Page 497 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 8. Long-Term Incentives 483

What a number of companies have done is establish consecutive three-year plans with a
potential payout each year as one of the three plans matures. Installing consecutive three-year
plans requires one-year and two-year phase-in plans for each. After the second year, each
payment is for a three-year period. Unless there is a need for a significant increase in
compensation, this approach also allows a gradual buildup in compensation as well: one-third
of the increase the first year, two-thirds after the second, and only after the third year is
the full increase in effect. For companies that are fully competitive and merely changing
emphasis within the elements, this allows a three-year wind-down of other elements.
Additional advantages of such an approach include (1) annual adjustments for candidates
rather than several years of waiting, (2) increased retention factor since portions of two awards
(i.e., a one-third and a two-thirds) are always outstanding, (3) a smoothing of payout from one
year to the next, and (4) the unlikelihood of business journals adding these annual payments
to salary and short-term incentive payments in reporting annual compensation (since they are
attributable to three years’ performance). The impact of the annual payout of multiyear
performance versus the single-year payout is demonstrated in Figure 8-6. After six years, both
plans have paid out the same amount, but the impact on total pay during each of the last six
years is quite different. Unfortunately, this type plan results in a double whammy to the
earnings statement under FAS 123R: the denominator will be increased by the number of
shares issued, and the numerator will be decreased by the fair-value expense charge.

$
Annual Payout Period End Payout Yrs

4-6
Yrs

Yrs Yrs Yrs Yrs
Yrs
1-3

1-3 2-4 3-5 4-6
1+2
1
1 2 3 4 5 6 7 1 2 3 4 5 6 7
Figure 8-6. Annual vs. periodic payout under multiyear plans

Regardless of when payment is made, the annual payout requires the ability to quantify objec-
tives with varying degrees of plus-and-minus performance over several years. Not surprisingly,
most plans provide some form of adjustment in objectives while the plan is operating. While this
is necessary to offset interim changes in accounting and tax treatment, it will be tempting to adjust
for business conditions, too—and possibly defeat the purpose of the plan. Indeed, some critics
claim that a good incentive plan is invariably adjusted after a bad financial year.
While it is logical to adjust targets when conditions outside the executive’s control
dictate, it is important to resist changing simply because of the manifestation of normal