Our last pay-for-performance update for the S&P/TSX 60 companies noted that the year-to-date performance trend was ahead of 2016 for most financial metrics, with results in line with investment analysts’ expectations. For more details of our last analysis, see “Second-quarter pay-for-performance update for the S&P/TSX 60 companies: high expectations,” Executive Pay Matters, October 6, 2017.
Figure 1 compares the first nine months of 2017 to the first nine months of 2016. Overall, the scorecard shows significantly stronger financial performance for top- and bottom line results, returns and cash flow. While total shareholder return (TSR) has improved since our last update, it is still tracking below 2016, setting the stage for challenging pay-for-performance discussions given the disparity between financial performance and shareholder returns. This serves as a reminder about timing differences between financial and market-based results: clearly in 2016 the market began to anticipate 2017’s performance uptick.
Figure 1. S&P/TSX 60 scorecard
Figure 2 shows notable earnings growth in 2017 across the various economic sectors. The energy, consumer staples, industrials and financials sectors show significant improvement over 2016 and the consumer discretionary sector shows a more modest improvement. Only two sectors are trailing 2016 performance: materials and technology.
Figure 2. S&P/TSX 60 EBIT growth by sector
Earlier this year, we reported that bonus payouts for 2016 performance increased from 2015 and trended above target. For more details, see “Pay-for-performance update for the S&P/TSX 60: pay for 2016 performance,” Executive Pay Matters, August 16, 2017. At first blush, year-to-date results could indicate an even stronger year for annual incentive plan payouts. But if we go back to the beginning of 2017, we see that expectations for the year were high and, in most cases, higher than the trajectory of year-to-date results. Assuming incentive plan goals were set at or near the robust analysts’ expectations at the start of 2017, many plans could track at or below target. So despite the strong results through the first three quarters, bonuses could be less robust than suggested by the trend from 2016 to 2017, because expectations were higher when goals were set.
Figure 3 shows that the majority of sectors in 2017 are experiencing less robust shareholder returns in 2017, attributable no doubt to the market beginning to account for the bounce back in 2016. Through the end of November, the S&P/TSX 60 was up 8% compared to 31% over the corresponding period in 2016.
Figure 3. S&P/TSX 60 TSR through November 30 by sector
Looking ahead to 2018, Figure 4 shows that analysts’ earnings estimates for 2018 are generally below 2017 growth results through the first three quarters. Analysts are predicting EBIT growth in excess of 10% for the materials, energy and industrials sectors, which portends robust incentive plan goals.
Figure 4. S&P/TSX 60 estimated 2018 EBIT growth vs. 2017
Meanwhile less robust EBIT growth is expected for the consumer staples, technology, financials, and consumer discretionary sectors, suggesting a delicate balance in setting incentive plan goals that balance attainability and reach.
- Goals that are too modest may risk overpaying for mediocre performance, potentially catching the ire of shareholders and proxy advisors in 2019.
- Goals that are too difficult risk making the plan irrelevant and potentially alienating employees if results falter early.
Now more than ever, it makes sense to consider a more rigorous approach to understanding the probability of future performance. Predictive analytics can help calibrate the levels of challenge for incentive plan goals, and payout attached to those goals. They provide a quantitative method of establishing financial performance targets and ranges (built from a combination of historical actual results, future analyst expectations and tempered with management plans), which facilitates a more thorough discussion between the board and management. Willis Towers Watson helps companies calibrate incentive plans goals using predictive analytics, namely with our proprietary predictive performance model (PPM). To learn more about our model, follow the link here.
Ming Young is an executive compensation consultant in Willis Towers Watson’s Toronto office. Christina Le is an executive compensation consultant in Vancouver. Sebastién Morrissette is an executive compensation consultant in the company’s Montreal office. Email email@example.com, firstname.lastname@example.org, email@example.com or firstname.lastname@example.org.