Next Generation Performance Awards

Two decades ago, only 30% of public companies granted performance-based equity awards; now the percentage of public companies utilizing performance-based equity has increased to 85%. Not only has there been a dramatic shift in the prevalence of performance awards but the design of these awards has evolved as well and continues to do so. Here are four ideas to take your own performance awards to the next level.

ESG

The past year has seen significant interest in the idea of tying vesting in performance-based equity awards to environmental, social, and governance targets. Historically, ESG has been more often treated as a short-term goal, but, as noted by Simiso Nzima of CalPERS in the NASPP webcast “Rethinking Next Year’s Equity Awards,” change in the ESG arena is often a long-term process and thus these goals are arguably more suited to long-term incentives.

Our COVID-19 quick survey found an increased interest in ESG targets for performance awards and I expect this trend to grow in the future.

Rigor

Another area where I expect to see companies continue to improve is in how possible payout outcomes of performance awards are evaluated. As investors develop a more sophisticated understanding of performance awards, companies may experience increased pressure to ensure that targets are meaningful.

Some practices to consider when evaluating the rigor of performance goals include:

• Outlier scenarios in addition to the expected outcome. If the company’s performance is significantly above or below the expected outcome, how does that affect award payouts?
• The effect of various scenarios on executives’ total equity holdings or total compensation. Company performance affects not just the value of performance awards held by executives but also all their time-based equity awards, short-term incentives, and other forms of compensation (e.g., profit-sharing). Failing to include this other compensation in your evaluation of performance awards could produce surprising results if the company’s performance is significantly better or worse than expected.
• More sophisticated analysis.  As described in the feature article in the Fall 2020 issue of The NASPP Advisor newsletter, the Monte Carlo simulation can be used to evaluate the rigor of a wide variety of performance goals beyond TSR.

Relative Metrics

Relative metrics can offer advantages over absolute targets. Goal setting is often easier because it isn’t necessary to predict financial performance. Moreover, relative targets can help mitigate the impact of market and economic volatility on performance awards because payouts are tied to whether the company is outperforming its peers, rather than an absolute target that may turn out to be unachievable or too easily achieved.

The past decade has seen a significant increase in the use of relative TSR for performance awards, a trend that so far hasn’t shown any sign of reversing. And TSR isn’t the only performance metric that can be measured on a relative basis. Given the uncertain economic environment we are currently operating in, we may see more types of relative metrics used to measure performance.

Volatility Mitigation

The past year has demonstrated that it is important to consider the potential for economic instability when designing performance awards. Relative metrics are one solution, but there are other solutions to consider. Several ideas are discussed in the feature article in the Spring 2020 issue of The NASPP Advisor, including:

• Interim annual goals tied to growth rates
• Setting interim goals at the start of each fiscal year
• Interim annual goals that automatically adjust based on the prior year’s performance

Find Out How You Compare to Your Peers

Participate in our pulse survey on performance awards to learn how prevalent the practices I discuss in this blog entry are. This is the second survey in the Equity Compensation Outlook, a collaboration between the NASPP and Fidelity Investments. The survey answers the following questions:

• How have companies adapted their performance awards in light of the current economic uncertainty?
• Did companies modify outstanding performance awards during the past year?
• Are companies using ESG targets in their performance awards?
• How do companies evaluate the rigor of their performance targets?
• Do companies provide interim progress reports to award recipients?

We are conducting the survey using an innovative new platform that allows us to make the results available quickly (about a week from today for the performance award survey). Even better, survey respondents can run their own data reports, create their own custom cuts of the data, and download a slide deck that can be used to present the results to their management team.

The survey is short—you can complete it in about 15 minutes—do it today before you forget!