Performance-based Equity

Understanding to newest “new” thing in the Total Rewards Portfolio

PresentersBrit WittmanDirector, Exec Comp and Corporate Comp DesignIntel

Steve LensingSr. Manager, Equity and Executive CompensationeBay

Dan Walter, CEPPresident and CEO(917) 734-4649dwalter@performensation.com

What is meant by “performance-based equity”?

Award is given for meeting goals

Vesting is accelerated for meeting goals

Vesting occurs after a period of time AND goals are met

Vesting occurs ONLY when goals are met

Shares are earned, but not vested, when goals are met

Payout may be separate from earning and vesting

Why do companies implement performance-based equity? Performance was always the stated “reason” for offering

equity◦ “We want people to share in the success and growth of the company”

◦ NOTE: Very little mention of failure and demise of the company

External optics (Glass Lewis, RMG)

Practice at peer companies

Is performance simply stock price (total Shareholder Return)?

◦ When does stock price no longer provide a reasonable link to pay?

The Equity Compensation Dilemma

1988-1999 the “No Lose” zone (and the period of the greatest growth in the use and value of equity compensation plans)

What are the most common performance metrics?

TSR – Total Shareholder return

◦ Absolute

◦ Relative to peer group (s)

Financial Goals

◦ Revenue

◦ ROIC

◦ EBITDA

◦ Cost

Other◦ Risk

◦ Staff Retention

◦ Innovation / Product Development

HRIS◦ Performance Appraisal /

Human Capital Management score

About a million others

As a stand-alone goal it may not◦ Provide line of sight to staff below C-Suite

◦ Link corporate long-term success to plan

◦ Pay evenly. Peer groups can differ widely, skewing results

◦ Reflect risk or other factors in today’s payout

Companies are starting to combine it with other metrics◦ Create a balance using Financial, HRIS and Project goals –

Total Compensation Intelligence™

◦ Multiple Independent goals

◦ Co-dependent goals – Generally must meet TSR threshold to be eligible for other goals

Relative TSR is King for now, but…

Profits / Revenues – without a balance to costs and/or risk these can provide unsustainable performance and even allow gaming the system

Individual Goals – Can pay without corporate performance

Companies generally over-leverage the upside and minimize the downside. All carrot, no stick means staff can just go for homeruns, without trying to win the game

Single metric without a balancing component can result in unexpected results (and possible media headlines)

Are there any pitfalls for using specific types of performance metrics?

What do performance equity plan structures look like? Most common US structure is Performance Unit award with

a three-year measurement period

◦ Relative TSR against a peer group

◦ Minimum payout set at a level that shows effort

◦ Target payout set at a slight stretch goal

◦ Maximum Payout set at a significant stretch goal

Smaller companies often use shorter measurement periods

Some companies allow for “forgiveness” of missed goals (Frowned upon by RMG)

Outside the US there is more use of multiple layered goals

CEO and executive management

Scientists, key Individual Performers

Individuals with long-term project deliverables

Outside the US it is not uncommon for these to go below the mid-level of and organization

Who receives performance-based equity?

Between 35% and 60% of companies offer performance equity◦ These numbers have been very volatile

◦ Some sources show this percentage decreasing (PWC, FW Cook)

◦ Some sources show this number increasing (Equilar, Mercer)

Common in Finance and Life Science, growing use in Tech Many companies are pushing these plans down in the

organization◦ Microsoft – Top 1,200

◦ HP – Approx. 30,000?

Used at both large and small companies

Who awards performance-based equity?

Communication and engagement with goals and awards Best practices for communicating performance-based equity?

◦ “Communication is the key to a successful program” – Allison McBride, International Paper

◦ Educate participants on how the goals drive corporate success and why they apply to the individual

◦ Communicate often, consistently and with enough detail for individuals to understand how they are linked to the movement of the underlying metrics

Do employees like receiving performance-based equity? ◦ Results are mixed

When alignment and line-of sight are correctly positioned and the individuals can see their role plans seem to be positively received

When performance is low, the result can be similar to impact of underwater stock options

For lower level staff minimums may need to be structured to ensure some value even when performance is not great

What should my company consider before implementing performance-based stock? Looking at the payout curve, performance levels versus

payouts ◦ Alignment with the employee’s total compensation

Improperly designed programs can have the same over-leveraged results as stock options

Too little leverage provides no motivation to out-perform

Too steep a curve can create risk-adverse staff “A share in my hand is worth five potential shares that may be lost if I

miss my goal”

◦ Alignment of performance metrics to key company goals

One or multiple metrics

Payouts levels vs. company performance  

◦ Alignment of payout with Shareholder return and market peers

Are you willing to “stick to your guns” if goals are missed?

What should my company consider before implementing performance-based stock?

Disclosure: CD&A must include metrics and reasons why they were used

Tax implications◦ Less predictable income planning BUT

◦ Better income deferral potential under 409A Administration

◦ Data Integration

◦ Financial Reporting

◦ Transaction Support Impact on CIC provisions and clawbacks Accounting impact is more complex than time-base equity

◦ Market-based awards have a fixed expense, but you cannot reverse it if goals are not met

◦ Performance-based goals (not based on stock price) require determining the probability of goals achievement and adjusting expense accordingly

Performance Based Equity at Intel Eligible: Management Committee Members (20 employees)

◦ Equity mix: 66% “OSUs” (performance RSUs) / 11% RSUs / 22% Options

3-year Performance Period; overlapping cycles

Performance Measures

◦ Relative TSR over performance period – median TSR of 15 direct competitors (the “Tech 15”) averaged with median TSR for the S&P 100

Payout Range

◦ Floor of 33%

◦ Maximum of 200%

◦ More highly leveraged above target than below (2 down; 3 up)

3-year Vest

◦ 100% vested and paid out at end of 3-year performance cycle

Eligible: SVPs and above (18 employees)

◦ Equity mix: 50% Options / 25% RSUs / 25% Performance RSUs

2-year Performance Period

◦ 2009-2010 and 2010-2011 periods were “decoupled” into two consecutive 12-month targets

Performance Measures

◦ FX-neutral revenue threshold

◦ Non-GAPP operating margin Both minimum FX-neutral revenue and non-GAAP operating margin thresholds must be met in

order of there to be any incentive payout

◦ Return on invested capital

2-year Vest

◦ 50% of the amount awarded is immediately vested upon grant and 50% will vest on the first anniversary of the grant

Performance Based Equity at eBay

Outside the US, performance is becoming the main foundation of share-based compensation

98% of FTSE 300 have performance share schemes

More than 90% of Australian companies have performance-based share remuneration

Say on Pay is the biggest driver of these plans

◦ Countries with some version of Say on Pay rules: UK, Australia, Sweden, Norway, Netherlands, Italy, Portugal, Spain, Austria, Germany, Ireland, Croatia, Hungary, Poland, Denmark, Finland, Estonia, Luxembourg, Switzerland, and Belgium

What is happening in the ROW?

What can we expect in the future?  Say on Pay will become a reality

Use of performance-based equity will grow first in the C-suite and then push quickly down into upper and middle management

US plan designs will quickly catch up with ROW plan designs

PREDICTION – Silicon Valley will embrace these plans as a best-practice and innovate them just as they did stock options.

◦ Performance plans provide a similar upside and downside risk that is better structured for our current volatile market