The Advisors' Blog

Last week, Dave Schmidt blogged about the challenges of disclosing metrics. Based on my experience, trying to establish a three year financial target to be used in a long-term incentive plan (LTIP) can be very challenging. Some companies will use – or consider – using relative financial performance, figuring “if we perform at least as well or better than our peers, we deserve to be paid our LTIP award.” While the use of relative financial performance is very appealing – as it avoids the need to (a) establish three year financial targets and (b) disclose targeted financial results in the CD&A – there are many practical challenges, including:

1. What measure(s) should be used?
2. Who is the relevant peer group?
3. Do we rely on reported results or make adjustments for unusual items?

Relative financial measures – such as EPS and revenue growth, 3-year average ROIC and ROE, etc. – may all provide a useful gauge about how well the company is doing relative to peers. However, depending on a company’s particular strategy, relative results may fall below the peer group median.

For example, a company may be willing to give up a little ROIC to attain higher revenue growth. Similarly, a bottom quartile ROIC performer may need to focus on profit improvement to exit the profitability cellar. As a result, revenue growth may be negative. Thus, the selection of the right relative financial measure must support the company’s business objectives.

Also, relative performance – particularly EPS growth – can be significantly impacted by your starting point. For example, if a company barely broke-even last year, any improvement will yield a large percentage increase in EPS, vaulting the company to the upper quartile of its peers. Not many compensation committees are willing to pay maximum incentives for an increase in EPS of $.03 to $.06, even though it represents 100% growth and 90th percentile relative performance. More thoughts to come…

– Mike Kesner, Deloitte Consulting