A good metric is only the start of an effective performance-based incentive plan

Did you know? 

Short- and long-term incentive programs are intended to align the economic interests of the company and its executives. Plan designers need to ensure:

• The performance metrics are relevant to the objective;
• Each metric is appropriately weighted;
• The performance standards for each metric (threshold, target, and maximum) are based on achievable, value-creating goals;
• The metrics are measured over an appropriate time horizon; and
• The potential rewards encourage the executives to work towards the highest level of achievement.

These conditions are codependent. To be effective, the performance objectives for even a simple plan with a single performance metric must be calibrated to ensure a fair tradeoff between the performance target and the associated payout.

• What range of performance outcomes should the plan reward? Where should the threshold cut in, and at what point should the incentive max out?
• At what level should the performance be measured? Corporate or business unit?
• How should the performance be evaluated? On an absolute basis, or relative to a peer group?

Each additional performance metric in the mix increases the plan’s complexity:

• Collectively, does the combination of performance metrics make sense? Do they complement each other or merely duplicate each other?
• How do the metrics influence each other in the incentive program?
  • Are the metrics independently arrayed, with the sum of weightings adding to 100%?
  • Is one performance objective used to increase or decrease the payout earned for another?
  • Do the results on a performance metric determine the size of the overall incentive pool?
  • Are payments of any kind triggered only if a designated metric meets or exceeds a specified performance level?

Analyzing your peers’ short- and long-term incentive awards provides essential insight into the competitive landscape. Taken together, five elements—metrics, weightings, performance terms, performance threshold/target/maximum ranges, and associated payouts—provide a complete picture of each peer’s incentive program. A side-by-side comparison of the peers succinctly distinguishes common from unusual features and shows how the elements interact. Ultimately, this insight can provide strong market corroboration for fine-tuning your own incentive plans.

MDG’s revised plan-based awards report provides a rigorous framework for analyzing your peers’ incentive plan designs. It cuts through a lot of the clutter typical of CD&A descriptions to focus on the essential elements of incentive plan design:

• Each metric is identified, and metrics with business unit goals are flagged;
• Detail is provided about how the various performance criteria interact (e.g., weightings, incentive gates/funding triggers, multipliers);
• Performance ranges and the degree of “stretch” between threshold and target or target and maximum performance levels is shown;
• There are separate exhibits for short- and long-term plans; and
• The associated payouts for each level of performance is shown.

While this report will still include more granular data available for analyses, our newest version of the plan-based awards report showcases the five criteria that are most essential to incentive plans. This information is presented in a display that easily permits comparison between peers and executives.

The new version can be accessed now by clicking on “plan-based awards” under the reports section of the peer group’s plan-based awards drop-down menu. Users who prefer to migrate more slowly can still access the older version under the title “plan-based awards (legacy)” in the drop-down list of reports.