say on Pay results were very similar to 2013:
• Continued scrutiny of “red flag” pay practices:
• Lack of alignment between performance and pay
• CIC Excise Tax Gross ups
• Single-trigger equity vesting
• Increasing focus on pay-performance relationships:
• Emphasis on performance share plans (vs. restricted stock or stock options)
• Gradual reduction in max payouts (200%  150%  125%; more prevalent in
some regulated industries [e.g., banking])
• Scrutiny of disclosure of the difficulty of performance goals
• Review of rTSR plans under negative TSR situations
11
% “passing” Average “for” Failures
2014 98.1% 90.3% 55 (1.9%)
2013 97.9% 91.2% 56 (2.1%)
Key Themes and Emerging Issues
In both the UK and US, “Pay-for-Performance” is ubiquitous. Almost all
companies espouse a pay for performance philosophy.
Most companies are now able to demonstrate that pay is aligned with
performance.
However, the next generation of P4P is addressing more difficult issues:
• Are we paying for the right performance?
• Are we paying for the right amount of performance?
• Are we delivering the right amount of pay for the right amount of
performance?
12
How should performance be defined?
Performance can be defined using numerous measures, against various
standards, and over an infinite number of time periods
Performance evaluation is highly dependent upon context, and can be:
• Financial
• Strategic
• Operational
• Qualitative or quantitative
• Measured in shareholder returns
• Evaluated relative to absolute goals or relative to peers or an index
13
Key stakeholders define performance using different
measures, standards and time frames
14
Stakeholder Measure Standard Timeframe
Wall St. Analysts/
Institutional
Investors
EPS Consensus
expectations
Quarterly/
Annual
Institutional
Shareholder
Services (ISS)
Total Shareholder
Return (TSR)
ISS peer group Three years
(also 5-yr for
Pay-TSR test)
Company
Employees
Key operating measures
(product quality, volume,
customer retention, etc.)
Prior year
and/or internal
budget goals
Annual
PM&P TSR + relevant financial
measures
Peer group 1-year, 3-year
and 5-year
UK CEO Value
Index
Shareholder Value
Added
Index or Peers 4 years
UK CEO Value Index measures performance
based on value added to shareholders
15
Total value added to shareholders is calculated as:
This measures performance from a shareholder perspective
Change in
share price
Dividends paid
Share
buybacks
Total value
added to
shareholders
CEO Value Index
Value Added over 4 years
Total Direct Compensation over 4
years
=
The UK CEO Value Index is a simple ‘rule-of-thumb’ to guide remuneration
decision-making. The Index calculates the value added to shareholders
per pound of compensation paid to the CEO over a four year period
UK CEO Value Index FTSE 100
Total Value Added vs. Total Remuneration
16
R² = 0.1785
£0
£5,000,000
£10,000,000
£15,000,000
£20,000,000
£25,000,000
£30,000,000
£35,000,000
£40,000,000
-£10,000 £0 £10,000 £20,000 £30,000 £40,000 £50,000 £60,000 £70,000 £80,000
TotalRemuneration
Total Value Added (millions)
Total Value Added vs. Total Remuneration
FTSE 100, 2009 to 2013
There are a number of companies who
continue to pay a significant amount
for minimal performance
Just 10% of FTSE 350 companies achieved
Indexes above £1,000
• Analysed 243 companies out of the FTSE 350 (including 7 that lost value)
• Companies ranked by their Index score
17
No. companies Index score range Median Index score
Top 10% 24 above £1,000 £1,735
Middle 10% 24 £186 to £246 £205
Bottom 10% 24 £31*
* Of those that added value
£0
£1,000
£2,000
£3,000
£4,000
£5,000
£6,000
£7,000
£8,000
0 50 100 150 200 250
UKCEOValueIndex
Ranking
UK CEO Value Index Rankings
Value added
Value lost
Top
10%
Middle
10%
Bottom
10%
LTI payouts are greatest for top performers
• Top 10% have the highest salary, bonus and LTI payments
• Median salary: higher for the bottom 10% than the middle 10%
• Middle 10% typically twice the market cap of the bottom 10%
• Size and pay relationship has broken down here
18
Top Middle Bottom Top Middle Bottom Top Middle Bottom
Upper Quartile £4,582,000 £2,482,842 £2,985,250 £4,037,583 £2,473,501 £2,675,750 £7,441,027 £2,888,699 £731,066
Median £4,049,299 £2,027,000 £2,580,000 £2,736,264 £1,550,000 £1,246,859 £2,151,707 £1,535,283 £331,986
Lower Quartile £3,612,000 £1,669,608 £1,905,750 £900,058 £756,800 £696,488 £0 £361,236 £0
£0
£1,000,000
£2,000,000
£3,000,000
£4,000,000
£5,000,000
£6,000,000
£7,000,000
£8,000,000
Remuneration breakdown for Top, Middle & Bottom ranked Index performers
Salary Bonus LTI
Upper quartile
Median
Lower quartile
Things to remember
• The pay governance debate is global, and the US can learn from
experience internationally
• Much of the world has settled on Total Shareholder Returns (TSR) as a
measure with which to calibrate pay, but a single measure of performance
may not be sufficient for a robust pay-for-performance relationship.
• Framing CEO pay in the context of overall value created allows more
meaningful discussions of pay philosophy and incentive design
• Analysis of pay relative to value of peers helps provide additional insights
into reasonableness of CEO pay...
• ...as does prospective testing. What does a ‘market’ pay package require in
terms of incremental value, to be justified?
19
So what should Compensation Committees do
differently?
• Ensure incentive programs are designed to support unique company
business strategy, not necessarily what is prevalent or “best practice”
• Disclose the “why’s” in addition to the “what’s”
• Understand how your CEO pay compares to everything, to anticipate potential issues
• Invest additional time in discussions of “performance” in Pay-for-
Performance relationships
• Focus on right measure of performance
• Focus on degree of difficulty of performance goals and calibration of payouts
• Proactively respond to potential threats to stronger alignment of pay and
performance
• CEO pay ratio disclosure may be catalyst for deleveraging executive incentive
programs
• Modifiers to LTI programs for “negative TSR” situations may disrupt strong pay-for-
performance relationships
• Caps on LTI payouts – particularly in regulated industries – skew P4P relationships
20
ADVANCING EXEMPLARY BOARD LEADERSHIP
Questions
Don’t Miss Our Upcoming Webinar
Join NACD and Pearl Meyer & Partners for the next program in
our Compensation Series
November 18, 2014
2:00 pm ET
Compliance & Communication: The Dynamic Duo of Disclosure
To register or check out the archives of earlier webinars in this
series, visit NACDonline.org/webinars.
22
23
If you have any questions regarding NACD credit or the
Fellowship programs, please contact:
Meghan Metzbower, Senior Board Services Manager
Phone: (202) 803-6764
Email: Fellowships@NACDonline.org
To learn more about NACD Fellowships, visit us at
NACDonline.org/Fellowships.
NACD Credit and Fellowship Information
ADVANCING EXEMPLARY BOARD LEADERSHIP
Thank You

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The Realities of Pay Performance for Alignment in 2014

  • 1. ADVANCING EXEMPLARY BOARD LEADERSHIP The Realities of Pay-for-Performance Alignment in 2014 Compensation Series August 7, 2014
  • 2. 2 Meet The Presenters Ryan Compaan Vice President, Pearl Meyer & Partners Martin Coyne (moderator) Director, Akamai and RockTech Simon Patterson Managing Director, Patterson Associates, a Pearl Meyer & Partners Practice
  • 3. 3 Click the buttons below to access additional resources Housekeeping
  • 4. 4 Housekeeping Click below for a copy of the slides. Slides are also available at pearlmeyer.com/PFPUKUS
  • 5. 5 You will automatically receive 1 NACD skill-specific credit for your participation. Credit may be applied to NACD Fellowship programs. Contact Fellowships@NACDonline.org for more details. The replay and slides will also be available early next week at NACDonline.org/webinars and pearlmeyer.com Housekeeping
  • 6. Pay for performance in the news In the UK 6 Barclays boss Antony Jenkins: ‘We pay for performance’ Gap widens between UK executive pay and results Extravagant CEO pay doesn’t reflect performance – it’s all about status
  • 7. …and in the US 7 ‘Pay for Performance’ No Longer a Punchline Shift Highlights Growing Role of Investors in Shaping Compensation Pay for Performance? It Depends on the Measuring Stick Misleading CEO Pay-for-Performance Numbers Target of SEC
  • 8. ‘Atlantic gap opens in bank chiefs pay’ 8 “If one banker epitomises the new period of modesty among European lenders, it is Ross McEwan. Last year, the New Zealand-born chief executive of Royal Bank of Scotland received a fifth of an almost $20m pay package earned by Lloyd Blankfein, his counterpart at Goldman Sachs.” The New York Times published its annual league table of chief executive pay at the US’s top 100 publicly quoted companies in April. The average has now climbed to $13.9m (£8.3m) That is nearly twice the average of £4.4m for CEOs within Britain's top 100 America's top 100 companies however are, on average, around three times larger in terms of turnover than Britain’s
  • 9. A KPMG survey found… • A majority of FTSE 350 companies are paying CEOs at least 60% of their maximum allowable bonus • This comes despite a quarter of companies reporting a fall in profits. • One third of companies paid their CEO a bonus of 80% of the maximum value • Only 10% of FTSE 100 and 7% of FTSE 250 CEOs did not receive a bonus in 2013 9Source: KPMG’s Guide to Directors’ Remuneration 2013, Nov 2013
  • 10. Recent studies even ask: is high pay inversely related to performance? • The US study found excess CEO pay is negatively related to future stock returns • Firms that paid their CEOs in the top 10% of “excess pay” earned negative abnormal returns over the next three years of approximately -8% • Stock options most negative result • Hypothesis • Effect stronger for CEOs who receive high incentive pay relative to peers • Study suggests overconfident CEOs accept large amounts of incentive pay and consequently engage in value destroying activities that translate into future reductions in returns and firm performance 10 Source: Performance for pay? The relation between CEO incentive compensation and future stock price performance, Jan 2013, by MICHAEL J. COOPER, University of Utah, HUSEYIN GULEN, Purdue University, & P. RAGHAVENDRA RAU, University of Cambridge. Data: Execucomp, S&P1500,1994-2011. ‘Excess incentive pay’ is defined as payment of restricted stock, options and other forms of long-term compensation in excess of the median pay to peer firms in the same industry and size group. Does the use of restricted stock, options and long-term incentive payouts necessarily translate into higher future returns for shareholders? A University of Utah study thinks not...
  • 11. US Proxy Season Trends • 2014 Say on Pay results were very similar to 2013: • Continued scrutiny of “red flag” pay practices: • Lack of alignment between performance and pay • CIC Excise Tax Gross ups • Single-trigger equity vesting • Increasing focus on pay-performance relationships: • Emphasis on performance share plans (vs. restricted stock or stock options) • Gradual reduction in max payouts (200%  150%  125%; more prevalent in some regulated industries [e.g., banking]) • Scrutiny of disclosure of the difficulty of performance goals • Review of rTSR plans under negative TSR situations 11 % “passing” Average “for” Failures 2014 98.1% 90.3% 55 (1.9%) 2013 97.9% 91.2% 56 (2.1%)
  • 12. Key Themes and Emerging Issues In both the UK and US, “Pay-for-Performance” is ubiquitous. Almost all companies espouse a pay for performance philosophy. Most companies are now able to demonstrate that pay is aligned with performance. However, the next generation of P4P is addressing more difficult issues: • Are we paying for the right performance? • Are we paying for the right amount of performance? • Are we delivering the right amount of pay for the right amount of performance? 12
  • 13. How should performance be defined? Performance can be defined using numerous measures, against various standards, and over an infinite number of time periods Performance evaluation is highly dependent upon context, and can be: • Financial • Strategic • Operational • Qualitative or quantitative • Measured in shareholder returns • Evaluated relative to absolute goals or relative to peers or an index 13
  • 14. Key stakeholders define performance using different measures, standards and time frames 14 Stakeholder Measure Standard Timeframe Wall St. Analysts/ Institutional Investors EPS Consensus expectations Quarterly/ Annual Institutional Shareholder Services (ISS) Total Shareholder Return (TSR) ISS peer group Three years (also 5-yr for Pay-TSR test) Company Employees Key operating measures (product quality, volume, customer retention, etc.) Prior year and/or internal budget goals Annual PM&P TSR + relevant financial measures Peer group 1-year, 3-year and 5-year UK CEO Value Index Shareholder Value Added Index or Peers 4 years
  • 15. UK CEO Value Index measures performance based on value added to shareholders 15 Total value added to shareholders is calculated as: This measures performance from a shareholder perspective Change in share price Dividends paid Share buybacks Total value added to shareholders CEO Value Index Value Added over 4 years Total Direct Compensation over 4 years = The UK CEO Value Index is a simple ‘rule-of-thumb’ to guide remuneration decision-making. The Index calculates the value added to shareholders per pound of compensation paid to the CEO over a four year period
  • 16. UK CEO Value Index FTSE 100 Total Value Added vs. Total Remuneration 16 R² = 0.1785 £0 £5,000,000 £10,000,000 £15,000,000 £20,000,000 £25,000,000 £30,000,000 £35,000,000 £40,000,000 -£10,000 £0 £10,000 £20,000 £30,000 £40,000 £50,000 £60,000 £70,000 £80,000 TotalRemuneration Total Value Added (millions) Total Value Added vs. Total Remuneration FTSE 100, 2009 to 2013 There are a number of companies who continue to pay a significant amount for minimal performance
  • 17. Just 10% of FTSE 350 companies achieved Indexes above £1,000 • Analysed 243 companies out of the FTSE 350 (including 7 that lost value) • Companies ranked by their Index score 17 No. companies Index score range Median Index score Top 10% 24 above £1,000 £1,735 Middle 10% 24 £186 to £246 £205 Bottom 10% 24 £31* * Of those that added value £0 £1,000 £2,000 £3,000 £4,000 £5,000 £6,000 £7,000 £8,000 0 50 100 150 200 250 UKCEOValueIndex Ranking UK CEO Value Index Rankings Value added Value lost Top 10% Middle 10% Bottom 10%
  • 18. LTI payouts are greatest for top performers • Top 10% have the highest salary, bonus and LTI payments • Median salary: higher for the bottom 10% than the middle 10% • Middle 10% typically twice the market cap of the bottom 10% • Size and pay relationship has broken down here 18 Top Middle Bottom Top Middle Bottom Top Middle Bottom Upper Quartile £4,582,000 £2,482,842 £2,985,250 £4,037,583 £2,473,501 £2,675,750 £7,441,027 £2,888,699 £731,066 Median £4,049,299 £2,027,000 £2,580,000 £2,736,264 £1,550,000 £1,246,859 £2,151,707 £1,535,283 £331,986 Lower Quartile £3,612,000 £1,669,608 £1,905,750 £900,058 £756,800 £696,488 £0 £361,236 £0 £0 £1,000,000 £2,000,000 £3,000,000 £4,000,000 £5,000,000 £6,000,000 £7,000,000 £8,000,000 Remuneration breakdown for Top, Middle & Bottom ranked Index performers Salary Bonus LTI Upper quartile Median Lower quartile
  • 19. Things to remember • The pay governance debate is global, and the US can learn from experience internationally • Much of the world has settled on Total Shareholder Returns (TSR) as a measure with which to calibrate pay, but a single measure of performance may not be sufficient for a robust pay-for-performance relationship. • Framing CEO pay in the context of overall value created allows more meaningful discussions of pay philosophy and incentive design • Analysis of pay relative to value of peers helps provide additional insights into reasonableness of CEO pay... • ...as does prospective testing. What does a ‘market’ pay package require in terms of incremental value, to be justified? 19
  • 20. So what should Compensation Committees do differently? • Ensure incentive programs are designed to support unique company business strategy, not necessarily what is prevalent or “best practice” • Disclose the “why’s” in addition to the “what’s” • Understand how your CEO pay compares to everything, to anticipate potential issues • Invest additional time in discussions of “performance” in Pay-for- Performance relationships • Focus on right measure of performance • Focus on degree of difficulty of performance goals and calibration of payouts • Proactively respond to potential threats to stronger alignment of pay and performance • CEO pay ratio disclosure may be catalyst for deleveraging executive incentive programs • Modifiers to LTI programs for “negative TSR” situations may disrupt strong pay-for- performance relationships • Caps on LTI payouts – particularly in regulated industries – skew P4P relationships 20
  • 21. ADVANCING EXEMPLARY BOARD LEADERSHIP Questions
  • 22. Don’t Miss Our Upcoming Webinar Join NACD and Pearl Meyer & Partners for the next program in our Compensation Series November 18, 2014 2:00 pm ET Compliance & Communication: The Dynamic Duo of Disclosure To register or check out the archives of earlier webinars in this series, visit NACDonline.org/webinars. 22
  • 23. 23 If you have any questions regarding NACD credit or the Fellowship programs, please contact: Meghan Metzbower, Senior Board Services Manager Phone: (202) 803-6764 Email: Fellowships@NACDonline.org To learn more about NACD Fellowships, visit us at NACDonline.org/Fellowships. NACD Credit and Fellowship Information
  • 24. ADVANCING EXEMPLARY BOARD LEADERSHIP Thank You