Introduction

Setting performance targets, for both short and longterm incentives, is one of the key activities in the remuneration committee's annual cycle. It has always been a difficult task to fairly balance the interests of all stakeholders, ensuring the targets are sufficiently stretching to satisfy shareholder expectations, but at the same time being considered fair and achievable by management. It has become even more challenging during the current period of prolonged uncertainty.

Effective target setting starts with process. In particular, ensuring that the company's expected performance, as it is captured in the annual budget or the long-term business plan, is scrutinised and agreed by the board before being used as the basis for incentive targetsetting by the remuneration committee. Then, ensuring that relevant data and reference points are provided to the remuneration committee to support their judgment in calibrating the target ranges.

As with any decision for a remuneration committee, it is important that the targets are set in the context of the specific circumstances and needs of the business, rather than by simply following market norms. At the same time, it is only natural for remuneration committees to ask "how does this compare to what others do?", and therefore providing relevant market reference points can help the committee in making an informed judgment when target setting.

The purpose of this 'toolkit' is to support remuneration committees and reward teams in this task by providing a range of market reference points on performance targets for profit metrics within both the annual bonus and longterm incentive of companies in the FTSE 100, FTSE 250, and FTSE Small Cap. We focus on profit as the most commonly used metric, often with the largest weighting, in these incentive plans.

Data is sourced from our A&M incentive targets database which is based on the latest available public disclosure as at January 2023.

Overview of a Good Target-Setting Process

Effective target setting starts with process. While this report is focused on targets for financial metrics, the principles below are relevant for any type of performance measure used in incentives, both short and long-term

Board

The forum to discuss, scrutinise, challenge, and agree the plan for company performance.

This might include:

  • Non-executive scrutiny: – What can the business reasonably be expected to deliver?
  • Sensitivity/scenario analysis – what are the upside/downside opportunities & risks?
  • Relativity to market expectations – how will we guide the market, how do plans compare to current and expected analyst consensus, what is the external messaging?

Agreed Budget / Plan

As an output from the board, the agreed business plan can then be used as an input into RemCo decision making on incentive targets.

Ideally, there should be a shared understanding of:

  • The achievability of the plan; and
  • The upside / downside risks

RemCo

The forum to calibrate the incentive targets using the agreed plan as a reference point. It is not good practice to re-open the board's discussion on the plan itself.

Good process can include:

  • Effective committee papers with relevant data and reference points readily available, and with clear references to the related board papers and decisions
  • Ensuring due consideration of the targets each year, rather than a simple 'rollover' from prior years
  • 'Two bites at the cherry' – an initial meeting to provide input on draft targets, with a second meeting for final approval
  • Considering relativity of targets to guidance and market expectations

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.