The View From the Top - Mark Cuban talks adapting to a COVID-19 world, diversity and inclusion, and more - Meridian Compensation Partners
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An Equilar publication
Issue 34, Fall 2020
The View
From the Top
Mark Cuban talks adapting
to a COVID-19 world,
diversity and inclusion,
and more
FEATURING
CEO Pay by U.S. President &
Interview with Shellye Archambeau
Critical governance issues post-pandemic The rising role of General Counsel
Demystifying data science for board members Setting incentives in uncertain times
How CEO pay ratios affect Say on Pay Executive equity awards and the pandemic
28 PERFORMANCE REVIEW examining incentive design
Redefining Success
Incentive design
and goal-setting in
uncertain times
By Ryan C. Harvey and
Ron Rosenthal
MERIDIAN COMPENSATION
PARTNERS, LLC
PM Images/gettyimges.com
29
T
o state the obvious, 2020 has approach was commonly used in the Great Recession in 2009 and may be
been an unprecedented year. a helpful approach if there is limited confidence in 2021 target setting. (See
The impact of the COVID-19 Figures 1 and 2.)
pandemic and the resulting While a 12-month performance period has long been the standard
economic shock has led many approach for most annual incentive plans, if uncertainty is particularly
compensation committees to high in 2021, companies could also consider the use of two semi-annual
wrestle with the treatment of or four quarterly performance periods. Under this approach, the target
2020 annual incentives, given the dramatic change bonus opportunity is allocated amongst each performance period. Goals
in business conditions since the first quarter of are established at the beginning of each period, and the payout earned is
the year. Depending on the industry and unique determined following the end of each period (and either paid currently
circumstances of the company, we are likely to see or “banked” and paid following the end of the full year). The compensation
a wide spectrum of approaches adopted—from committee would have an opportunity to consider changes in the economic
companies that leave 2020 incentives unchanged environment and business expectations when setting targets for subsequent
to companies that modify incentive plan goals to performance periods, allowing for a more dynamic goal-setting process.
reflect the new business conditions. Dividing an annual incentive into shorter performance periods adds some
As companies prepare for 2021, developing complexity to the plan design, increases the need for frequent participant
appropriate incentive compensation arrangements communication and no longer ties the annual incentive to achievement of
and performance goals becomes the next major the annual budget/operating plan. However, in a highly volatile economic
challenge. Even in an ordinary year, establishing environment, this approach can help avoid setting performance goals that
incentive plan goals is often challenging. However, the board and management
2021 could be one of the more challenging years later find to be regrettable Figure 1
in recent memory for setting performance targets based on changing Typical Performance Curve
given the uncertain economic and political business conditions.
200
environment. Companies must continue to balance Companies could
Payout (Percent of Target Bonus)
the motivation and competitiveness of incentives also review the type
with setting appropriate goals that align with and weighting of
investor expectations and hold executives performance metrics 150
accountable for performance. In the balance of for 2021. While financial
this article, we will explore alternative approaches metrics such as earnings
to annual and long-term incentive (LTI) plan growth, revenue and cash 100
design and goal setting that companies can explore flow typically receive
to address this increased uncertainty in 2021. substantial weighting
in annual incentives to
50
Annual Incentive Considerations drive achievement of 80 90 100 110 120
When addressing the difficulty of goal setting key financial objectives,
Performance (Percent of Target Goal)
in an uncertain environment, the first strategy companies could consider
to consider is adjusting the slope of the moderately decreasing the
Figure 2
“performance curve.” The performance curve is weighting of such metrics
“Flattened” Performance Curve
simply the relationship between the performance for 2021 to lower the risk of
goals and the corresponding incentive payout. setting financial targets in 200
Payout (Percent of Target Bonus)
By flattening the performance curve, a company a period of limited visibility.
can reduce the sensitivity of incentive payouts to Instead, companies could
business performance. This should generally apply consider increasing the
150
to both the “upside” (achievement above target) weighting of (or including)
and the “downside” (performance below target). strategic, operational
A flatter performance curve reduces the likelihood and/or ESG metrics to
100
of being “out of the money” and, similarly, reduces drive achievement of key
the likelihood of a maximum payout if conditions initiatives and increase
improve quicker than expected. Additionally, the the weighting on measures
incremental change in payouts for performance that are likely to be more 50
above/below target will be reduced due to the within management’s 80 90 100 110 120
flatter slope of the performance curve. This control in 2021. Performance (Percent of Target Goal)
30 PERFORMANCE REVIEW examining incentive design
Long-term Incentive Considerations
For the last decade, the majority of senior executives’ LTI opportunity
CONTRIBUTORS
at many companies was granted in the form of performance shares or
similar arrangements, in response to investors’ preference for strong
alignment of pay and performance. However, for companies with
significant business uncertainty in 2021 that have traditionally tied
vesting of performance shares to attainment of financial targets, the
first question that needs to be considered is whether performance shares
RYAN HARVEY RON ROSENTHAL
should be awarded in 2021. Most performance share arrangements have
Partner Lead Consultant
a three-year performance period, which only further exacerbates the MERIDIAN MERIDIAN
goal-setting difficulties. While in most cases the performance/alignment COMPENSATION COMPENSATION
benefits of continuing to grant performance shares will outweigh the PARTNERS, LLC PARTNERS, LLC
goal-setting challenges, some companies may consider reducing the
weighting of, or eliminating, performance shares for 2021 annual grants
and re-allocating the target opportunity to either time-vested stock options prevalence of market share metrics or even
and/or restricted share units. relative financial metrics, if companies are
For the majority of companies that choose to maintain the use of willing to use unadjusted GAAP results.
performance shares in 2021, some of the same considerations discussed Most performance share arrangements
previously for annual incentive plans will apply to performance share goal measure performance over three years.
setting. For example, companies could consider flattening the performance Measuring performance over a multi-year period
curve to address uncertainty. will continue to be the ideal. However, another
Additionally, a company might consider the use of relative metrics, approach that can address uncertainty is to use
where appropriate. Measuring performance relative to other companies three one-year performance periods. A goal-setting
eliminates the challenge of setting an absolute goal. However, incorporating approach for such a design that can be particularly
a relative metric requires the availability of comparable peer companies effective is to set three annual growth goals with
with similar business dynamics. It also requires companies to identify a each year’s growth calculated based on the prior
metric that is easily comparable across companies without adjustments. year’s actual performance. All three annual growth
Total shareholder return (TSR) is the most widely used relative metric, and targets are set at the beginning of the three-year
we may see increased use of TSR as a metric in 2021. period. However, each
Where appropriate, we may also see an increase in the year’s performance
2020 has truly been is measured
Figure 3 independently based
Payout Scale for Illustrative Arrangement in Figure 4 an “unprecedented” on its growth over
year, and 2021 is the prior year. This
THRESHOLD TARGET MAXIMUM allows for some
shaping up to be opportunity to earn
Annual EPS Growth 5% 10% 15%
Payout (% of Target) 50% 100% 200%
nearly as challenging. an incentive even if
performance for one
of the years is well
Figure 4 below expectations. Likewise, if a single year is
Hypothetical Performance and Payout well above expected performance, the following
year’s growth is measured from that strong year,
thereby increasing the required performance in
BASELINE YEAR 1 YEAR 2 YEAR 3
the following year. (See Figures 3 and 4.)
Target EPS - $3.85 $4.33 $4.62 2020 has truly been an “unprecedented” year,
+10% +10% +10%
Actual EPS $3.50 $3.94 $4.20 $4.80 and 2021 is shaping up to be nearly as challenging
for establishing reasonable performance targets.
Actual Growth - 12.50% 6.60% 14.30%
Companies’ approach to incentive compensation
Annual Earned - 150% 66% 186% arrangements may require some unconventional
thinking in 2021, but should also remain true to
Final 3-Year
134% 134% 134% strong governance and performance principles that
Payout (averaged)
have guided past design, whenever possible.Discover Meridian
Executive Compensation That Works.
The advisers at Meridian
Compensation Partners craft
executive compensation solutions
that fit each unique situation.
We don't clone. We customize.
See how we can help you navigate
through today's challenges.
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