Our last update highlighted an upward performance trend for companies in the materials sector in 2016. The second-half turnaround improved financial results compared to both the first half of 2016 and 2015 full-year results. For a more detailed analysis of the sector’s 2016 financial performance, see “Fourth-quarter pay-for-performance update for the materials sector: An upward trend,” Executive Pay Matters, March 27, 2017. Our blog this quarter explores how the improved 2016 financial results affected annual incentives for 2016 and long-term incentive plans (LTIP) that culminated in 2016.
A year ago, the bonus payouts for the materials sector were the lowest of all the sectors we reviewed, with a median payout below target (87% of target) and a lot of CEOs receiving a bonus of 50% of target or less. Improved results in 2016 elevated bonuses, as shown in Figure 1. Not only did the median payout improve to 103% of target, but a large number of CEOs, nearly one-fifth of the sample, enjoyed robust payouts of 170% of target or more. Perhaps the grim performance outlook in the first quarter of 2016 – when incentive plan goals are typically set – influenced how goals were set and helped many companies substantially beat their incentive plan targets.
Figure 1. Distribution of CEO bonus payouts in the materials sector
The distribution of 2016 bonus payouts reveals more above-target payouts: 45% of the sample above the target range (more than 110% of target) versus 33% being below the target range (90% of target or less). A closer examination reveals even more change, as most companies changed payout buckets in 2016:
- Only 17% stayed in the same payout range
- Half (50%) moved moderately: up or down by one or two ranges
- Nearly 34% realized a significant change: moving up or down by three or more ranges
The fact that almost a quarter moved up significantly suggests that many of the companies who received lower bonuses for 2015 results were rewarded for the 2016 financial rebound.
We also reviewed the results of LTIP payouts for performance awards ending in 2016 (generally launched 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 45% of the sample is at either extreme, including a number with no payouts. And almost a quarter of the sample paid out near target. But when we consider the impact of stock performance over time, the target-or-better scenarios tend to become more valuable as target-or-better performance generally combines with strong stock performance to make the payouts more valuable. Including stock performance, 51% of plans paid out above the target range (more than 110% of target), compared to 34% above target when stock gains are excluded. We also see more plans in the top bucket (more than 170% 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 45% of the LTIP awards in the top or bottom bucket compared to only 36% of the bonus awards. Perhaps that’s why some companies simply opt to use relative total shareholder return in their long-term incentives. But 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 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 materials sector still faces headwinds in 2017: Increased domestic production capacity and large inventory stockpiles may reduce demand from China; and the persistent strength of the U.S. dollar continues to hinder exports and increase labor costs. However, investors anticipate tailwinds as well: An end to the decline in commodity prices, increasing demand from the developing world and fiscal stimulus. Stay tuned for our next sector update which will illuminate mid-year performance and provide a preliminary sense of whether 2017 will continue the upward trend. 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.
Chris Kozlowski is an executive compensation consultant in Willis Towers Watson’s Pittsburgh office, and Louise Martin is an executive compensation consultant in the company’s Minneapolis office. Email firstname.lastname@example.org