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Article | Executive Pay Memo North America

Health care equipment and supplies industry 2018 pay-for-performance update: improved incentive payouts tied to strong performance outcomes

Executive Compensation

By Mitchell Bardolf and Min Ko | July 16, 2019

The health care equipment and supplies industry experienced strong pay and performance alignment in 2018, with robust performance leading to above-target annual and long-term incentive (LTI)  payouts.

Continued pricing pressure is likely to be offset by economies of scale achieved through mergers and acquisitions, with consistent revenue growth buoyed by increased demand from a larger elderly population.

Annual incentive payouts for 2018 performance exceeded those for 2017 performance. The median CEO bonus rose to 120% of target for 2018 compared with 110% of target in 2017 (on a consistent CEO basis). This outcome slightly surpassed the S&P 1500, which was 115% for 2018.

As we detailed in our last blog ("Pay-for-performance health care equipment and supplies update: a rebound in 2018, but softened expectations in 2019", Executive Pay Matters, April 2, 2019), 2018 performance was strong. Strong revenue growth combined with improving profit margins to enhance the income statement. Returns on assets and cash flow also ticked up. Despite the strong financial performance, price/earnings valuation ratios declined with the broader market, keeping total shareholder returns (TSR) in the single digits. However, the industry’s overall TSR of 6% still outperformed the overall S&P 1500 performance (-5%).

While the industry met revenue growth expectations from the start of 2018, results for other common incentive plan metrics such as earnings before interest and taxes, earnings per share, cash flow and return on equity all trailed consensus analysts’ expectations. Despite growth outcomes falling below expectations, annual and long-term incentive plan (LTIP) outcomes for the majority of industry CEOs paid out above the target range. This begs a question about the rigor with which management and boards forecast and calibrate optimal target goals and ranges to ensure the alignment of pay and performance.

Annual incentive payouts

Figure 1 compares the distribution of annual incentive payouts (as a percentage of target) for 2018 and 2017. The median CEO payout for 2018 of 120% of target reflects a rather noticeable increase compared to 2017 (110% of target). This outcome is likely driven by an increase in the percentage of CEOs earning 130% to 150% of target (increased to 26% from 15%) and a decrease in the percentage of CEOs earning a payout of 70% to 90% of target (decreased to 4% from 11%). Payout outcomes were otherwise generally consistent.

Dynamic incentive payouts over time continue to be the norm: 70% of the sample changed payout buckets in 2018 versus 2017.

  • Only 30% stayed in the same payout range.
  • 44% moved moderately: up or down by one or two ranges.
  • 26% realized a significant change: moving up or down by three or more ranges.

LTIP payouts

We also reviewed how LTIPs that culminated in 2018 and 2017 paid out, as illustrated by Figure 2. While the median payout was still above target, the 2018 payout (114% of target) reflects a slight decrease compared to 2017 (120% of target).

For plans ending in 2018, we observed more companies paying out below the target range: 34% earned less than 90% of target in 2018 compared to 20% for 2017. While the number of companies paying out above 110% of target remained fairly consistent overall (61% in 2018 versus 58% in 2017), the distribution of payout outcomes shifted fairly significantly. We continue to see more LTI payouts at the extremes than for annual incentives, which further underscores the complexities of setting goals over a multiyear time horizon.

Changes in the LTIP payouts are rather noticeable on a year-over-year basis:

  • 20% stayed in the same payout range in 2018.
  • 60% moved moderately: up or down by one or two ranges.
  • 20% moved significantly (up or down by three or more ranges).

It’s important to also note that since most long-term performance plans pay in stock, the value of the awards upon vesting is amplified, i.e., above-target payouts are generally worth even more due to rising stock prices, whereas below-target payouts tend to suffer from weaker stock prices.

The industry’s 2019 growth expectations have generally weakened relative to 2018. With continued pressure to control cost within the overall health care industry and an ever-changing regulatory environment, particularly in overseas markets, companies will be challenged to control costs and still deliver innovative products and solutions.

How did your incentives pay out for 2018? Do participants and investors agree that payouts are appropriate? Pay for performance is a perennial challenge. Willis Towers Watson has developed deep analytics to help our clients choose the right metrics, set the right targets and calibrate the appropriate range of goals and payouts around the target. If you need to rethink the incentives your company provides, consider how predictive analytics can elevate your company’s pay-for-performance programs (follow this link to learn more).

Next quarter’s blog will explore performance for the first half of 2019, providing preliminary insights into potential 2019 incentive plan payouts. For a look at 2018 pay outcomes for CEOs in the broader S&P 1500, see “S&P 1500 pay-for-performance update: 2018 incentive plan payouts trend above target,” Executive Pay Matters, July 16, 2019.

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