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Short term performance based incentives - Coggle Diagram
Short term performance based incentives
Incentives to an indvidual, typically to an executive director and in the form of a cash bonus that are achieved. Performance targets might be related to a rise in the share price, growth in sales or profits, growth in earnings per share or to non-financial performance criteria
Bonuses may depend on the achievement of both individual targets and the performance of the company as a whole
A threshold is normally set at which no bonus is paid, thereafter the bonus will increase in line with performance but may e subject to a cap
The review period for short-term incentives is usually linked to the financial year, with the executive being rewarded according to the financial performance of the company in that year
All financial targets are liable to manipulation including those which must be calculated in accordance with accounting standards
The fact that a performance measure can be manipulated is not necessarily a good reason not to use it
One might reasonably expect the auditors and the audit commtitee to be on their guard to ensure that critical performance measures are not being manipulated and to pay particularly close attention to key judgement and estimates made by management in this regard
What is probably more important is that the targets used are aligned with the interests of shareholders, this is not necessarily the case with certain profit targets. Higher annual profits do not necessarily guarantee higher dividends and higher share prices
There are many different ways of measuring financial performance including
Earnings per share
Annual profit before interest and tax
Total shareholder return - this is a measure of the performance which combines share price appreciation and dividends paid to show the total return to the shareholder expressed as an annualised percentage. It is calculated by the growth in capital from purchasing a share in the company assuming that the dividends are reinvested each time they are paid
Earnings before interest, tax, depreciation and amortisation
Return on capital employed
Other KPIs - quantifiable values that the company uses internally to assess how effectively it is meeting its strategic objectives such as cash conversion or net income
Annual bonus schemes often measure performance against more than one target. Under this sort of arrangement a director may not be entitled to receive a bonus unless both targets have been met. Alternatively a company may operate more than one bonus scheme, one of the schemes could be linked to short term financial results and the other to the achievement of idnvidiual or strategic objectives. Under this sort of arrangement a director would usually be entitled to receive a bonus if only one of those targets was met
A company might also offer a deferred annual bonus scheme whereby participants are entitled to use some of all of their annual cash bonus to buy shares in the company. These shares might then be held in trust for three years after which the individual may be entitled to the award of addition free matching shares from the company subject to a requirement that the company has met a target growth objective for the 3 year period
Even though annual bonuses can incentivise behaviour that is harmful to long term success, they remain the most popular type of variable pay
96% of FTSE 350 companies have an annual bonus scheme
Some CEOs are potentially able to receive up to 435% of their salary.
Specific financial measures based on the company's KPIs remain the most common performance measure for annual bonuses in the FTSE 350. They include total shareholder return, earnings per share, cash conversion, net income, return on capital employed and profit before interest and tax
Only 23% of companies disclose specific non-financial targets