Companies adjusting performance measures for incentive programsEvaluating impact of programs on risk becoming more important

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Evaluating impact of programs on risk becoming more important In response to the impact of the recession and ongoing legislative and regulatory focus on executive pay, companies are strengthening how their incentive compensation programs align with business strategies to reinforce payouts that are commensurate with performance.

Evaluating impact of programs on risk becoming more important

In response to the impact of the recession and ongoing legislative and regulatory focus on executive pay, companies are strengthening how their incentive compensation programs align with business strategies to reinforce payouts that are commensurate with performance. One of every two organizations has introduced or plans to introduce new financial performance measures to their 2010 annual incentive program, according to a new survey by Mercer.

Mercer’s 2010 US Executive Compensation and Performance survey, which is an update to a survey conducted in June 2009, assesses organizations’ decisions about executive salaries, annual and long-term incentive program design and related compensation issues. It includes responses from more than 120 employers across the US.

According to Mercer’s survey, one-third of organizations have introduced new financial measures to their annual incentive plans while another 17 percent introduced non-financial measures. Moreover, one-fifth of organizations are allowing for more discretion with their annual incentive plan payouts, indicating continued uncertainty of the economic environment. Other changes include increasing the range of performance for corresponding payout levels and increasing threshold payout opportunities. (See Figure 1).

“The demand from shareholders and legislators to tie pay to performance is not subsiding,” said Bruce Greenblatt, a partner with Mercer’s rewards consulting business. “Companies want to set credible goals that will motivate employees and satisfy stakeholders, but goal-setting remains a challenge with the economic outlook still uncertain.”

Payouts reflect the difficult year organizations faced in 2009. Almost half (48 percent) of companies expect their annual incentive plans to pay out below target or not at all. For many organizations, this is the second year with weak incentives. Just five percent of companies are planning for maximum payouts.

Long-term incentive programs
According to Mercer’s survey, long-term incentive (LTI) grant levels appear to be stabilizing. While slightly more than one-quarter (26 percent) of organizations reduced the dollar value of 2009 LTI grants relative to targets, most organizations (65 percent) awarded grants consistent with the value of historic targets. At this point in their planning, more than half (59 percent) of companies expect to deliver the same value in 2010 as 2009 while 24 percent are still finalizing their plans.

Of those organizations that reduced LTI grant values relative to targets in 2009, actions for 2010 are split between restoring cuts (27 percent), maintaining grant levels (31 percent) and being undecided about making adjustments (31 percent).

“Equity compensation has been a hot topic this past year and discussions now are focusing on how to link long-term incentive awards with performance,” said Mr. Greenblatt. “This is particularly important since shareholders are interested in how companies are positioning themselves for recovery as the economy stabilizes.”

When considering long-term incentive design, however, the pace of change appears to be slowing. As indicated in Mercer’s June 2009 survey, nearly two-thirds of companies made at least one change to their LTI programs, while only about one-quarter anticipate making changes in 2010. “Companies made a number of changes to their programs in 2009 in response to the equity market downturn and economic downturn,” explained Mr. Greenblatt. “They’re now taking a breather and looking for some more stability in their programs.”

Other compensation issues for 2010

Mercer’s survey also assessed other compensation issues with respect to incentive programs. Among the findings:

* Risk assessment: Assessing risk in incentive plans has become a hot issue over the past 18 months. More than one-third (36 percent) of organizations have completed or plan to complete such an assessment. According to Mr. Greenblatt, the disclosure requirement related to risk in compensation policies and programs issued by the Securities and Exchange Commission (SEC) will prompt more organizations to conduct risk assessments. “Companies will be validating whether their programs, particularly incentives, and pay program governance leads to inappropriate risk-taking. This will provoke them to assess whether the design of their plans, performance measures and performance targets are aligned with the underlying business risks of the company.”

* Say on pay: Despite reports of “say on pay” – a nonbinding shareholder vote on executive compensation – becoming more prevalent, less than one-quarter (19 percent) of companies has adopted or is considering adopting it for 2010.

* Mandatory deferrals: In response to the financial services sector situation, organizations are discussing steps to mitigate excessive risk-taking. Although requiring all or a portion of annual incentives to be paid in stock that would vest over time is one option talked about (and implemented in some financial service organizations), Mercer’s survey shows that it is not a trend in other sectors. Only four percent of companies outside of the financial sector indicated they had or were considering such a feature.

About Mercer
Mercer is a leading global provider of consulting, outsourcing and investment services. Mercer works with clients to solve their most complex benefit and human capital issues, designing and helping manage health, retirement and other benefits. It is a leader in benefit outsourcing. Mercer’s investment services include investment consulting and multi-manager investment management. Mercer’s 18,000 employees are based in more than 40 countries. The company is a wholly owned subsidiary of Marsh & McLennan Companies, Inc., which lists its stock (ticker symbol: MMC) on the New York, Chicago and London stock exchanges.

For more information, visit www.mercer.com.

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