Short-term Performance Incentives for Executives

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Short-term Performance Incentives for Executives

• Performance Incentives for Executives Managers
• Incentive Timing
  Reward
• Bonus lt 12 months
  Cash
• Long-term Incentive 2-5 years Stock
  or Cash
• Short-term Performance Bonus
• Basis individual or team of managers
• Contingency Meeting or exceeding Performance
  metrics (choice before or after the fact).

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Short-term Performance Incentives for Executives
(Halloran, M., ACA Journal, 1998)

• Designing Short-term Performance Incentives
  Things to Consider
• 1. What is strategically important during the
  measurement period?
• 2. How important is the bonus vis a vis salary
  and LTIs?
• 3. What factors can the CEO or SBU managers
  influence?
• 4. What can be measured?

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Short-term Performance Measures

• Financial Measures - tied to accounting and/or
  market performance goals.
• 1. Earnings measures
• EPS - very popular measure of financial
  performance does not reflect cash flow.
• Operating Income, Net Income - measure of total
  profits in a time period. Can be manipulated by
  making optimal accounting choices.
• Cash flow - total cash generated from business,
  takes appreciation, amortization into account.

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Short-term Performance Measures (Halloran, ACA
Journal 1998)

• 2. Returns to Financial Investments
• ROE - return on equity. Reflects efficient use
  of stockholders investments. Uses book value of
  equity.
• ROCE - return on capital employed. Means return
  on total capital regardless of source of
  financing - can be equity or debt. Used in
  capital intensive industries.
• ROS - return on sales. Captures efficiency of the
  selling/producing process. Does not consider
  investment in business.

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Short-term Performance Measures (Halloran, ACA
Journal 1998)

• 3. Value-based Financial Measures - accesses the
  income of a business relative to capital
  invested. Takes into consideration business risk.
  More closely aligned to market values than other
  financial metrics. Avoids book values that
  financial returns measures use reflecting initial
  purchase of assets.
• EVA - economic value added.
• Formula Net Operating Income After Taxes -
  investment in assets X weighted average cost of
  capital.

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Short-term Performance Measures

• Non-Financial Performance Measures - related to
  value chain, non-financial strategic objectives
• 1. Value Chain Activities - customer service,
  product development, productivity, etc.
• Customer service - customer satisfaction, cycle
  time
• Product development - new products, patents,
  revenues from new products
• Productivity - quality (six sigma), cycle time,
  unit output costs (labor productivity,
  utilization of raw materials, overhead, etc.)

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Applying the Performance Measures with the
Balanced Scorecard Approach (Kaplan Norton,
HBR, 1992)

• Balanced Scorecard - approach to evaluate
  performance of executives using a blend of
  financial and non-financial measures. It tries
  to align the performance objectives and rewards
  of executives with both strategic goals and
  shareholder goals.
• 1. Balanced scorecards are more likely to be
  used for short-term goals.
• 2. Different weights are given to different
  objectives.

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Applying the Performance Measures with the
Balanced Scorecard Approach (Kaplan Norton,
HBR, 1992)

• Balanced Scorecard Performance Measures are
  Derived from Specific Strategic Goals
• 1. Financial Measures
• 2. Customer Measures
• 3. Internal Business Operational Measures
• 4. Innovation and Learning Measures
• Refer to example of Balanced Scorecard at ECI
  taken from Kaplan Nortons 1992 HBR article.