The Ups (and Downs) of Aligning
Pay and Performance
An updated look at the realities of the
pay-and-performance relationship
Introduction
It was another good year of payouts for performance awards in 2013. As companies seek to
better align pay with performance, many have been turning to long-term performance awards.
ClearBridge Compensation Group and Fidelity Stock Plan Services teamed up again for a
second installment of assessing the pay-and-performance alignment of these awards. This time,
we examined not just the pay-and-performance relationship, but specifically how it fares during
economic uncertainty. With an expanded database and another year of performance award
payouts, we took a deeper dive into the pay-and-performance relationship.
We discovered that while performance award payouts continue to be in directional alignment
with performance, the relationship can be influenced by economic conditions. As the economy
began to rebound over the past few years, performance award payouts in 2012 and 2013 were
higher than in prior years, perhaps due to the uncertain times in which the goals for these
awards were set. In addition, we found that the pay-and-performance relationship is not as
strong among low-performing companies.
On the whole, performance awards continue to align pay with performance. However, given
the long-term nature of these awards, in times of uncertain and rapidly shifting economic
conditions, this relationship may be challenged.
Research Highlights
• Performance award payouts continue to be in directional alignment with company
performance: Approximately two-thirds of awards reflected this alignment with total
shareholder return (TSR) or earnings per share growth (EPS).
• Performance award payouts in 2012 and 2013 have a higher proportion of abovetarget payouts compared with performance award cycles ending in earlier years, likely
driven by significant economic uncertainty at the time performance goals were set.
• High-performing companies tend to demonstrate stronger alignment between
performance and award payouts than low-performing companies do.
• TSR has risen in prevalence as a performance measure and is widely used, although
earnings measures continue to also be highly prevalent.
A research study conducted by:
ClearBridge Compensation Group
and Fidelity Investments
Research Methodology
Company Statistics
ClearBridge analyzed performance award data collected from Fidelity Stock Plan Services for 131 clients with share-based
performance awards with performance periods of one year or more. The total number of participants in these plans
ranged from one to 2,270 employees, with an average of 185 employees. Additional research statistics are provided in
Exhibit 1.
Exhibit 1: Key Statistics among Companies with a Performance Plan (# companies: n = 131)
Number of Employees
Market Capitalization*
% of Employees Receiving
Performance Award
Vesting Years
Performance Period Years
<2.5K
2.5K–10K
10K–25K
25K–100K
21
41
31
29
>100K
9
<$1B
$1B–$5B
$5B–$10B
$10B–$25B
>$25B
18
42
21
26
15
<1%
1%–5%
5%–10%
10%–15%
>15%
77
43
6
2
3
1 year
2 years
3 years
4 years
5 years
15%
18%
57%
7%
3%
1 year
2 years
3 years
4 years
5 years
25%
15%
55%
3%
2%
* Nine companies in the study are currently not publicly traded.
Analyzing the Pay-and-Performance Relationship
We analyzed 159 performance award payouts spanning a period of six years (2008 through 2013). These payouts were
compared to a company’s performance measured relative to performance of the S&P 500® index. Specific performance
measures analyzed included:
• Revenue growth
• Net income growth
• Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) growth
• Earnings per Share (EPS) growth
• Return on Capital (ROC)
• Return on Equity (ROE)
• Total Shareholder Return (TSR)1
The pay-and-performance relationship was analyzed over the same period as that of the performance award
measurement period. For example, the payout for a performance award with a three-year performance measurement
period ending on December 31, 2012, was compared with a company’s performance relative to the S&P 500 for the same
three-year period ending December 31, 2012.
Each performance award payout (ranging from a zero payout to a maximum payout under the plan) and a company’s
corresponding performance ranking relative to the S&P 500 were plotted on a pay/performance scale. The pay/
performance scale was divided into four quadrants reflective of the pay-and-performance alignment (see Exhibit 2).
Total Shareholder Return (TSR) is defined as stock price appreciation, including reinvestment of dividends.
1
For plan sponsor use only.
2
THE UPS (AND DOWNS) OF ALIGNING PAY AND PERFORMANCE
Exhibit 2: Pay/Performance Alignment
Performance Award Payout
Max
Low Performance/High Pay
High Performance/High Pay
Low Performance/Low Pay
High Performance/Low Pay
Target
0%
50%
100%
Company Performance Percentile Rank Relative to the S&P 500
Payouts falling in the upper right quadrant (High Performance/High Pay) or lower left quadrant (Low Performance/Low
Pay) are considered to be aligned with a company’s relative performance. Payouts falling in the other quadrants represent
a potential disconnect between pay and relative performance. In addition, regression analyses were performed to assess
the statistical correlation between payouts and relative performance.
Pay-and-performance: Does It Exist?
Performance Award Payouts vs. Relative Performance
As described above, performance award payouts were assessed versus a company’s relative performance over the same
time period as the performance period covered by the performance award.
When performance award payouts were compared against a company’s TSR performance versus the S&P 500, 103 of
155 observations (66%) fell within the upper right and lower left quadrants, indicating that there was general alignment
between payouts and relative TSR performance (see Exhibit 3). This represents a slight decline from the results of our 2012
study, in which 72% of performance award payouts were aligned with relative TSR performance.
Exhibit 3: TSR Performance versus S&P 500 (n = 155)
Max
High Performance/
High Pay (n = 67)
Performance Award Payout
Low Performance/
High Pay (n = 31)
R² = 0.1248
Target
High Performance/
Low Pay (n = 21)
Low Performance/
Low Pay (n = 36)
0%
25%
50%
75%
100%
TSR Percentile Rank Relative to the S&P 500
For plan sponsor use only.
3
THE UPS (AND DOWNS) OF ALIGNING PAY AND PERFORMANCE
While the results of this analysis indicate that pay-and-performance
are aligned overall, approximately one-third of the payouts indicate a
potential disconnect between pay-and-performance. Furthermore, it
is worth noting that among high-performing companies (companies
that performed above the 50th percentile), 76% of payouts were
aligned with performance. In contrast, payouts among lowperforming companies (companies that performed below the 50th
percentile) were aligned only 54% of the time. We will explore this
differential further in a later section.
Among high-performing companies,
76% of payouts were aligned with
TSR performance. In contrast,
payouts among low-performing
companies were aligned only 54%
of the time.
Replicating the TSR pay/performance analysis for EPS growth performance versus the S&P 500, we find similar results. In
86 of 127 observations (68%), payouts align with performance, i.e., payouts tend to be at or above target when relative
EPS growth is at or above the median EPS growth for S&P 500 companies. Payouts are generally below target when
relative EPS growth is below the median S&P 500 EPS growth (see Exhibit 4). This represents a very slight decline from the
results of our 2012 study, in which 70% of performance award payouts were aligned with relative EPS performance.
Exhibit 4: EPS Growth Performance versus S&P 500 (n = 127)
Max
High Performance/
High Pay (n = 52)
Performance Award Payout
Low Performance/
High Pay (n = 30)
R² = 0.267
Target
When performance award payouts are compared
to relative EPS performance rather than relative
TSR, extreme high performance/low pay outliers
are removed, indicating better alignment when
performance is strong. However, in the reverse
situation when performance is low, there
continues to be high payouts that are misaligned.
High Performance/
Low Pay (n = 11)
Low Performance/
Low Pay (n = 34)
0%
25%
50%
100%
75%
EPS Growth Percentile Rank Relative to the S&P 500
Similar to our 2012 study, the statistical correlation between
performance award payouts and relative EPS growth is greater
than the correlation between payouts and relative TSR, with fewer
significant outliers. In fact, when performance award payouts are
compared to relative EPS performance, extreme high performance/
low pay outliers are removed. This is likely because most awards
(68%) are based on financial metrics, which are more directly linked
with EPS than with TSR.
Among high-performing companies,
83% of payouts were aligned with
EPS performance. In contrast,
payouts among low-performing
companies were aligned only 53% of
the time.
We also find the same relationship that we discovered with TSR,
where high-performing companies demonstrate a higher percentage of pay/performance alignment (83%) compared to
low-performing companies (53%).
For plan sponsor use only.
4
THE UPS (AND DOWNS) OF ALIGNING PAY AND PERFORMANCE
How Does Economic Uncertainty Influence Pay-and-Performance?
While the majority of performance awards are directionally aligned with performance, as discussed above, there continue
to be a meaningful number of awards classified as “misaligned.” In order to further analyze this disconnect, we examined
the pay-and-performance alignment and found two factors to be influential: the timing of goal setting and whether the
company was a high or low performer.
Impact of Goal Setting
In our deeper dive analysis of the pay-and-performance alignment, we found a difference in the payout levels based on
the year of the payout (see Exhibit 5). The vast majority of performance award payouts in 2012 or 2013 paid out at target
or above, while payouts in 2011 were more evenly distributed above and below target.
Exhibit 5: Performance Award Payouts by Year
13%
2012
18%
4%
2011
22%
7%
4%
54%
22%
2010
46%
30%
0%
29%
25%
Zero
50%
Below Target
Target
16%
n = 55
16%
n = 45
19%
75%
Between Target and Max
n = 38
100%
Max
The way that companies set their long-term performance goals can be heavily impacted by the economic outlook and
environment at the time the goals are being set. Because award cycles are most commonly three years and because
longer-term cycles can have more goal setting challenges, we further examined this relationship among three-year awards
only (see Exhibit 6).
Exhibit 6: Performance Plan Payouts by Year for Three-Year Awards
13%
2012
2011 3%
15%
23%
0%
49%
3%
31%
2010
17%
Below Target
15%
55%
3%
25%
Zero
For plan sponsor use only.
8%
16%
28%
50%
Target
5
Between Target and Max
21%
75%
n = 55
n = 45
n = 38
100%
Max
THE UPS (AND DOWNS) OF ALIGNING PAY AND PERFORMANCE
There was significant economic uncertainty at the time companies were setting goals for three-year performance awards
that paid out in 2012 and 2013 (i.e., goals were set in 2009 or 2010). Given the economic uncertainty, companies likely set
their goals to reflect the bleak economic outlook at the time and their inability to predict when the market might rebound.
When the general market then recovered over the course of the performance cycles, these awards may have paid out
above target even though the company’s performance did not look as strong on a relative basis (see Exhibit 7).
Exhibit 7: Goal Setting and Performance History
S&P 500 Index Stock Price
$1,600
Timing of Goal Seng and Payouts vs. S&P 500 Index Historical Stock Price:
3-Year Performance Awards
$1,400
$1,200
$1,000
Legend
X = Goals Set
O = Award Payout
$800
$600
!"##$
$0
Jan-07
Jan-08
Jan-09
Jan-10
2008-2010 Performance Cycle
Jan-11
Jan-12
Jan-13
2009-2011 Performance Cycle
2010-2012 Performance Cycle
Exploring the Differences between Top Performers and Bottom Performers
We segmented the performance award payouts into three performance categories, in order to dissect the differences
between these groups:
Performance Rank vs. S&P 500
Performance Category
Greater than or equal to 75 percentile
Top Performers
Between 25 and 75 percentiles
Middle Performers
At or below 25 percentile
Bottom Performers
th
th
th
th
When we looked at performance award payouts compared to relative EPS performance, we found that the Top Performers
and Bottom Performers were directionally aligned with performance. However, an interesting phenomenon occurs in the
Middle Performers group, where the payouts skew toward above target (74%). See Exhibit 8.
For plan sponsor use only.
6
THE UPS (AND DOWNS) OF ALIGNING PAY AND PERFORMANCE
Exhibit 8: Performance Awards Segmented by EPS Performance Level
Distribuon of Above/Below Target Payouts by EPS Performance Level
12%
Top Performers
26%
Middle Performers
74%
70%
Boom Performers
–100%
88%
–80%
–60%
30%
–40%
–20%
EPS Below Target Payouts
0%
20%
40%
60%
80%
100%
EPS Above Target Payouts
This relationship indicates that when companies perform very well or very poorly, they are equally effective in aligning pay
with performance. However, when performance is in the middle, companies lean toward rewarding their employees to
accomplish other objectives, such as attraction, retention, etc.
Replicating the same analysis with relative TSR performance, we find directionally similar results, except that with TSR, the
Bottom Performers are more evenly split between below target and above target payouts than might be expected (see
Exhibit 9).
Exhibit 9: Performance Awards Segmented by TSR Performance Level
Distribuon of Above/Below Target Payouts by TSR Performance Level
15%
Top Performers
35%
Middle Performers
65%
58%
Boom Performers
–80%
–60%
–40%
–20%
42%
0%
TSR Below Target Payouts
For plan sponsor use only.
85%
7
20%
40%
60%
80%
100%
TSR Above Target Payouts
THE UPS (AND DOWNS) OF ALIGNING PAY AND PERFORMANCE
Pay for What Performance?
Performance Measures Used
Consistent with the findings in our 2012 study, TSR and EPS are the most common measures used by companies. TSR
has risen in prevalence as a performance measure and is widely used, although earnings measures continue to also be
highly prevalent.
Exhibit 10: Performance Measures
TSR/Stock Price
Earnings
Returns
Fidelity
Revenue
CB100
Equilar
Cash Flow
Other Financial
Non Financial
0%
10%
20%
30%
40%
50%
60%
ClearBridge 100 is a proprietary database of executive compensation practices among 100 S&P 500 companies representing a cross-section
of industries.
Impact of Performance Measure Used on Pay/Performance Alignment
Performance award payouts tend to be best aligned with TSR or earnings performance. However, metrics such as revenue
growth and returns (e.g., ROC and ROE), when also measured on a relative basis, did not result in as strong a correlation
between performance and payouts. Exhibit 10 summarizes payout alignment relative to the S&P 500 for various
performance measures. Pay-and-performance alignment reflects the percentage of observations falling within the top
right quadrant or the bottom left quadrant of the pay/performance chart, while pay-and-performance disconnect reflects
the percentage of observations falling within the top left or bottom right quadrants of the pay/performance chart.
Exhibit 11: Relationship between Pay and Relative Performance
EPS Growth
32%
68%
TSR
34%
66%
Net Income Growth
41%
59%
Revenue Growth
44%
56%
ROC
44%
56%
EBITDA Growth
47%
53%
ROE
47%
53%
Pay-for-Performance Disconnect
For plan sponsor use only.
Pay-for-Performance Alignment
8
THE UPS (AND DOWNS) OF ALIGNING PAY AND PERFORMANCE
There is little difference overall in how performance awards pay out when comparing plans based on an absolute or a
relative measure. Plans that are based on a combination of absolute and relative measures, however, paid between target
and maximum 83% of the time, which may indicate that absolute and relative performance provide a “check” or “hedge”
against each other (see Exhibit 12).
Exhibit 12: Absolute vs. Relative Plans
Absolute
Relative
Both
14%
26%
23%
2%
39%
15%
n = 42
62%
17%
n = 13
83%
0%
25%
Zero
19%
Below Target
50%
Target
n=6
75%
Between Target and Max
100%
Max
Impact of Performance Periods
Three-year measurement periods continue to be the most common time horizon to assess performance under
performance-based incentive awards (see Exhibit 13). In recent years, some companies have adopted a shorter
performance period, such as one or two years, to help mitigate some of the challenges with long-term goal setting
in an uncertain economic environment, although it remains a minority practice.
Exhibit 13: Prevalence of Performance Periods in Performance Awards
79% 80%
2011
2012
19% 19%
5%
1 Year
9%
6%
2 Years
3 Years
10%
4+ Years
Similar to our findings from our 2012 study, while we would expect a stronger pay-and-performance alignment for
performance awards with a one-year measurement period compared with performance awards with a three-year
measurement, given it is easier for companies to predict one year of future performance as opposed to three years,
we continue to find the converse to be true. As Exhibit 14 indicates, the pay-and-performance relationship, where
For plan sponsor use only.
9
THE UPS (AND DOWNS) OF ALIGNING PAY AND PERFORMANCE
performance is defined as EPS growth relative to S&P 500 companies, does not correlate as well as we would have
expected for one-year performance awards. In fact, we found high pay resulted from low performance 50% of the time
(12 of 24 occurrences of low performance paid at or above target), which is counter to achieving alignment between
pay-and-performance. This may be attributed to the fact that it often takes time to gather momentum toward achieving
a goal, and a one-year goal may not afford sufficient time.
Exhibit 14: EPS Growth Performance versus S&P 500—One-Year Plans (n = 47)
Max
High Performance/
High Pay (n = 20)
Performance Award Payout
Low Performance/
High Pay (n = 12)
R² = 0.2872
Target
Low Performance/
Low Pay (n = 12)
0%
25%
High Performance/
Low Pay (n = 3)
50%
75%
100%
EPS Growth Percentile Rank Relative to the S&P 500
Exhibit 15: EPS Growth Performance versus S&P 500 – Three-Year Plans (n = 76)
Max
Performance Award Payout
Low Performance/
High Pay (n = 17)
High Performance/
High Pay (n = 30)
R = 0.27
Target
High Performance/
Low Pay (n = 7)
Low Performance/
Low Pay (n = 22)
0%
25%
50%
75%
100%
EPS Growth Percentile Rank Relative to the S&P 500
For plan sponsor use only.
10
THE UPS (AND DOWNS) OF ALIGNING PAY AND PERFORMANCE
Conclusion
All things considered, the trend toward performance awards has represented an improvement in the effort to align pay
with performance. However, the last two years of payouts in 2012 and 2013 have demonstrated some of the challenges
with these awards, and how economic conditions can heavily influence the outcome of these awards.
Furthermore, high-performing companies exhibit a strong pay-and-performance relationship, whereas low-performing
companies don’t show as strong of an alignment with payouts at lower levels. Although it seems that companies strive to
achieve a high correlation between pay-and-performance, economic factors and retention issues may contribute to how
this relationship actually plays out.
While all of the factors that contribute to the ultimate payout may not be foreseeable at the beginning of each
performance period, companies should seek to establish a pay-and-performance scale that supports the company’s
long-term business strategy and compensation objectives.
For plan sponsor use only.
11
THE UPS (AND DOWNS) OF ALIGNING PAY AND PERFORMANCE
About the Authors:
Yonat Assayag
Partner, ClearBridge Compensation Group, LLC
Yonat Assayag is a partner at ClearBridge Compensation Group, an independent executive
compensation consulting firm. Ms. Assayag has over fifteen years of experience advising
boards and senior management on performance measurement and compensation strategy and
design, with the ultimate goal of aligning reward programs with the creation of shareholder
value. Her client experience includes working with both publicly-traded and privately-held
companies in a variety of industries. Prior to joining ClearBridge, Ms. Assayag was a Principal at
Mercer specializing in executive compensation, and prior to that she held various corporate HR
roles. She has spoken frequently at conferences and authored numerous articles on executive
compensation issues.
Ms. Assayag holds an MBA from New York University’s Stern School of Business and a BS in
Business Administration from Syracuse University.
Carl J. Stegman
Senior Vice President — Product Management, Fidelity Stock Plan Services
Carl Stegman is Senior Vice President of Product Management for Fidelity Stock Plan Services.
With fifteen years of experience in financial services and managing system applications, Mr.
Stegman helps drive the success of Fidelity’s Stock Plan Services product offering, serving U.S.
multi-national public companies and their global participant base. For the last seven years,
he has been dedicated to the Stock Plan Services business focused on delivering enhanced
functionality to clients and their participants.
Mr. Stegman earned a Bachelor’s degree from Northeastern University, Boston, MA and an
MBA in Management Information Systems (MIS) from Bentley College, Waltham, MA. He is
Series 7, 63 and 24 registered.
RESEARCH METHODOLOGY:
Analyzed performance award data collected from Fidelity’s Stock Plan Services for 131 clients with share-based performance
awards having performance periods of one year or more. Analyzed 159 performance award payouts spanning a period
of five years (2008 through 2013) and only included payouts where a company’s plan allowed a maximum payout to be
above the plan’s target payout. Payouts were categorized based on the company’s TSR and EPS performance relative to
the performance of the companies in the S&P 500 index for the same measure. The pay-and-performance relationship
was analyzed over the same period as that of the performance award measurement period. For example, the payout for a
performance award with a three-year performance measurement period ending on December 31, 2012 was compared to a
company’s performance relative to the S&P 500 peer group for the same three-year period ending December 31, 2012.
FOR PLAN SPONSOR USE ONLY.
ClearBridge Compensation Group and Fidelity Investments are not affiliated.
The Fidelity Investments and pyramid design logo is a registered service marks of FMR LLC.
Investment and workplace savings plan products and services offered directly to investors and plan sponsors are provided
by Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917.
634649.2.01.953499.101
CB/Fidelity-WP-0214