Our last update highlighted the challenges faced by companies in the energy sector in 2016 and the resulting performance outcomes. The year (2016) started with a 12-year low of approximately $26 per barrel of West Texas Intermediate. But after a cycle of increases and decreases in the second half, it ended with an effective price range of $44 to $51 per barrel. For a more detailed analysis of the sector’s 2016 financial performance, see “Fourth-quarter pay-for-performance update for the energy sector: The road to recovery,” Executive Pay Matters, March 27, 2017. Our blog this quarter explores how the 2016 financial results affected annual incentives for 2016 and long-term incentive plans (LTIP) that culminated in 2016.
Bonuses paid in 2016 for the 2015 performance cycle in the energy sector were among the lowest of all the sectors we reviewed. The median payout was just below target (95% of target), and a lot of CEOs received bonuses of 50% of target or less. However, the 2016 performance cycle produced elevated bonuses, as shown in Figure 1. Not only did the median payout improve to 115% of target, but a larger number of CEOs, nearly one-fifth of the sample, enjoyed payouts of 170% of target or more. While select financials improved for the full year, it would appear that the downturn in the industry in the first quarter of 2016 — when incentive plan goals are typically set — influenced the goal-setting process.
Figure 1. Distribution of CEO bonus payouts in the energy sector
The distribution of 2016 bonus payouts reveals more above-target payouts: 53% of the sample above the target range (more than 110% of target) versus 33% being below the target range (90% of target or less). Moreover, a closer examination reveals the extent to which companies changed payout buckets in 2016:
- Only 29% stayed in the same payout range
- 39% moved moderately up or down by one or two ranges
- 32% moved dramatically up or down by three or more ranges
We also reviewed the results of LTIP payouts for performance awards ending in 2016 (generally granted in 2014). We compare the award payout to the award target in two ways: the LTIP payout without the impact the change in stock price has on the share-based plans, and the LTIP payout with the change in the stock price. Figure 2 shows the distribution of these outcomes.
When payouts are examined without the change in stock price, we notice about 67% of the sample is between 70% of target to 130% of target, with almost a quarter of the sample receiving near target. But when we consider the impact of stock performance over time, the sample of payouts at either extreme increases significantly, primarily due to the multiplier effect of stock price. Including stock performance, 19% of plans paid out in the top bucket (more than 170% of target), compared to 11% when stock gains are excluded. Similarly, 54% of plans paid out less than 70%, compared to 18% when stock gains are excluded.
Figure 2. LTIP payouts ending in 2016 as a percent of target
Setting goals over a multi-year time horizon always presents a challenge. This is especially true in the energy industry where there is so much volatility and recent history of depressed prices. This often prompts companies to turn to relative total shareholder return within long-term incentives. But we believe there may be another way.
Increasingly, companies are considering how predictive analytics can be used to help calibrate annual and long-term incentive plan goals. In response to market demand, Willis Towers Watson has developed a proprietary approach to simulate future financial and stock performance to estimate the probabilities of various degrees of goal achievement. This modelling helps companies calibrate incentive plan goals and ranges. To learn more about our predictive performance model (PPM), follow the link here.
Investment analysts’ are cautiously optimistic about the energy sector for 2017 in part based on expectations that oil prices have bottomed out, but also due to expectations that the new administration will focus on infrastructure, loosen regulations, cut taxes and help spur growth. Conversely, protectionist trade policies and a strong U.S. dollar could present complications that the sector will need to overcome. Stay tuned for our next sector update which will examine mid-year performance and provide a preliminary sense of whether 2017 will continue the upward trend in pay-for-performance awards.
For a look at 2016 pay outcomes for CEOs in the broader S&P 1500, see “Pay-for-performance update for the S&P 1500: pay for 2016 performance,” Executive Pay Matters, June 27, 2017.
John Rhew is a consulting director and the leader of Willis Towers Watson’s executive compensation consulting practice in Houston, and Ayush Gupta is a consultant in Willis Towers Watson’s executive compensation practice in Dallas. Email firstname.lastname@example.org