CEO Performance Metrics
An Analysis of the Prevalence and Types of Metrics in S&P 1500 Incentive Plans
Shareholder pressure to ensure a strong link between pay and performance continues to grow, as issues like say on pay empower investors to weigh in on the details of compensation. Companies are responding by gradually shifting from time-based awards to more performance-based incentives. As companies move towards performance measurements, there is a wide array of performance criteria a company can utilize in the design of its pay plans. The metrics a company chooses are an expression of the strategy executives and firms have chosen in their quest for growth and success. The recent economic volatility spurred many companies to make temporary adjustments to their incentive plans; some plan details were shifted to stem the tide of unique circumstances without severing the link between pay and performance.
To gain a better understanding of the performance measures companies are using to incentivize their executives, Equilar studied the incentive plans of S&P 1500 CEOs for the past three fiscal years. Only CEOs that served in the position at the end of a given fiscal year are included. The plans are separated into short-term (one-year performance period or less) and long-term (greater than one year) incentive plans.
Short-Term Incentive Plans
Among companies with plans in place for their Chief Executive Officers in fiscal 2010, the average number of metrics used to judge performance was 2.65, a continued rise from the averages of 2.61 in 2009 and 2.55 in 2008. As companies look to diversify their performance measurements, the number of metrics will likely continue to increase. The number of companies using 3 or more distinct metrics has also risen, from 45.8 percent of companies in 2008 to 50.4 percent in 2010.
The chart below shows the breakdown of the number of metrics used in short-term plans over the last three years.
Equilar also looked at the most popular metrics used in short-term incentive plans. Earnings (includes both earnings per share and net income) continue their reign as the most popular short-term measurement, appearing in 51.2 percent of companies' plans. The next-most-prevalent metric cited was non-financial goals, with 38.5 percent of S&P 1500 companies including them in their plans. Non-financial goals typically include metrics that are related to strategic objectives but don't appear in financial statements, such as quality or safety.
The most notable trend among the metrics tracked is the reversal in prevalence from the prior year. Many of the metrics that increased in prevalence in 2009 saw a decrease in 2010, while other metrics that faltered in 2009 have rebounded in the past year. These vacillations suggest that many companies made temporary adjustments to their annual incentive plans to deal with 2009's unique economic environment, only to revert back to previous metrics in the more stable economy of 2010. In 2009, Liz Claiborne replaced their 2008 metrics of operating profit, ROIC, and EPS with new criteria: cash flow, total debt reduction, and cost management. This change, they noted, occurred “in response to the sudden and severe economic downturn.” 1 In order to maintain their business, Liz Claiborne wrote that they needed to address “pressing needs of reducing costs, managing debt and managing cash flow in order to focus the management team on ensuring the Company's ongoing survival and building a stronger platform for long-term viability and success.” 2 In 2010, when the recession had waned somewhat, Liz Claiborne reversed its annual metric decisions, marking “a return to the Company's pre-2009 annual incentive plan metrics, with the reintroduction of earnings per share.” 3
The following chart compares the most prevalent metrics in short-term incentive plans for CEOs at S&P 1500 companies over the last three fiscal years.
Long-Term Incentive Plans
For S&P 1500 Chief Executive Officers enrolled in long-term incentive plans, the average number of metrics used to judge performance was 1.68. Unlike their short-term counterparts, the average number of metrics used in long-term incentive plans has stayed fairly consistent for the past three fiscal years, between 1.66 and 1.67. Compared to annual plans, long-term measurements are typically more focused on a single specific metric, but there was some increase in companies using multiple metrics over the past three years. The prevalence of companies using two or more metrics grew from 45.9 percent in 2008 to 48.8 percent in 2010.
The chart below shows the breakdown of the number of metrics used in long-term plans over the last three years.
In 2010, the most prevalent metric used to measure performance was total shareholder return (TSR), used by 40.7 percent of companies. The next-most-prevalent metric in use was earnings, appearing in 32.6 percent of companies' long-term plans. Earnings continue to be the most popular overall metric for incentive plans (short- and long-term combined).
As with short-term incentive plans, there was a general reversal from 2009 to 2010; metrics that decreased in use in 2009 increased in 2010 and vice versa. Two major exceptions, however, were TSR and earnings. TSR's prevalence in long-term incentive plans has been steadily rising, appearing in 34.0 percent of companies in 2008 and increasing to 40.7 percent in 2010. Conversely, the use of earnings as a long-term performance measurement has steadily been decreasing over the past three years, falling from 40.4 percent in 2008 to 32.6 percent in 2010. As companies attempt to link pay to company performance, total shareholder return is solidifying itself as the popular choice.
The following chart compares the most prevalent metrics in long-term incentive plans for CEOs at S&P 1500 companies over the last three years.
1. Liz Claiborne, Inc. (April 13, 2010). Form DEF 14A – Annual Report. Retrieved from EDGAR.
2. Liz Claiborne, Inc. (April 13, 2010). Form DEF 14A – Annual Report. Retrieved from EDGAR.
3. Liz Claiborne, Inc. (April 7, 2011). Form DEF 14A – Annual Report. Retrieved from EDGAR.