How to Optimize Company Performance

How to Optimize
Company Performance
Shane Dikolli, Associate Dean, Duke University (US)
Dan Kapinos, Director, Radford / Aon Hewitt (US)
Stacey Petrey, VP – Total Rewards, Mylan (US)
Carl Stegman, SVP Product Mgmt, Fidelity Stock Plan
Services (US)
WHY IS PERFORMANCE EQUITY
HERE TO STAY IN PLAN DESIGN?
The Say-on-Pay Web
Proxy/CD&A
Disclosure
2013 Say-onPay Results
Proxy Advisory
Firms
SEC Rule
Making
2014
Say-on-Pay
Votes
Institutional
Shareholders
Performance
(TSR)
The Media
Dodd-Frank
Clawbacks & CEO Pay Ratios
Consultant Independence Committee Conflicts
Hedging & Pledging Policies
Broad-based Equity Granting Trends: 2005-2013
Proportion of Participants by Award Type
Options
2005
2006
2007
Restricted
2008
2009
Proportion of Grant Value by Award Type
Performance
2010
2011
Source: Fidelity Stock Plan Services Administration data, 2005-2013
2012
Options
2013
2005
2006
2007
Restricted
2008
2009
Performance
2010
2011
2012
2013
Research Highlights
•
•
Payouts continue to be in directional alignment with relative performance
High-performing companies tend to demonstrate stronger alignment between
performance and award payouts than low-performing companies
–
–
•
Performance award cycles ending in the last two years (2011 and 2012) have paid
out better than cycles ending in earlier years
–
•
Significant economic uncertainty at the time performance goals were set may be contributing
to this outcome
Across most data sets, TSR has risen to the top as the most prevalent performance
measure, although earnings measures continue to be widely used
–
•
This is particularly true when comparing payouts for awards based on one year of
performance vs. three years
Raises questions as to whether companies are setting a “floor” when setting performance
goals
Awards based on an earnings measure resulted in above target payouts more often than
TSR-based awards
Using absolute or relative measures do not result in any materially different payout,
but using both resulted in max payouts a vast majority of the time
Past performance is no
guarantee of future results.
Source: Fidelity Stock Plan Services and
ClearBridge Compensation Group
Performance Plan Study, 2013
Performance Plans Align Pay with TSR Performance
TSR Performance Versus S&P 500 (n=155)
Max
Overall, payouts aligned with
TSR Performance
High Performance High Pay (n= 67)
66% of the time
Performance Share Payout
Low Performance High Pay (n= 31)
R² = 0.1248
Key Conclusions:
 Among high performing
companies, 76% of payouts
were aligned with performance
Target
Low Performance Low Pay (n= 36)
0%
Past performance is no guarantee
of future results.
Source: Fidelity Stock Plan Services and
ClearBridge Compensation Group Performance
Plan Study, 2013
 In contrast, payouts among
low performers were
directionally aligned only 54%
of the time
High Performance Low Pay (n= 21)
25%
50%
75%
TSR Percentile Rank Relative to the S&P 500
100%
Performance Plans Align Pay with EPS Growth
EPS Growth Performance Versus S&P 500 (n=130)
Payouts aligned with EPS
Performance
Max
Performance Share Payout
Low Performance High Pay (n= 30)
High Performance High Pay (n= 52)
68% of the time
Key Conclusions:
R² = 0.2954
 EPS has a stronger statistical
correlation to performance
compared to TSR, with fewer
significant outliers
Target
Low Performance Low Pay (n= 36)
0%
Source: Fidelity Stock Plan Services and
ClearBridge Compensation Group Performance
Plan Study, 2013
High Performance Low Pay (n= 12)
25%
50%
75%
EPS Growth Percentile Rank Relative to the S&P 500
Past performance is no guarantee of
future results.
 High Performance Low
Pay outliers are almost
entirely removed
100%
What Influence Does the Performance Measure
Selected Have on Payouts?
 Performance award payouts tend to be best aligned with plans based on TSR or earnings
performance, producing alignment two-thirds of the time
 Metrics such as revenue growth and returns (ROC and ROE), when also measured on a relative basis,
did not result in as strong a correlation between performance and pay
Past performance is no guarantee of future
results.
Source: Fidelity Stock Plan Services and ClearBridge
Compensation Group Performance Plan Study, 2013
What Influence Does the Performance Measure
Selected Have on Payouts? (Con’t)
There is little difference in how plans pay out when comparing absolute vs. relative plans

 Plans that are based on a combination of absolute and relative measures, however, paid between
Target and Max 83% of the time. This may indicate that when both measures are combined together
in the same plan design, they provide a “Check” or “Hedge” against each other.
Performance Plan Payouts
Absolute vs. Relative Plans
Relative
23%
Absolu te
14%
Both
15%
26%
62%
2%
38%
17%
0%
Past performance is no guarantee of future
results.
Source: Fidelity Stock Plan Services and ClearBridge
Compensation Group Performance Plan Study, 2013
19%
83%
25%
50%
75%
100%
WHAT IS THE ACADEMIC EVIDENCE
ON OPTIMAL EXECUTIVE
COMPENSATION?
Table 2, Core and Guay
(2010)*
Insights from Table 2, Core and Guay (2010)*
•
Annual pay appears as if it is not related to stock returns
– Need to consider portfolio-based effects
•
•
Portfolio-based effects tied to stock returns “punishes” poor
performance & “rewards” good performance in ways that cashbased plans do not do.
Pay = CEO ability + cost of effort +
incentive risk premium + excess pay.
Portfolio holdings tied to stock returns appears to be the yardstick for
measuring the optimality of compensation.
*Core, J. E., & Guay, W. R. (2010). Is CEO Pay Too High and Are Incentives Too Low? A Wealth-Based
Contracting Framework. Academy Of Management Perspectives, 24(1), 5-19. doi:10.5465/AMP.2010.50304413
WHAT ROLE DOES LEADERSHIP
GOVERNANCE, EDUCATION AND
EXECUTIVE COMPENSATION DESIGN
HAVE IN DETERMINING COMPANY
PERFORMANCE
Economic theories of efficient compensation predict a positive relationship
between executive pay and company performance, yet successful efforts to
document this relationship are few.
My research finds company performance can be optimized through executive
leadership backgrounds and compensation design.
Specifically, my results show the following:
1.Undergraduate and graduate training, and undergraduate degrees from best-inclass institutions, were significantly related to better company performance.
2.The use of performance-dependent compensation and the use of financial
measures in performance compensation are notably related to better company
performance.
Study Parameters: Company Performance, Founder Status, Chief
Executive Officers and Named executive officers
Leadership
Experience
CEO (Founder and nonFounder) & NEOs
% Prior Affiliated Roles
% Prior BOD Experience
% Current BOD & BOD
Education
CEO (Founder and
non-Founder) & NEOs
% Graduate Degrees
% Best in Class
Institution
% Related Field
Agency Theory: Non-Founder CEO
1. Compensation Mix: Larger % of total compensation
paid in cash v. stock, larger % of benefits & perks
2. Performance Design: Lower utilization of nonfinancial measures
Leadership
Role Governance
CEO (Founder and non-Founder)
& NEOs
% of Combined Roles
Stewardship Theory: Founder CEO
1. Compensation Mix: Smaller % of total compensation paid in
cash v. stock, smaller % of benefits & perks
2. Performance Design: Higher utilization of financial measures
The quality and performance of an organization’s top management is often the single most
important determinant of both the success and survival of the organization (Drucker, 1954).
What differentiates leaders? Executive Leadership Governance Conceptual Framework
How top management teams are constructed from an incumbent selection, role scope and collective experience and
background will influence their ability to work together effectively (Eisenhardt, Kahwajy, & Bourgeois, 1997)
Founding executives influence the structures and processes of their developing organization (Mintzberg, 1989;
Mintzberg & Waters, 1982)
Further, Hambrick and Mason’s (1984) ‘upper echelons perspective’ states that organizational outcomes, such as
strategic choices and performance levels, are partially predicated by managerial background characteristics
Leadership
Experience
Education
CEO (Founder and
non-Founder) &
NEOs
% Prior Affiliated
Roles
% Prior BOD
Experience
% Current BOD &
BOD Leadership
CEO (Founder
and nonFounder) & NEOs
% Graduate
Degrees
% Best in Class
Institution
% Related Field
Role
Governance
CEO (Founder and nonFounder) & NEOs
% of Combined Roles
Compensation Design: Does it Differentiate? Compensation design Conceptual Framework
To formalize the relationship between owners of and managers, Jensen and Meckling (1976) developed an agency
framework where owners of a firm (the principal) delegate decision making to management (the agent)
Both agency and stewardship theory are concerned with how principals can increase the likelihood that agents
will act to maximize shareholder wealth (Tosi, Brownless, Silva, & Katz, 2003)
As such, the goal of the compensation contract is to increase the likelihood that leadership agents will act to
maximize shareholder wealth while taking into account founder status through the design of key compensation
indicators identified in this study
Agency Theory: Non-Founder CEO
1. Compensation Mix: Larger % of total compensation
paid in cash v. stock, larger % of benefits & perks
2. Performance Design: Lower utilization of nonfinancial measures
Stewardship Theory: Founder CEO
1. Compensation Mix: Smaller % of total compensation paid in
cash v. stock, smaller % of benefits & perks
2. Performance Design: Higher utilization of financial measures
Executive Summary: what differentiates? Total shareholder return findings
Executive Leadership Governance
Leadership Education:
•Strong Relationships between Percentage of NEOs with UG or GR degrees in related field and 1YR
TSR
•Positive Relationships between with Percentage of NEOs with UG degrees, GR degrees and total
education disclosure
Leadership Experience:
•Positive Relationship between All NEOs (including CEO) having current board affiliations and 1YR
Leadership Governance:
•Negative Relationship between CEO-only combined role and 1YR TSR
Executive Compensation Design
Performance Dependent Compensation
•Strong Relationships with Percentage of CEO performance dependent compensation and 1YR/3YR TSRs
Financial Measure Utilization
•Strong Relationships between CEO utilization of more than one financial measure and 3YR TSR
•Positive Relationships between NEO utilization of more than one financial measure and 3YR TSR
* After controlling for two-digit SIC grouping
HOW DO MANAGER TRAITS
MATTER?
The Consequences of
Manager Traits
•
Manager traits seem to matter for:
– Investment Policy, Financial Policy, Firm Strategy (Bertrand &
Schoar, 2003 QJE)
• Fee, Hadlock and Pierce cast doubt on these results (2013, RFS)
–
–
–
–
–
•
Performance (Chang, Dasgupta, & Hilary, 2010 MSc)
Voluntary Disclosure (Bamber, Jiang & Wang 2010, TAR)
Financial Reporting (Ge, Matsumoto, & Zhang 2011, CAR)
Tax Avoidance (Dyreng, Hanlon & Maydew 2010, TAR)
Compensation (Graham, Li & Qiu, 2012 RFS)
But traits do not help us understand why managers matter
What Manager Traits?
•
Professional characteristics
– Tenure, MBA education, Honors/Awards, Career concerns, Ability,
Reputation
•
Physical characteristics
– Height, Facial characteristics, Voice pitch, Voice Dissonance
•
Life experiences
– Military experience, Growing up during the Great Depression.
•
Cognitive biases
– Overconfidence, Optimism
•
Innate preferences
– Risk aversion (e.g., measured by religious affiliation of location), Ethics,
Integrity
WHAT ABOUT OPTIMIZING
PERFORMANCE WITH BROAD-BASED
EMPLOYEES?
2013 Aon Hewitt Engagement Study
•
•
Aon Hewitt’s Engagement Practice conducts annual survey and
study on employee engagement across hundreds of companies
around the globe.
How does one measure employee engagement?
Say
Stay
Strive
Employees speak
positively about
organization to coworkers, clients and
potential employees
Employees have an
intense sense of
belonging and desire
to be part of the
organization
Employees are
motivated and exert
effort toward success
in their job and for
the company
Engagement & Performance
•
Companies with high levels of employee engagement perform at
higher levels, and companies with low levels of employee
engagement perform at lower levels.
50%
Co’s in Top Quartile of Engagement yield
TSRs 50% higher than average TSR
Co’s in Bottom Quartile of Engagement yield
TSRs 50% lower than average TSR
50%
Investing in Engagement
•
Strong correlations exist between investments in engagement
and future performance
•
•
Example – Strong Positive Correlation between 2010 Engagement and
2011 Sales Growth
1% increase in engagement predicted 0.6% increase in sales
What’s Your Company’s Engagement Level?
•
•
For the most part, about 60% of organizations are highly or
moderately engaged
That leaves approximately 40% that are passively engaged or
actively disengaged
•
•
Passively Engaged – could become engaged in right work environment
and could be disengaged if the wrong conditions are present
Actively Disengaged – negative about the company, no desire to stay or
go above and beyond with jobs (destroying value)
Highly Engaged
20%
40%
23%
17%
Moderately Engaged
Passive
Actively Disengaged
What Drives Employee Engagement?
Key Driver
Globally
Europe
North
America
Career Opportunities
1
1
1
Organization Reputation
2
2
3
Pay
3
3
Recognition
4
5
Communication
5
4
Managing Performance
2
Innovation
5
Work Processes
4
Other Engagement Driver Views:
Job Function
Job Level
Employee’s Generation
Priorities for Improved Engagement
•
•
Leadership – if leaders do not drive engagement efforts, who will?
• 54% of global employees view senior leadership favorably
• Employees want to see and hear from leadership – to hear about
the business, know its direction, to know they care, and to be
inspired
Reputation – what does your company want to be famous for in the job
market?
• #2 engagement driver but only 52% of employees can answer
question positively
• Function of business performance, social responsibility and
general impressions
• Examples – Amazon, Apple, Disney, Google and Johnson &
Johnson
Priorities for Improved Engagement
•
•
•
Total Rewards
• Career Opportunities - #1 driver but only 47% of employees think
they have good advancement opportunities
• Pay – 44% of employees believe they are paid fairly and a lower
amount of job loyalty present in today’s marketplace
• Recognition – 48% of employees believe they receive proper
recognition
Communication – Only 49% of employees believe their company is
effective at communication
Enabling Performance – Only 55% of employees believe they have
the resources to be productive
Mylan, Duke University, and Radford/Aon Hewitt are not affiliate with Fidelity Stock Plan Services
Fidelity Stock Plan Services, LLC.
682773.1.0
Thank You
Shane Dikolli
Duke University
dikolli@duke.edu
Dan Kapinos
Radford, an Aon Hewitt Company
dkapinos@radford.com
Stacey Petrey
Mylan Pharmaceuticals
stacey.petrey@mylan.com
Carl Stegman
Fidelity Stock Plan Services
carl.stegman@fmr.com