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Incentive Compensation Plans
ABC has two incentive compensation plans: the Annual Performance Plan (the “Performance Plan”) and the Annual Incentive Plan (the “Incentive Plan”). Each is designed to reward executive officers when ABC achieves predetermined financial and performance goals. The Performance Plan funds awards to ABC’s CEO and his direct reports (Messrs. Smith, Jones, and White, and Ms. Brown). The Incentive Plan funds awards to ABC’s other executive officers.
ABC maintains the separate incentive plan for the CEO and his direct reports in order to comply with Internal Revenue Code Section 162(m). Section 162(m) precludes a public company from taking an income tax deduction for compensation in excess of $1 million paid to its CEO or any of its four other highest paid executive officers. However, the $1 million cap does not apply to a bonus or any other compensation paid pursuant to an incentive compensation plan that establishes performance goals that are approved by the shareholders. ABC’s shareholders approved the goals set forth the Performance Plan in 200__.
The key features of the two plans are summarized below.
Annual Incentive Plan
The Compensation Committee takes several steps to set the basis for awards under the Incentive Plan.
First, at the beginning of the year, the Committee establishes three goals for each of EPS, ROE, and EPA. These goals are at different levels, considered “threshold,” “target,” and “maximum.” In establishing these goals, the Compensation Committee considers ABC’s operating plan for the coming year, the outlook for the industry and ABC’s peer group, and the median performance of peer companies during the preceding three- and five-year periods. The Committee also assigns a specific weight to each metric. The assigned weights for 2006 were 50% for EPS, and 25% each for ROE and EPA. These weightings reflect the significant value ABC places on earnings-an important measure for shareholders. Finally, the Compensation Committee establishes target compensation amounts for each officer. Generally, target pay equals the median pay for comparable positions at peer companies.
To determine awards at year-end, the Compensation Committee first measures ABC’s actual results-making adjustments for changes in accounting rules, gains from the sale of subsidiaries or assets outside the ordinary course of business, or a restructuring or other non-recurring charge or adjustment, if appropriate.
- If performance matches the threshold goals for each of EPS, EPA and ROE, the Incentive Plan will fund 50% of the aggregate target pay set at the start of the year.
- If results fall below threshold for one or more measure, the Compensation Committee has the discretion to fund up to 25% of target pay to reward incremental progress and to facilitate retention of critical employees.
- When results meet target goals, the Incentive Plan will fund 100% of the aggregate target pay.
- In the event results meet the maximum goals, the Compensation Committee has the discretion to fund as much as 300% of aggregate target pay.
The maximum potential funding was set at 300% of target to give the Compensation Committee significant flexibility to reward executives should ABC perform at a “break out” level relative to specific financial goals and in the top decile of the peer group.
The following chart shows how the Compensation Committee might use its discretion to determine a “performance percentage” based on hypothetical performance results:
The Compensation Committee may alter the performance percentage by as much as 30% in either direction to account for factors such as the quality of earnings and the overall performance of the economy and the industry. The Board believes that 30% discretion is appropriate because it permits adjustments without rendering the performance goals and targets irrelevant or waiving them entirely.
To determine the bonus pool for the Incentive Plan, the Compensation Committee multiplies the performance percentage by the aggregate maximum target compensation that was established at the start of the year for achieving all performance goals. For 2006, the bonus pool was equal to $_____.
Once the bonus pool is constituted, individual payouts are based on each executive officer’s performance and contribution to ABC, taking into account the performance and contribution of the group or business line that the officer leads. An individual award may vary from zero to some multiple of target pay. Ultimately, awards under the Incentive Plan for all the executives other than the CEO and his direct reports may not exceed the bonus pool.
Annual Performance Plan
The Performance Plan creates an annual maximum bonus pool for the year to come using a shareholder-approved formula. For 2006, the bonus pool was equal to 0.55% of total revenue-a measure that emphasizes the importance of revenue growth by sharing a portion of it with the individuals in the best position to affect ABC’s results.
Awards to the CEO and his direct reports under the Performance Plan are made using the standards applied and the performance percentage calculated under the Incentive Plan. For each executive, the Compensation Committee considers his or her target compensation, progress toward the individual performance goals set forth in his or her CEO scorecard, and his or her contribution to the achievement of ABC’s financial and strategic objectives. Ultimately, awards to the CEO and his direct reports may not exceed the maximum bonus pool created under the Performance Plan.