Long-term Incentives or LTI plans can play an important role in a company’s compensation strategy, particularly if stock options aren’t available or possible.
An LTI plan sets metrics for senior executives that may be based on 6-month or annual results but are paid over a period of time, from 2-4 years. Since these payments are not earned immediately, executives must stay to collect and the LTI plan becomes a retention program. For example, an executive earns an LTI bonus of $1,200 in year 1, but the bonus is paid in 3 installments (1/3 in year 2, 1/3 in year 3, 1/3 in year 4).
The problem most companies have with LTI’s is establishing proper metrics that are controllable by the executives covered by the plan. Traditional metrics might be “B-B-C” or Bookings (orders), Billings (invoices) and Collections (cash flow).
Companies have tried to use other metrics but with varying results. One example of a bad result features the company Transocean. This company operates oil rigs around the world and was responsible for the rig that exploded in the Gulf of Mexico in early 2010. Eleven people, including 9 workers were killed in the explosion and 200 million gallons of oil were released into the Gulf before the leak was finally closed.Transocean added ‘safety’ as a metric for its bonus system and recentl
Transocean added ‘safety’ as a metric for its bonus system and recently it was revealed that senior executives received safety bonuses (!) for 2010. Safety represented ? of the executives’ bonus formula and despite this catastrophe, executives earned 2/3 of the safety portion of their bonus. Here is a quote from a “Fortune” magazine article concerning this decision:
Transocean (RIG) put the fool in April Fool's Day last week by awarding the five executives $898,282 in bonuses in recognition of the "best year in safety performance in our company's history."
This was at best an odd claim to make for a year in which 11 people, including nine Transocean employees, were killed when the company's Deepwater Horizon drilling rig blew up in the Gulf of Mexico. Showering executives with cash after a double-digit death toll looked even stranger after the board explicitly cited safety concerns in withholding bonuses in 2009
( “Transocean's safety-bonus buffoonery”, Fortune, posted by Colin Barr April 6, 2011)
Employee satisfaction, particularly from your “A” or top employees, is also vitally important. It’s possible for certain managers to get good financial results even if they mistreat employees badly. Eventually these employees resign or lower their productivity or quality, which is terrible for future business and customer relationships. There is an expression ? ‘what gets measured, gets done’. If managers aren’t rewarded or held accountable for employee satisfaction or engagement, it won’t happen. Engagement surveys are very effective in measuring this metric.
Finally, cash flow is a metric that’s not used enough to evaluate performance. Many companies put emphasis on sales, orders or billings but that ignores the necessity of actually collecting money for these transactions. If everyone is committed to this last step of the sales process ? collections ? cash flow improves, borrowing costs go down and the business becomes healthy.
LTI’s are an important tool of management compensation if they’re designed properly. Plans should be simple, relevant to true business performance measures and allow for unexpected results. Using the ‘common sense’ rule could also prevent mistakes like the Transocean ‘safety bonus’.
Oh ? there’s a happy ending to the Transocean ‘safety bonus’ story:
Yes, CEO Steven Newman (right) and his top four flunkies will give around a quarter of their 2010 bonuses ? more than $250,000 ? to a charity the firm formed last year to compensate the families of the accident victims. Just in case you missed the generous spirit behind this gesture, the company specifies that the execs chose to relinquish the safety portion of their bonuses "voluntarily."
That voluntary decision has nothing to do with the beating Transocean is taking in the press, needless to say.
( “Transocean's safety-bonus buffoonery”, Fortune, posted by Colin Barr April 6,2011)