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Gerard Leider Partner George Paulin Partner

This episode of the Executive Compensation Podcast delves into the complexities of annual incentive plans. Featuring discussions with experts from Meridian, the focus is on the design, trends, and challenges of these plans across various industries.

Basics of Annual Incentive Plan Design

The conversation begins with an explanation of typical annual incentive plans. These plans are predominantly performance-based, targeting a 12-month period to motivate executives. Often calculated as multiples of base salary, the payout scales generally include thresholds, targets, and maximums, with potential earnings ranging from zero to 200% of the target. While financial performance goals such as profits, returns, and cash metrics are primary drivers, non-financial metrics and individual goals also play a significant role. The option for executives to defer part of their payment is a common feature in these plans.

The discussion then addresses why these plans tend to be formulaic. This approach aligns with business strategies and financial goals, while also meeting external demands for pre-established goals.

Recent Trends in Annual Incentive Design

Key trends in annual incentive design were highlighted, including:

1. Stability in Goal-Driven Models: Despite evolving trends, the basic goal-driven model remains prevalent.
2. Integration of Non-Financial Goals: Strategic, individual, and ESG goals are increasingly incorporated into incentive plans.
3. Shift Toward Informed Judgement: There’s a move from arbitrary discretion to informed judgement in decision-making.
4. Incorporation of Relative Goals: Some companies in certain industries have started using relative goals in their annual plans.

Challenges in Designing Annual Incentive Plans

The podcast identifies several challenges in creating effective annual incentive plans:

1. Setting Financial Goals: Establishing realistic and motivational financial goals can be difficult, especially in uncertain economic times. Flexibility and the ability to make adjustments for unforeseen events are crucial.
2. Differentiating Performance Timeframes: It’s important to clearly distinguish between short-term financial goals and long-term strategic measures in incentive plans.
3. Balancing Risk and Leverage: Finding the right balance between risk and reward in the payout structures is a complex but essential task.

Listen to the full podcast here: What Board Members Need to Know About Annual Incentive Plans – Meridian Compensation Partners (meridiancp.com)

The Executive Compensation Podcast is available on all major podcast directories including iTunes, Spotify and Google Play.