The Advisors' Blog

– Broc Romanek

Arthur J. Gallagher & Co. recently completed its 8th annual study of short- and long-term incentive plan design trends among Top 200 companies. Some key findings include:

Short-term Incentive Plans (STIPs):
• Of the 200 companies reviewed, 61% of companies with STIPs indicated the use of “umbrella” STIP plans (also referred to as “inside/outside” plans or “plan within a plan”), which along with prior-year results, were the highest in the past five years.
• Many companies use individual performance measures in their STIPs. Of the 198 companies with some form of a short-term incentive, including companies with umbrella plans, 27% included individual, specific objectives for one or more NEOs.
• Earnings per share (EPS) was the most common single measure in STIPs. Thirty-eight percent (38%) of companies with non-discretionary STIPs used EPS in 2015, which is slightly lower than last year (40%).
• Ninety percent (90%) of companies disclosing their STIP measures and metrics used at least one type of income-based measure in 2015, which is lower than last year (93%). This category includes EPS, net income, operating income, EBITDA, etc.
• Median performance over target was 1.4% as compared with 7.0% in 2014. Median payout was 10.8% over target as compared with 21.5% in 2014.
• Of those companies with bonus or short-term incentive plans:
o 86% used at least one financial measure.
o The remaining 14% of companies used discretion (no formula-based determination).
o In all, 64% used discretion in part or in whole in 2015.
Long-Term Incentive Plans (LTIPs):
• Continuing in 2015 and for the seventh consecutive year was the shift away from appreciation awards (stock options/stock appreciation rights (“SARs”)) and towards performance awards that are earned based on achieving performance goals.
• The collective use of performance-based awards (which includes performance shares/units, performance-based restricted stock, performance stock options, premium stock options, and long-term cash plans) totaled 95% in 2014 and 2015, up from 93% in 2013, 88% in 2012, 82% in 2011 and 77% in 2010. On the flip side, the prevalence of stock option/SAR grants, in total, has declined steadily from 82% in 2008 to 61% in 2015.
• TSR is the most commonly used performance measure in LTIPs, with 56% of LTIPs using TSR in 2015, down slightly from 57% in 2014. This measure had steadily increased in use over the past few years, from 46% in 2011, to 51% in 2012 and 55% in 2013.

LTIPs
• Similar to STIPs, some type of income measure is commonly used in LTIPs. Fifty-one (51%) of companies with LTIPs used at least one measure of income in 2015, up from 49% in 2014 but less than the 53% prevalence in 2013. Of the income measures, EPS is still used most often with 58% prevalence in 2015 as compared to 57% in both 2013 and 2014.
• The use of revenue measures was flat with 2014 at 20% of companies, up from 18% in 2013. This was just below the high of 21% over the last six years.
• Forty-seven percent (47%) of the companies used a capital efficiency measure in 2015, which has increased from 31% in 2009. This category includes return on invested capital, return on equity, return on capital, and return on net assets, economic profit, and economic value added.
• Median payout was 4.0% over target, up from 2.0% over target in 2014. For those companies disclosing results, performance was 5.0% over target as compared with 4.6% in 2014.
• Seventy-five percent (75%) of performance periods reported were three years in length. which is up from 69% in 2014. Twenty percent (20%) used one-year performance periods, down from 27% in 2014. Twenty-one percent of these plans added two or more additional vesting years to get to at least three years of vesting. Also, for those companies using one-year performance periods, over half (56%) of them set performance goals annually over a three-year period.

Thirty-eight percent (38%) of companies with STIPs and LTIPs used one or more of the same measures in both incentive programs, which is slightly more than 37% in 2014.