Pepsi Bottling Group has seen some pretty flat share activity in the last year, with prices puttering between $26 and $30. So it should come as little surprise that the company took the fizz out of executives’ compensation this year, too.
Pepsi Bottling’s directors decided earlier this month against awarding performance-based restricted stock awards, since the company’s top executives failed to meet their performance measures. According to filings with the Securities and Exchange Commission, the restricted stock was granted in 2003 and scheduled to vest only if certain performance targets were achieved in 2003, 2004 and 2005. On Feb. 2, the board’s compensation and management development committee decided the performance targets were not met, and canceled the awards.
News? Not exactly; Pepsi Bottling spokeswoman Kelly McAndrew says the executives knew several years ago they would lose the bonus because they missed their 2003 goals. Still, governance and compensation experts say, Pepsi Bottling’s restricted-stock system stands out: executives actually have to work for it.
The cancellations affect Chief Executive John Cahill, Chief Operating Officer Eric Foss, as well as the chief financial officer and the president of Pepsi Bottling’s European subsidiary. All four had to surrender 63,830 shares each, which at last week’s prices were worth around $1.8 million.
Even as many companies abandon stock options in favor of restricted stock and other long-term incentive payouts, few restricted-stock plans are tied to performance measures. According to Paul Hodgson, compensation expert for The Corporate Library, 95 percent of long-term incentive awards are “time-vested:” they just require the potential recipients to remain on the job for a few years to receive the shares, regardless of performance.
Friske
Doug Friske, a managing principal at Towers Perrin who helps head the firm’s executive compensation practice, says requiring recipients of restricted-awards to meet multi-year goals is also a rarity. Friske estimates that most restricted stock programs are created so that there is an 80 percent probability of achievement. “You have to do really, really badly not to pay out,” adds Hodgson. “That’s how they are structured.”
That lax approach may be starting to change. “Boards have become more active in setting performance goals,” says James Harris, founder and president of Seneca Financial Group, a investment company that specializes in turnaround opportunities. Harris is currently chairman of the governance committee at El Paso Electric, and had been a director at Peregrine Corp. until its purchase by Hewlett-Packard; he says boards themselves have started to become more active in setting the performance goals.
Typically, management prepares a forecast for three years. A range of potential outcomes are created, called threshold, target and maximum. They generally span from some defined level below the target to somewhere above the target. For example, if a company sets a growth rate target of 5 percent, nothing would be paid to executives if the growth rate comes in below 3 percent, half the payout would be made at 3 percent and double the payout would be delivered at 7 percent or higher. If the actual growth rate comes in somewhere between the three thresholds, management would get a proportionate payout, Friske explains.
EXCERPTS
The excerpts below are from the Form 4 filings of several Pepsi Bottling Broup executives:
John Cahill, Chairman And CEO
The restricted stock listed in Table 1 [63,830 shares] was granted in 2003 and was scheduled to vest only if certain cumulative performance targets were achieved in fiscal years 2003, 2004 and 2005. On February 2, 2006, the Compensation and Management Development Committee of the Board of Directors of The Pepsi Bottling Group, Inc. certified that such cumulative performance targets were not met. As a result, the Reporting Person will not vest in the restricted stock and the restricted stock has been forfeited.
View The Form 4 Filing For John Cahill, Pepsi Bottling Group Chairman and CEO (Filed 2 Feb. 2006)
Eric Foss, COO
The restricted stock listed in Table 1 [63,830 shares] was granted in 2003 and was scheduled to vest only if certain cumulative performance targets were achieved in fiscal years 2003, 2004 and 2005. On February 2, 2006, the Compensation and Management Development Committee of the Board of Directors of The Pepsi Bottling Group, Inc. certified that such cumulative performance targets were not met. As a result, the Reporting Person will not vest in the restricted stock and the restricted stock has been forfeited.
View The Form 4 Filing For Eric Foss, Pepsi Bottling Group COO (Filed 2 Feb. 2006)
Alfred Drewes, SVP And CFO
The restricted stock listed in Table 1 [63,830 shares] was granted in 2003 and was scheduled to vest only if certain cumulative performance targets were achieved in fiscal years 2003, 2004 and 2005. On February 2, 2006, the Compensation and Management Development Committee of the Board of Directors of The Pepsi Bottling Group, Inc. certified that such cumulative performance targets were not met. As a result, the Reporting Person will not vest in the restricted stock and the restricted stock has been forfeited.
View The Form 4 Filing For Alfred Drewes, Pepsi Bottling Group SVP And CFO (Filed 2 Feb. 2006)
What benchmarks do companies use for their performance-based pay? In general, targets are pegged to some sort of “quantity” target such as profits, or “quality” targets such as return-on-assets or return-on-equity.
Van Putten
The most popular target are operating earnings, revenues or a popular cash flow measure: earnings before interest, taxes, depreciation and amortization; some capital-intensive companies peg pay to a target for return on invested capital or return on assets. “It’s not a perfect science,” concedes Steve Van Putten, executive-compensation practice leader for Watson Wyatt.
Thinking Long-Term
Most restricted-stock programs are structured as annual plans. But those can create what Friske calls “dysfunctional behavior”—managers working hard to ensure they meet these short-term goals at the expense of other longer-term priorities.
To avoid that, Friske says, companies increasingly shun specific budgets and looking at probability of achievement. Their goal might be to craft a compensation plan that assures the executive will hit his “threshold” eight out of 10 years, the “target” five of 10 years, and the “maximum” in only one or two of the 10 years.
“This is a significant change,” he explains. “Companies are actually trying to determine the probability of achievement. They are testing their budget numbers for reasonable outcomes. They are bringing in some rigor to the whole goal setting process.”
Pegging incentive pay to the performance of a company’s peers is less prevalent when setting annual bonuses, but more common for long-term compensation, Friske says. Usually that peg somehow relates to total shareholder return, but in general “it’s still rare,” he says. One obstacle: companies would typically need to wait more than a month for the year-end numbers to be reported to see how their peers fared, depending upon the financial goal, and many don’t want to wait that long.
Van Putten says another problem with tying incentives to other companies’ performance is that different companies define metrics such as earnings differently; some might use GAAP while others use pro forma calculations, for example.
Harris opposes peer-based performance bonuses because they can penalize small companies unable to compete with their industry’s largest, most dominant companies. “If you are competing against Exxon, BP and Shell, these are huge companies that dominate the market,” he says.
Companies must also test the results of their performance-based incentives after instituting them, Van Putten warns. If total shareholder return is in the bottom quartile over the prior three years and while the company pays in the top quartile, “there’s a disconnect,” he says.
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