making pay for performance work - willis towers watson€¦ · · 2013-10-03making pay for...
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Making pay for performance work
Towers Watson’s Autumn Conference
Short-Term Incentives
Alasdair Wood & Beth Powell 3 October 2013
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Why do short-term incentives exist?
The number of reasons
and importance of each
reason will vary by
company, and even
employees group, based
on variables such as:
• Company philosophy
and values
• Employee / union
perspectives
• Impact of marginal
increases in
individual effort on
business
performance
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To tie people costs to affordability/profits
To share in business success / foster sense of
inclusion
To focus employees on specific goals and behaviours
To motivate employees to perform better in order to
receive higher pay
To provide fair levels of pay reflecting an employee’s
individual contributions
To attract high-performing individuals to the
organisation
And therefore – to be market competitive in terms of
structure of pay
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The premise behind short-term incentives
Short-Term Incentives
Increase in Discretionary
Effort
Increase in Business Results
Expectancy Theory
An increase in effort will lead to attainment of desired performance which
leads to receipt of fair reward that is valued by the recipient
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Question for Group
Do short-term incentives motivate your employees to
perform better?
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Why are short-term incentives still important when long-term
business success is the key objective?
Although most industries operate according to a long-term business
strategy, short-term incentives are still critical because:
It is easier to set annual targets and objectives than multi-year ones
It is easier to measure annual performance than multi-year
performance
Employees rely on receiving regular payments for personal
budgeting purposes
The decisions that most employees make most of the time impact
business performance within a one-year timeframe (exceptions
include executives and planning department)
Employees may not be in same position or even with same
employer over multi-year period
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
The latest trends in Short-term Incentives
of performance or a
discretionary
performance
threshold are the two
most common
scenarios
are the same for most
organisation-wide plans but
more differentiated in other
plan types
of companies award
payment in cash and
only 8% defer the
award
represent the
median percentages
of target that a low
and high performer
typically receive
respectively
Profit is the most commonly used
metric used to determine
bonus pay-out levels for tiered
and organisational wide plans,
and individual performance
rating from the Performance
Appraisal system for individual
incentive plans
Individual award payments
A threshold
of 70% –
80% 94%
0% and
150% 1/3
The incentive
pool
is typically determined using
financial and non-financial
methods for tiered plans, pure
financial results for
organisational wide plans and
for individual incentive plans
have a budgeted approach
using a sum of targets
of companies have
introduced new plans and
have the same focus for
the coming 2 to 3 years
of companies only pay
someone a bonus if they
are in employment on the
date the bonus is paid
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Eligibility • Who should be
eligible?
• Segmentation
Performance criteria
Pay-out
Payout schedule
Deferred
Cash/shares
Performance
measurement
Target setting
Absolute/relative
Time period (LTI)
Link and weights
Targets
weighting
Additive/
multiplicative
Quantum
Minimum
Maximum
Target
Calibration
Payout curve
Link to
performance
levels
Funding Budgeted
amounts
Profit share
Funding above
a minimum
return
Design parameters to consider in incentive plans
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Financial
Non-financial
Group, BU,
individual
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Potential combinations
Design Decisions Some alternatives
Participation 1. Executives Only
2. Executives & Mid-Managers
3. All Employees
Performance Criteria 1. Group Sales
2. Group Profit
3. Business Unit financials
4. Milestone achievements
5. Individual Behaviours
Performance Measurement 1. Relative to peers
2. Relative to budget
Links & weights 1. Additive
2. Multiplicative
3. Matrix
Quantum 1. Market aligned
2. Based on funding pool
3. Same for all
Calibration 1. Market aligned
2. Based on funding pool
3. Same for all
Funding 1. Sum of targets
2. Based on profit pool
Pay-out 1. Quarterly
2. Annual Cash award
3. Shares
4. Deferred cash
= 6,480 potential
STI designs!
x
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3
5
2
3
3
3
2
4
x
x
x
x
x
x
Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Eligibility
Manual / Clerical Staff
Professionals
Managers
Executives
Tiered
incentive
plans
most
common Most likely to be
segmented by function,
e.g. sales, critical roles
Most likely to use a Group-
based performance measure
and have a portion deferred
into shares
Most likely to have team
bonuses (but still only
used by c. 15%
companies)
Most likely to use an
Individual-based
performance measure
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Leaders
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Question for Group
Has your company made any changes to eligibility
levels in the last five years?
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Eligibility • Who should be
eligible?
• Segmentation
Performance criteria
Pay-out
Payout schedule
Deferred
Cash/shares
Performance
measurement
Target setting
Absolute/relative
Time period (LTI)
Link and weights
Targets
weighting
Additive/
multiplicative
Quantum
Minimum
Maximum
Target
Calibration
Payout curve
Link to
performance
levels
Funding Budgeted
amounts
Profit share
Funding above
a minimum
return
Design parameters to consider in incentive plans
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Financial
Non-financial
Group, BU,
individual
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Short-term incentive plan funding can be ‘top down’…
Company performance
Budget / on target
£X
Stretch
£Y
e.g. pool = 3%
of operating
profit
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… or bottom up…
Employee group Number of
employees Average salary Target STI (%) Target STI (£)
A 10 £300,000 60% £1,800,000
B 150 £100,000 40% £6,000,000
C 300 £60,000 25% £4,500,000
D 1,000 £40,000 15% £6,000,000
E 4,000 £25,000 10% £10,000,000
Total incentive
pool £28,300,000
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
… or a combination of both approaches
Company performance
Budget / on target
£28.3m
Stretch
>£28.3m
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
The degree of flexibility in funding places greater or lesser
emphasis on performance ratings and distribution of awards
1 3 2 4 5
Performance rating
Beyond
budget?
Within budget
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• Forced
ranking
• ‘Rob Peter to
pay Paul’
• Discretionary
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Question for Group
How are short-term incentive awards funded
at your company? How do you differentiate higher
performers? Does the process work well?
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Eligibility • Who should be
eligible?
• Segmentation
Performance criteria
Pay-out
Payout schedule
Deferred
Cash/shares
Performance
measurement
Target setting
Absolute/relative
Time period (LTI)
Link and weights
Targets
weighting
Additive/
multiplicative
Quantum
Minimum
Maximum
Target
Calibration
Payout curve
Link to
performance
levels
Funding Budgeted
amounts
Profit share
Funding above
a minimum
return
Design parameters to consider in incentive plans
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Financial
Non-financial
Group, BU,
individual
Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Incentive performance measures should support achievement
of business objectives
Strategy Key
performance indicators
External messages
Executive performance
measures
Management / employee
performance measures
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Value tree analysis can help identify linkages between
headline measures and levers that employees can pull
towerswatson.com
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Pre Tax
RONA
Operating
Margin
Capital
Turnover
COGS as %
of revenue
SG&A and
other
Operating
Costs as %
of revenue
Depreciation
as % of
revenue
Net PP&E as
% of revenue
Working
capital as %
of revenue
Long-term
liabilities as
% of revenue
Net other
assets /
goodwill as
% of revenue
Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
The emphasis on individual / business unit measures
generally decreases with employee seniority
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
A company’s position on the growth/income curve can be a
good place to start when considering performance measures
Start-up phase Growth phase Mature phase
High growth Medium growth and income High income
Incentive arrangements are
typically awarded annually and
should encourage stewardship
of the business
Incentives focus on high
potential rewards on success.
Typically one-off block
grant/awards
Incentives motivate
management to drive business
forward
Deal-based equity incentive
Market-based salary levels
Market-based equity incentive
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Growth phases have different characteristics, including
implications for performance measures
Start-up phase Growth phase Mature phase
Business profile
Business aim Proof of concept/
breakthrough
Create new market or displace
an industry/region
Top line growth
Build out capability/brand
Build the business/profit
growth
Efficiency/maintain market
share
Own the market/monopoly
Milk and defend the franchise
Executive role Entrepreneurialism/
breakthrough thinking
‘Doer’/’Deliverer’ Custodianship
Manage the franchise
Culture Intellectual
Aspirational
Freewheeling
Pragmatic/hands on/can
do/needs must
Professional/expert
management
Capital volume Low Low but growing fast
Phased financing
High
Core finance Equity lots
Debt light
Debt/equity mix
Role of mezzanine financing
Mainly debt to get equity
leverage impact
KPIs
Categories Milestones ‘Growth in’ measures ‘Return on’ measures
Examples Patents
Market entry
Proof of concept
Growth in turnover
Breakeven profit
Revenue/market share
Gross margin
Operating profit
EBITDA/EBIT
PBT/Earnings
EPS
PBT/Earnings/EPS
Return of Capital
Employed
Return on Equity
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Question for Group
How are short-term incentive performance
measures selected at your company? Are they well
aligned with strategic objectives?
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Implementation & Communications
© 2013 Towers Watson. All rights reserved.
Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Regardless of design, successful incentive plans tend to
possess certain common traits around perceptions and
understanding Employees understand their roles and how they can 'win'
Employees believe that they can win
Employees believe that the reward for winning is worthwhile
Fair Perception that goals for all participants have equal stretch and performance has
been fairly assessed
Simple Easily understood by participants
Aligned with
role Employees understand how they can influence outcomes
Champions Managers 'own' the plan and see it as a tool to improve performance
Return On
Investment Management and shareholders feel there is a sufficient return on investment
Support Infrastructure (processes and systems for tracking performance) in place
Business literacy and training used to link employees with key business drivers
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Motivating
Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Question for Group
What steps has your company taken to
enhance level of understanding and perceived
value of short-term incentives?
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© 2013 Towers Watson. All rights reserved.
Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Eligibility • Who should be
eligible?
• Segmentation
Performance criteria Financial
Non-financial
Group, BU,
individual
Pay-out
Payout schedule
Deferred
Cash/shares
Performance
measurement
Target setting
Absolute/relative
Time period (LTI)
Link and weights
Targets
weighting
Additive/
multiplicative
Quantum
Minimum
Maximum
Target
Calibration
Payout curve
Link to
performance
levels
Funding Budgeted
amounts
Profit share
Funding above
a minimum
return
Design parameters to consider in incentive plans
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Financial performance targets are usually set by reference to a
range of inputs
Budget
Judgement/
climate
Historic
performance
Peer group/
relative
performance
Investor
expectations
Incentive
Plan
Target
Growth
expectations
Board views External
standards
(e.g. cost of
capital)
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
It can be helpful to consider threshold, target and maximum
performance in the context of the expected distribution…
Performance ranges may be established based on the probability of
achievement and subsequent motivational impact
100% 0%
Threshold (80% - 90%)
Stretch (10% - 20%)
Target (50% - 60%)
Probability of Achievement
80% 60% 20%
Typical Design
50%
Poor Poor Motivation
10% 90%
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…alongside other key inputs to provide a balanced view
5.0%
6.2%
12.0%
5.0%
12.0%
10.5%
13.0%
10.0%
12.4%
9.3%8.9%
12.5%
10.4%
8.7%
10.7%
11.7%
12.8%
0%
5%
10%
15%
HistoricalSep06-Sep09
HistoricalSep07-Sep10
HistoricalSep08-Sep11
HistoricalSep09-Sep12
ForecastSep10-Sep13
ForecastSep11-Sep14
ForecastSep12-Sep15
ForecastSep13-Sep16
A B C D E Median PSPtarget
range (4)
Historicaltargets
3 yr historical EPS andresulting vesting under plan
Internal EPSprojections (2)
Analyst ForecastSep13-Sep16 (3)
FTSE 100(excl Co
ABC)
An
nu
al
EP
S G
row
th
0% vesting
99.12% vesting 83.8%
vesting
100% forecastvesting
72% forecastvesting
64% forecastvesting
100% vesting
83% forecastvesting
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The degree of performance/payout leverage is also a key
factor – should you offer a broad performance range…
Target
Performance
Threshold Target
Maximum
Pa
yo
ut
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Performance
Threshold Target
Maximum
Pa
yo
ut
…or a narrower range with higher leverage (perhaps
appropriate when targets can be set with more certainty)
Target
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Question for Group
How does your company determine
short-term incentive performance targets? Do all
stakeholders support targets every year?
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