Our last update highlighted that while 2016 financial results in the industrials sector generally lagged those of 2015, investment analysts were optimistic about 2017. For a more detailed analysis of the sector’s 2016 financial performance, see “Fourth-quarter pay-for-performance update for the industrials sector: Optimistic outlook,” Executive Pay Matters, March 27, 2017. This quarter our blog explores how modest 2016 financial results affected annual incentives and long-term incentive plans (LTIP) that culminated in 2016.

A year ago, the bonus payouts for the industrials sector ran parallel to overall S&P 1500 results, with a median payout marginally over target (101% of target) and many CEOs receiving a payout around the target range (90% to 110% of target). This year, bonus payouts for the industrials sector remained stagnant with a median payout of 100% of target, though fewer CEOs received payouts around the target range. While results in 2016 trailed 2015, slightly more CEOs received bonus payouts above the target range, though fewer received payouts of 170% of target more, as shown in Figure 1. Based on the pay and performance results of the sector, it would appear that the goals set for 2016 were not appreciably more challenging than those for 2015.

Figure 1.  Distribution of CEO bonus payouts in the industrials sector

Figure 1.  Distribution of CEO bonus payouts in the industrials sector
 
The distribution of 2016 bonus payouts reveals comparable payouts above and below target: 43% of the sample above the target range (more than 110% of target) versus 40% being below the target range (90% of target or less). A closer examination reveals that most companies changed payout buckets in 2016:

  • Approximately a third of companies (31%) stayed in the same payout range
  • Half (50%) moved moderately: up or down by one or two ranges
  • Nearly one-fifth of companies (19%) realized a significant change, moving up or down by three or more ranges

We also reviewed the results of LTIP payouts for performance periods ending in 2016 (mostly granted in 2014). We compare the award payout to the award target in two ways: the LTIP payout without the impact from the change in stock price on share-based plans, and the LTIP payout with the effect from stock price. Figure 2 shows the distribution of these outcomes.

When payouts are examined without the change in stock price, we notice about a quarter of the sample at the low end of the spectrum, and another large grouping right around target (20%). If we consider the impact of stock performance over time, target-or-better scenarios tend to become more valuable as we would expect those payouts to generally be correlated with strong stock performance, which increases the gain achieved from share awards. Including stock performance, which was strong during the second half of 2016, 51% of plans paid out above the target range (more than 110% of target), compared to 38% above target when stock gains are excluded. We also see double the amount of plans in the top bucket (more than 170% of target). 

Figure 2.  LTIP payouts ending in 2016 as a percent of target

Figure 2.  LTIP payouts ending in 2016 as a percent of target

The high concentration of LTIP payouts at the extremes reveals the complexities of setting goals over a multi-year time horizon. Ignoring the impact of stock performance, we see 34% of the LTIP awards in the top or bottom bucket compared to 24% of the bonus awards. Perhaps that’s why some companies simply opt to use relative total shareholder return (TSR) in their long-term incentives. Despite the prevalence of TSR, there can still be challenges in customizing a LTI program that suits an individual company’s business drivers and needs.

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 developed a proprietary approach to simulate future financial and stock performance to estimate the probabilities of various degrees of goal achievement. This modeling helps companies calibrate incentive plan goals and ranges. To learn more about our predictive performance model (PPM), follow the link here.

The industrials sector still shows promise for a strong 2017: Analysts’ projections for the sector over 2017 have been increasingly positive in recent months, potentially stemming from excess cash which may increase investment and production capacity. In addition, low manufacturing inventories may indicate the potential for a rebuilding phase with end users in mind. However, potential challenges could be developing as well: rising interest rates, legislative uncertainty, and a stronger U.S. dollar which could hurt U.S. exports and profitability. Stay tuned for our next sector update which will expand on mid-year performance and provide a preliminary sense of whether 2017 results will continue to be lackluster or live up to analyst optimism. For a look at 2016 CEO pay trends in the broader S&P 1500, see “Pay-for-performance update for the S&P 1500: 2016 pay outcomes,” Executive Pay Matters, June 27, 2017.


ABOUT THE AUTHORS

Paige Patton

Paige Patton

Willis Towers Watson
Detroit

Alex Ha

Alex Ha

Willis Towers Watson
Chicago


Paige Patton is a senior executive compensation analyst in Willis Towers Watson’s Detroit office and Alex Ha is a senior executive compensation analyst in Willis Towers Watson’s Chicago office. Email paige.patton@willistowerswatson.com, alex.ha@willistowerswatson.com or executive.pay.matters@willistowerswatson.com.