Long-Term Incentive Plans Best with Performance Shares

Larry Schumer, a Boston-based principal in Buck’s Compensation practice and author of the research report, said that embracing a performance model is in its early stages but the concept appears to be increasingly gaining traction. “The link between pay and performance is paramount in executive compensation plans,” Schumer asserted.

“Almost all compensation committees are at least discussing these issues,” Schumer wrote in the report. “We are still in the early stages of this movement, but it is happening quickly. As it progresses, it will be interesting to see how performance plans evolve and whether they grow to be the dominant component of total LTIP opportunities for top executives.”

Of the three types of LTIPs – performance shares, stock options, and restricted stock – Schumer most enthusiastically backs the performance shares. “Performance Shares provide the strongest link to performance,” the consultant declared. “They have been prevalent in the largest, more mature companies for many years. We give them a performance score of A because shares are earned only for attainment of specific financial goals set by the Board or Compensation Committee.”

Although noting the decreasing use of stock options in LTIPs, Schumer said options rate a “B” or “B+” because they have no intrinsic value and may never have value unless a company’s financial performance raises its stock price.

Schumer said Buck rates restricted stock a low performance score of “D” because, as a time-based award, it rewards executives “for just sticking around.” Even a stock price that drops 20% over the vesting period still provides 80% of the value for what was likely poor performance, the consultant said.

The consultant offered an example of a performance share model that sets a target number of shares that a CEO could earn for performance over a three-year period. The model could have two metrics, each equally weighted and each with a specific target – Return on Equity (ROE) over three years targeted at 12% and Total Shareholder Return (TSR) over three years against a peer group at the 55th percentile.

The report is available here .