r-tsr winning the race - communicating performance-based equity compensation
TRANSCRIPT
Communica)on: The Key to Winning the Rela)ve TSR Race
As is the case with all compensa0on programs, clear and transparent communica0on is cri0cal to success. This is especially true for performance-‐based equity awards, which are o=en among the most complex forms of employee compensa0on. And although performance-‐based equity awards present significant opportuni0es to improve communica0on, they also require careful approaches to employee engagement. The following ar0cle explores common communica0on challenges associated with Rela0ve TSR and other performance metrics and presents solu0ons to ensure the successful implementa0on and management of performance equity plans. To start, we begin with the short story to set the scene and to illustrate the consequences of poor communica0on:
A Runner’s Tale
Meet Bob. He’s been fast his en1re life. When he was five years old, he ran across his backyard with the wind blowing through his hair. He thought he might be as fast as a car, but he wasn’t allowed to run on the street to find out.
When he got older, he wanted to run on the high school track team, but he was home schooled. To get around this, Bob would 1me his own runs by holding a stopwatch in his hand. Then, to see where he stood, he checked the local teams’ race results posted in the newspaper. His 1mes always beat the reported 1mes, so Bob knew he was fast.
In college, Bob started racing world-‐class runners. He first no1ced the other compe1tors were far more muscular than him. They had very specific warm-‐up and prepara1on rou1nes. It was obvious that many made running their first priority. Unlike Bob, school and work seemed to not be a distrac1on for the other compe1tors. Bob was impressed, but not too concerned.
During his first college track meet, Bob signed up to run three events: the 100-‐meter dash, the 5K race, and the marathon.
When he looked at the line-‐ups, he no1ced that he was running against different compe1tors in every race. In fact, every other runner seemed to specialize in short, mid-‐ or long-‐range events. Of course, Bob was not really worried.
As he lined up for the 100-‐meter dash, Bob no1ced the size of the runners on either side of him. They were huge. The gun went off and Bob realized he had a very good view of the back of their shirts as they ran away. Bob finished in last place and was very disappointed. How did this happen, didn’t they know that Bob was fast?
Bob’s First Race
Compensation Thought Leadership 2012Q3 - Communication
Thinking over Bob’s story, several important ques0ons emerge. Why did Bob finish in last place? Perhaps Bob was compe0ng against the wrong peers? Perhaps Bob was in the wrong race based on his skills and experience? Or perhaps, due to a lack of informa0on from leaders, team members and other external forces, Bob was not fully informed to complete successfully in the 100-‐yard dash? Regardless, if Bob had more informa0on prior to the race, it may have influenced his prepara0on and in-‐race decisions, thereby improving his chances of finishing first. Clearly, more context and beOer communica0on would have helped Bob, and the same goes for the ever-‐changing and increasingly complex world of execu0ve compensa0on, par0cularly equity compensa0on.
Globally and in the United Sates, as companies hear the call to ac0on from shareholders for greater alignment between corporate performance and execu0ve compensa0on, more companies are making the shi= toward performance-‐based equity incen0ves. However, for performance awards to effec0vely influence behaviors and impact decision-‐making processes, there must be an effec0ve and frequent communica0on channel. For example, as performance awards become increasingly complex, it is difficult for employees to understand the performance criteria being measured, the manner in which is it measured, and the specific performance levels against the goals that are being achieved during the period.
Employees will always be challenged in comprehending the ac0ons required to sustain a certain level of performance unless they have access to ongoing informa0on and know where they stand to-‐date. Finally, if the design of the award does not align with the company’s overall strategy and ac0ons, the importance of the performance award will diminish in the eyes of employees. Without a certain level of communica0on throughout the design and measurement process, the en0re meaning of performance awards can easily be lost on par0cipants.
Communica)ons Gone AwryIn order to understand the importance of communica0on in the performance award process, one must first understand common situa0ons where communica0on was not delivered effec0vely:
‣ Failed Communica)on of Plan Design
Imagine a technology company where employees receive grants of performance shares with ves0ng 0ed to the company’s total shareholder returns (TSR) rela0ve to the TSRs of selected peer companies. And at this par0cular firm, TSR performance ranked at the 95th percen0le of the peer group a=er the last three-‐year performance period. At first glance, award recipients expected a payout of 200% given their strong outperformance against the peer group. The only problem was that the company’s actual TSR was flat over the same 0meframe.
While the company did outperform most of its peers, shareholders did not receive any real apprecia0on. The design of the Rela0ve TSR plan an0cipated this outcome and included a modifying func0on buried in the fine print to limit employee gains whenever absolute TSR is nega0ve or flat. As a result, final payouts under the Rela0ve TSR plan were reduced to 100% of target. This approach made shareholders happy, but award recipients were taken aback. This was all new news to them, and they had worked hard to outperform the peer group in a tough economic environment.
If the company had previously disclosed to award recipients that final payouts might be modified based on absolute performance when TSR is flat or nega0ve, the reac0on from employees could have been different. The ul0mate lesson here is to both an0cipate unusual award outcomes in the plan design process, and to then communicate the poten0al ramifica0ons of plan design decisions to affected employees.
Effec)vely communica)ng the possible outcomes of the plan design or communica)ng with shareholders during the design process can allow the company to avoid design nuances that will not be well-‐received by the marketplace.
‣ Failed Communica)on of Award Values and Goals
Now consider a financial services company that first adopted the prac0ce of gran0ng awards 0ed to Rela0ve TSR in 2012. Prior to this year, the company’s annual equity grants consisted of tradi0onal stock op0ons and performance shares 0ed to a complex series of internal metrics. Therefore, consolida0ng the equity program around awards 0ed to Rela0ve TSR was viewed by the Compensa0on CommiOee as a simpler, more transparent approach to equity compensa0on. Furthermore, the move to Rela0ve TSR served to reinforce the Compensa0on CommiOee’s commitment to shareholder value crea0on and to crea0ng strong alignment between pay and performance. However, for employees not aOuned to the corporate governance environment, the en0re Rela0ve TSR concept seemed to be a distant abstrac0on from the solid opera0onal metrics they had previously aimed for. While complex, the past system was well-‐ingrained in the company’s culture. Without solid context around the new compensa0on paradigm, employees felt unmo0vated.
Clearly, when the company adopted performance equity awards 0ed to Rela0ve TSR metrics as their new method of long-‐term compensa0on, they did not do enough to explain to recipients how the awards worked and why the company was compelled to switch to this design. Specifically, the company did not explain what day-‐to-‐day and long-‐term ac0vi0es would drive performance under the new incen0ve system, nor did they share how this approach would ul0mately allow everyone in the company to focus on clear and transparent goals. In sum, the Compensa0on CommiOee relied on the promise of Rela0ve TSR plans to ease communica0on, while neglec0ng the fact that any change requires steady employee engagement.
A Runner’s Tale Con/nued...
Let’s get back to Bob for a moment. AQer Bob finished last in the 100-‐meter dash, he was very disappointed, but he ate an energy bar, drank some water, and got ready for the next event: the 5K race. Joe, one of Bob’s teammates, said he heard a couple of the runners in the next race had decided to run the first half quickly to wear out the compe11on and let the finish be just amongst themselves. When the gun went off Bob ran at his own pace, far in the rear. When the race got to the halfway point, he started passing 1red compe1tors. As he started the last lap he no1ced that there were only three people in front of him. He ran hard and passed one of them just as he crossed the finish line. He didn’t win, but that small bit of informa1on gave him a chance. It also gave him confidence for the marathon. Remember, Bob knew he was fast.
The 5K Race
Returning from our story, we see that once Bob was exposed to open communica0on from his teammates, he fared much beOer against the compe00on. The same can be applied to the world of equity compensa0on. In fact, the Execu0ve Board found that “companies rated by their employees in the top quar0le in terms of openness of communica0on have delivered TSR [results] (10-‐year TSR 1998–2008) of 7.9% compared with 2.1% at other companies.” So, not only do employees benefit from more open communica0on, but so too do companies and its shareholders.
What steps can companies take to open up lines of communica0on with employees, par0cularly with respect to equity compensa0on?
This process needs to start before an award is granted. Once a company decides to issue a performance award based upon a certain metric, the company should start to communicate to employees, shareholders, and the general popula0on. They must help everyone understand why
The goal of all performance equity is to retain and reward par)cipants while s)ll delivering value to the company and shareholders. Without effec)ve communica)on that value is lost.
“Companies rated by their employees in the top quar)le in terms of openness of communica)on have delivered TSR of 7.9% compared with 2.1% at other companies”, according to the Execu)ve Board.
his is the appropriate metric and how it 0es in with the company’s overall business plan. The company should con0nue this stance on the importance of the metric from the very beginning of the plan design all the way through its comple0on. One must “walk the walk” if he or she is going to “talk the talk.”
Addi0onally, if the company is going to change its focus on certain performance metrics or adopt a completely new plan design, we find it helpful for companies to perform a detailed “kickoff presenta0on.” In this presenta0on, the company should go through the design and inner workings of the plan’s specific details. Examples of hypothe0cal payouts should be included, both on the posi0ve and nega0ve ends of the plan. Addi0onally, it may help to explain the external factors contribu0ng to the plan’s design, such as shareholder pressure, changing business goals, or a desire to become a leader in corporate governance. Companies can perform these presenta0ons internally, with the help of an external consultant or with the support of cross-‐func0onal teams from across the business, and in our experience, both forms of assistance produce posi0ve employee reac0ons.
Some companies have also started to provide more concise award agreements and plan summaries. They create simple documents that present informa0on in a clear manner, rather than using generic, wordy legal language. This helps employees understand the design of the plan, its metrics, and the award opportunity, plus it creates a more direct link between performance expecta0ons, goals and behaviors that can drive desired outcomes. It should be noted that one can also be too detailed and lose the aOen0on of employees. As such, documents should try to be as clear as possible without providing excessive informa0on. Part of the solu0on in this case is to understand your various audiences. Communica0on should be tailored to different groups based on their experience and knowledge of company opera0ons.
Kickoff presenta)ons and detailed award agreements can really help the par)cipants not only understand the terms of the award, but also the goals of the company.
A Runner’s Tale Con/nued...
The marathon was the first race of the next day. Bob used some of this 1me to study his compe1tors. More importantly he worked on a race strategy. He spoke to his coach and other coaches about the best approach to the race course. He recruited friends to stand at every mile marker and give him his 1me and those of his compe1tors. His friends recruited their friends and random crowd members to fill the gaps and cheer whenever Bob passed by. When the gun went off Bob focused on both strategy and execu1on. The crowd cheered and his adrenaline rushed. Bob felt faster than ever.
The Marathon
Between finishing the 100 yard dash in last place and star0ng the marathon with extreme confidence, Bob learned that beOer informa0on leads to valuable insights that could help him perform at a high level. However, now Bob is taking his communica0on to an en0rely new level. He does not just want to understand the complexi0es of the race and his opposi0on at the start; he also wants to understand how he is performing during the race. This type of informa0on will allow him to understand exactly what he needs to do in order to be successful as the race progresses.
We also observe employees responding well to this sort of in-‐game informa0on, allowing them to understand exactly where they stand on performance goals during performance periods. In fact, Aon HewiO recently released a new study linking employee engagement levels with financial performance. The study found that “organiza0ons with high levels of engagement con0nue to outperform the overall stock market index and posted total shareholder returns 22% higher than average in 2010.” Furthermore, companies with lower levels of engagement yielded TSRs that were 28% lower than the average. This even held true during more vola0le financial 0mes. To sum this
Frequent consistent communica)ons ensure con)nued par)cipant alignment and evolu)on. Long-‐term incen)ves require long-‐term execu)on.
up, when employees are ac0vely engaged in companies, the companies perform beOer, and the best way to keep employees engaged is to communicate performance and goals o=en and progress towards the desired outcomes.
So what are companies doing to maintain constant and open streams of communica)on with employees?
Many companies have started to improve their internal compensa0on communica0on. One major technology company created a series of short, animated videos to explain the basics of equity compensa0on. You’ll have to see the videos to believe it, but they make learning about equity quick, easy and entertaining. Another well-‐ known technology company holds a presenta0on on annual performance awards at the 0me of grant for all employees every year, going through the plan specifics in detail. Addi0onally, this company then calculates performance levels quarterly, releasing a statement to employees to show where they stand and how much 0me is le= in the performance period. This informa0on is also provided to the Compensa0on CommiOee to ensure appropriate plan governance. The plan is also reported in the company’s annual proxy filing to inform shareholders on the design of execu0ve awards.
Some companies have also hired outside consultants to oversee the ongoing communica0on of their performance plans. This includes company statements reminding employees of the importance of achieving their performance goals and where they stand. To this end, Radford has designed a web-‐based communica0on tool called PeerTracker. This tool, designed on a company-‐specific basis, allows plan par0cipants and Compensa0on CommiOee members to view real-‐0me informa0on on the company’s performance rela0ve to their comparator group on a daily basis. Similarly, Performensa0on also offers assistance with tracking data for financial and opera0onal goals and communica0ng messages for performance programs. Whether the metric is TSR or a financial or opera0onal measure, high-‐performing companies use frequent and consistent communica0on of performance to reinforce goals and drive toward successful outcomes.
A Runner’s Tale Con/nued...
Bob’s running of the marathon went well. At the first mile marker he was right on pace. Every mile marker aQer that he knew if he needed to speed up or slow down, and he knew where his compe1tors were and he received water and advice for the upcoming mile. The crowd kept cheering and the adrenaline kept rushing. As he began the final mile of the race he looked ahead and saw his coach had given the crowd a series of signs telling him exactly what he needed do in the final mile. He read as he ran and focused on tac1cs and the finish line. Bob didn’t even no1ce as he passed the runners in front of him. All he felt was the joy as he finished. SECOND! As it turns out, Bob was fast, but he s1ll had room to be even faster next 1me
The Conclusion
With real-‐0me informa0on, Bob was able to adjust his tac0cs and change his behavior to boost his level of performance. The informa0on filtered to him through his different communica0on channels gave him a compe00ve advantage and the constant reminders of his performance mo0vated him through to the finish.
Companies can give their employees the same opportuni0es Bob had by simply establishing effec0ve communica0on processes. It needs to start at the very beginning, even before you design your plan, and follow through to the conclusion of the performance period and the final determina0on of final payouts. Mul0ple studies show there is a connec0on between effec0ve communica0on and company performance. The company may not finish at the very top every 0me, but they are likely to have a more engaged workforce, mo0vated to do their best. This can result in a compe00ve advantage.
Providing par)cipants with milestones throughout the performance cycle allows them to help understand the company’s performance and manage their own success.
To contact the authors of this ar0cle, please write to Dan Walter at [email protected], Terry Adamson at [email protected] or Daniel Kapinos at [email protected]. Dan is the President and CEO of Performensa0on and is located in San Francisco, CA. Terry is a Partner in Radford’s valua0on prac0ce and is based in Philadelphia, PA. Daniel is a Senior Consultant in Radford’s valua0on prac0ce and is based in Radnor, PA.
About Performensa)on
Since 2006 Performensa0on has focused on providing high performance compensa0on plans for publicly-‐traded and privately-‐held companies. As a recognized industry thought leader, we learn as much as possible about your company to diagnose the founda0ons of success. We then apply this knowledge to custom-‐fit solu0ons. We offer assistance in tracking and monitoring complex performance metrics and collaborate with leading firms such as Radford to ensure access to best of class equity valua0on and TSR metric tracking. Our plan design and communica0on services deliver structure and messaging that align your goals, culture and vision with holis0c compensa0on programs.
About Radford
Radford is the industry leader, providing advice and benchmarking to technology and life sciences companies to address their toughest HR and rewards challenges: aOrac0ng, engaging and retaining talent. Our advisors provide industry-‐specific exper0se, applying an analy0cal approach that integrates market data, trends and our experience in working with more than 2,000 companies – from Global 1000 firms to start-‐ups – to balance the needs of execu0ves, employees and shareholders. Our advice is customized to a client’s unique situa0on to ensure your rewards programs are not just compe00ve -‐ but can be a compe00ve advantage.
Radford’s uniquely data-‐driven perspec0ve is why more technology and life sciences companies, and their Board of Directors and Compensa0on CommiOee, trust Radford for compensa0on data and advice than any other firm. Radford clients rely upon our global survey databases of nearly five million incumbents for real-‐0me insight on total compensa0on levels, prac0ces and emerging trends to inform their HR and reward strategies.
Headquartered in San Jose, CA, we have professionals in Bangalore, Beijing, Boston, Brussels, Chicago, Frankfurt, Hong Kong, London, New York, Philadelphia, San Francisco, Shanghai and Singapore. Radford is an Aon HewiO company. Visit www.radford.com, or for more informa0on, contact [email protected].
About Aon HewiY
Aon HewiO is the global leader in human resource solu0ons. The company partners with organiza0ons to solve their most complex benefits, talent and related financial challenges, and improve business performance. Aon HewiO designs, implements, communicates and administers a wide range of human capital, re0rement, investment management, health care, compensa0on and talent management strategies. With more than 29,000 professionals in 90 countries, Aon HewiO makes the world a beOer place to work for clients and their employees. For more informa0on on Aon HewiO, please visit www.aonhewiO.com.
About Aon
Aon plc (NYSE: AON) is the leading global provider of risk management, insurance and reinsurance brokerage, and human resources solu0ons and outsourcing services. Through its more than 61,000 colleagues worldwide, Aon unites to empower results for clients in over 120 countries via innova0ve and effec0ve risk and people solu0ons and through industry-‐leading global resources and technical exper0se. Aon has been named repeatedly as the world's best broker, best insurance intermediary, reinsurance intermediary, cap0ves manager and best employee benefits consul0ng firm by mul0ple industry sources. Visit www.aon.com for more informa0on on Aon and www.aon.com/manchesterunited to learn about Aon's global partnership and shirt sponsorship with Manchester United
About the AuthorsPerformensation Contacts:Dan Walter, President and CEO +1 (415) 625-3406 [email protected]
Mel Jameson, SVP+1 (415) 625-3406 [email protected]
Radford Contacts:Boston OfficeEd Speidel, Partner +1 (508) 628-1552 [email protected] Buyniski, Partner +1 (508) 628-1553 [email protected] Surdel, Associate Partner +1 (508) 628-1551 [email protected]
Philadelphia OfficeTerry Adamson, Partner +1 (215) 255-1802 [email protected]
New York OfficeRam Kumar, Director +1 (212) 441-2007 [email protected]
San Diego OfficeKen Wechsler, Director+1 (858) 755-8675 [email protected]
San Francisco OfficeLinda E. Amuso, President +1 (415) [email protected] Knopping, Partner +1 (415) 486-7122 [email protected] Burg, Associate Partner +1 (415) 486-7137 [email protected]
San Jose OfficeBrett Harsen, Associate Partner
+1 (408) [email protected]
LocationsBangalore, Beijing, Boston, Brussels, Chicago, Frankfurt, Hong Kong, London,New York, Philadelphia,San Francisco, Shanghai and Singapore