The Advisors' Blog

– Melissa Means, Pearl Meyer & Partners

Absolute performance goals are specific targets against which future performance is measured. Typically linked to the company’s business strategy; they are relatively easy to measure and communicate; are consistent with shareholder expectations of typical practices; and give plan participants a strong sense of control and influence. For example, a company might set an absolute goal of $1B in revenue from a starting point of $900M, with achievement based on actual revenue at the conclusion of the performance period. The downside is that absolute goals rely heavily on effective planning and forecasting and also may create an incentive for executives to set lower goals to increase their chances of a payout.

In contrast, relative performance goals measure company performance against a group of peers or a company index. For example, a performance-based LTIP might require performance in the first quartile relative to a group of 20 peer group companies, based on revenue growth for the performance period. Such comparative performance assessments tend to be motivational in both good years and bad, with the greater likelihood of payouts even in a down year likely to aid retention. While suited to longer performance periods, relative metrics are more sensitive to changes in the composition of the comparator group or the alignment of different companies’ fiscal year-end. Relative measures also can be more difficult to communicate to a broad-based population, while outcomes may be inconsistent with investor expectations, the company’s cash flow or its ability to pay out the awards.

Generally speaking, companies that are facing significant change and prefer a performance-based LTIP with a one-year performance period would be better off using absolute metrics, while a similar company facing significant change that is measuring results over two to three years may prefer relative performance measures.