David Outlaw, CEP
Managing Director, Valuation & HR Advisory Services
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If you’re considering changes to your long-term incentive plan, we can help you structure a new award design based on your specific business objectives. As specialists in equity compensation with a knack for analytics, we regularly work with board-level compensation consultants, management teams, and legal counsels to bring greater clarity and structure to award design initiatives.
You’ve developed a strategy for what you want to achieve in your LTIP. We help you build out the nuts and bolts on how to get there using decision modeling to strengthen recommendations. For example, should your design measure performance against a custom peer group or the entire S&P 500? We back-test and run correlation analyses to bring insight to this decision. How about setting threshold, target, and stretch return on equity (ROE) goals? We test how peers set goals and run models to calculate probabilities of achievement.
Whatever your selection, you can show your executives and compensation committee that significant rigor and evidence went into it. We’ll even help you build slides that explain the underlying analytics.
How We Help: All Designs
We work with you to do the following:
Create a Preliminary List of Design Options
From the universe of possible award constructs, the first step is to narrow down those that will suit your particular needs and circumstances. This process includes:
- Analyzing your current compensation program to identify gaps and aspirational goals
- Identifying relative priorities such as say-on pay optimization versus delivering more line of sight to award recipients
- Reviewing with you current industry trends in award design, including operational metrics, TSR metrics, hybrid designs, and other creative alternatives
- Assembling a menu of award design alternatives by flexing different terms and levers
Refine Your Selections
- Test the suitability of alternative designs via analytical modeling. Modeling may include:
- Peer firm development and correlation testing
- Metric selection and goal-setting
- Backtesting and scenario analysis to assess potential unintended consequences
- Award cost constraints and how ASC 718 valuations impact granting opportunities
- Work toward a “short list” of top award designs meriting closer consideration
Test the Designs
- Track how each design scenario will affect the proxy and participant grant quantities
- Model realizable pay to calibrate different levels of upside and downside leverage
- Refine the design to optimally balance the story in the proxy and the perceived value to executives
Assess Risks and Develop Final Recommendations
- Review potential negative surprises and ways to manage risks such as:
- Volatility in reported proxy values in the Summary Compensation Table (SCT)
- ASC 718 anomalies that may affect the SCT or give rise to other accounting surprises
- Disengagement or misunderstanding from executives
- Potential ISS scorecard problems
- Develop recommendations, considerations, and next steps for implementation of your grant design
How We Help: TSR Designs
Relative total shareholder return (TSR) awards are incredibly versatile, but also complex and prone to causing proxy or executive surprises.
We take a “levers” approach in which we unpack the various design levers, develop a short-list of competing design variations, and then model each so that you can make an informed and comparative decision:
- Scenario model the ASC 718 accounting cost to help manage the risk of issuing a depressed quantity of units or having a cost explosion in the proxy
- Back-test the cost and payouts of alternative design scenarios to paint a picture of how the award would have fared had it been issued over the past 5 to 10 years
- Perform attribution analyses so you understand the relative impact of each plan term
After arriving at an optimal award design, we assist with the ongoing performance tracking and communication of how the award is performing to the compensation committee and participants. We automate calculation of the updates through our web-based tool, AwardTraq, and also design customized total rewards statements for plan participants.
Below are some of the more common design variations and corresponding analytics we consider:
TSR Comparator Group
- Perform correlation and beta analyses to weigh the costs and benefits of using a broad market index, specialty index, your proxy peers, or some other group
- Back-test the alternative comparator groups for potential anomalies or surprises
Payout Method
- Analyze historical returns to weigh the costs and benefits of using a percentile ranking or market outperformance design
Payout Upside and Downside
- Model changes to the payout curve (e.g., 150% or 200% upside) and ease of payout levels (e.g., 75th or 85th percentile to pay out at max)
Other Creative Design Formulations
- Evaluate other design variations, such as a total value cap, absolute TSR modifier, and mandatory post-vesting holding period
How We Help: Non-TSR Designs
For designs with financial and operational metrics, we provide additional modeling in support of goal-setting and other essential design considerations.
Metric Selection
- Perform correlation analyses to compare and contrast alternative metrics (e.g., revenue, EBITDA, ROE, etc.) and their correlation with long-term shareholder value creation
- Review analyst reports and investor messaging to validate metric alignment with external expectations
Performance Period Design
- Discuss the implications of setting multiple 1-year performance targets or one 3-year target from the competing perspectives of ISS, ASC 718 grant date rules, and forecasting line of sight
- Identify design alternatives to avoid future-dated tranche values and the corresponding proxy and financial statement volatility that results
Goal Setting
- Implement empirical and simulation models to quantify and prove goal difficulty (e.g., distribution fitting and simulation modeling)
- Evaluate analyst consensus estimates to support proposed goal levels
- Collaborate with financial planning and analysis (FP&A) groups to leverage existing projections
Test Other Design Possibilities
- Model alternative award designs for hybrid awards containing both a market and performance condition
- Identify accounting policy and cost risks, and present different design possibilities to manage these risks
