5 Ways to Reinvent Performance Awards

It’s hard to set goals during periods of economic uncertainty, especially for performance awards that are subject to a three-year performance period (as is the case for 82% of respondents to the NASPP/Deloitte Consulting 2019 Stock Plan Design Survey). Here are five ways to structure performance awards to make goal setting a little easier.

1. Use Relative Metrics

Over half of respondents to the NASPP/Deloitte survey have already figured out that a significant advantage of relative metrics, such as relative TSR, is that they simplify goal setting: awards are earned if the company’s performance meets or exceeds that of its peers. Even if the company’s overall performance is down, the awards can still pay out if the company is ahead of its peers. But while goal setting is easier with relative targets, identifying the right peer group is no walk in the park.

2. Shorter Performance Period with Time-Based Vesting

Shortening the period for which targets must be defined could take some of the uncertainty out of goal setting. In the memo “Re-Thinking Long-Term Performance Plan Periods Within the Context of COVID-19,” Pay Governance suggests shortening the traditional three-year performance period to two years, with one year of time-based vesting after the performance period ends (so that the total vesting period is still three years). One concern with this approach is that it won’t meet ISS’s requirement for a three-year performance period.

3. Three-Year Performance Period With Interim Annual Goals

The feature article by Deidre Salisbury and Liz Stoudt of Infinite Equity in the Summer edition of the NASPP Advisor suggests three approaches for using annual goals within an overall three-year performance period:

• Compound Annual Growth Rates: Set interim one-, two-, and three-year goals based on growth rates
• Compound Annual Growth Rates with Adjustment: Similar to the first approach, except the starting point for each year is automatically adjusted based on the prior year’s performance (e.g., 10% growth over the prior year).
• Multi-tranche Measured Annually: Set the goals at the beginning of each year. While this gives the company a lot of flexibility in setting goals, a disadvantage is that the second- and third-year tranches will not have a grant date until the goals are set.

In all three approaches, no portion of the award is paid out until the end of the three-year performance period. Pay Governance suggests also including a three-year relative target in addition to the annual goals.

4. Lengthen Performance Period

Another approach suggested by Pay Governance is to allow a longer period to achieve the targets, e.g., five years, but provide that the award will vest as soon as the targets are met (but not before a minimum service period, e.g., three- years, has elapsed). In this approach, the performance award could vest at any point within the minimum and maximum vesting period, e.g., any time between three to five years after grant.

5. Discretion

Lastly, a fifth approach is to provide the compensation committee with discretion to adjust award payouts (upwards or downwards) as they deem appropriate. Discretion used to be a four-letter word but now that performance awards can no longer be exempt from the compensation deduction limitation under Section 162(m), this is a more feasible approach. Beware the accounting consequences however: too much discretion could trigger liability treatment for the award. If the award isn’t subject to liability treatment, exercise of discretion could be treated as a modification.

- Barbara