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Article | Executive Pay Matters

Industrials sector 2018 pay-for-performance update: earned incentives trended above target

Executive Compensation
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By Alex Ha and Delphine Habarov | July 16, 2019

Annual incentive payouts trended higher for the industrial sector in 2018. The median CEO bonus rose to 120% of target for 2018 compared to 115% of target in 2017 (on a consistent CEO basis). This is higher than the overall trend of the S&P 1500, which was 115% for 2018.

As we detailed in our last blog (“Pay-for-performance industrials update: strong 2018 financials expected to downshift in 2019Executive Pay Matters, April 2, 2019), 2018 performance was strong. Across both the income statement and statement of cash flows, the sector posted improvements in key metrics such as revenue growth, earnings before interest and taxes (EBIT) and cash-flow growth. However, balance sheet metrics remained relatively stagnant year-over-year, and total shareholder return struggled along with the broader market.

Across all three financial statements, the industrials sector performed well relative to the consensus analysts’ expectations in early 2018, which impacted annual and long-term incentive plan (LTIP) payouts. Revenue and EBIT, both common bonus plan metrics, managed to outpace expectations, and return on equity met analysts’ estimates. Although cash flow and EPS fell short of high expectations, performance was strong on a standalone basis, posting double-digit growth figures year-over-year.

Annual incentive payouts

Figure 1 compares the distribution of annual incentive payouts (as a percentage of target) for 2018 and 2017. The median CEO bonus rose from 115% to 120% of target for 2018. What’s notable is that about 58% of the CEOs earned above the target range (more than 110% of target) in 2018. In comparison, 18% earned with the target range (90% to 110% of target) and only 25% earned a bonus payout below the target range (90% of target or less) in 2018.

Even though the median payout only increased by five percentage points, 65% of the companies changed payout buckets in 2018 versus 2017.

  • Only 35% stayed in the same payout range.
  • 43% moved moderately: up or down by one or two ranges.
  • 22% 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. The median LTI payout increased from 100% of target in 2017 to 118% of target in 2018.

For plans ending in 2018, we observed significantly more companies paying out above the target range: 59% earned more than 110% of target in 2018 compared to 43% for 2017, driven by an important increase of payouts above 170%. Payouts below 90% decreased significantly (26% in 2018 versus 43% in 2017).

We also observed variation in LTIP payouts at the company level, as only 31% stayed in the same payout range in 2018.

  • 44% moved moderately: up or down by one or two ranges.
  • 24% 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 sector’s 2019 growth expectations are softer than we’ve seen over the last few years, largely influenced by the uncertainty of the escalating trade concerns between the U.S. and China. However, the potential for further adoption of digital technology coupled with relatively cash-rich balance sheets that could spur investment are reason for optimism that the sector could grow.

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 through 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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