The New Standards – Methods for Linking Business Performance and Executive Incentive Pay

<p>Preface ix</p>
<p>Acknowledgements xv</p>
<p>Chapter 1 To the CEO 1</p>
<p>Well–Designed Incentives Are Governance Defined 3</p>
<p>Old School 6</p>
<p>Act Now 7</p>
<p>You Do Not Run Your Company 9</p>
<p>The New Standards 10</p>
<p>It Is Not about You 14</p>
<p>Last Things First 16</p>
<p>Bottom Lines 17</p>
<p>Chapter 2 Business Valuation and Incentive Policy 19</p>
<p>The Rosetta Stone 20</p>
<p>Stealing the Playbook of Business Valuation 21</p>
<p>Incentives and Value Creation 25</p>
<p>Value is a Function of the Quality and Quantity of Earnings 28</p>
<p>Cost of Capital and Expected Returns 30</p>
<p>As Long as We re at it 32</p>
<p>What Are We Paying For? 34</p>
<p>Total Business Return 37</p>
<p>The DCF Model Serves as a Proxy for Other Valuation Methods 40</p>
<p>Free Cash flow 43</p>
<p>FCF and the Irrelevance of Accounting Choices 45</p>
<p>Income and Capital: FCF s Drivers Should Be the Main Incentive Drivers 46</p>
<p>The Shape of Things to Come 47</p>
<p>Quando, Quando, Quando 49</p>
<p>The Past is Relevant Only as Prologue 50</p>
<p>Valuation Perspective: Operational Results, Debt, and Capital Structure 52</p>
<p>Chapter 3 Market Practices in Incentive Pay 59</p>
<p>How Much Are We Paying for Management Incentives? 64</p>
<p>Variable Pay versus Incentive Pay 67</p>
<p>Mismatch Makers 74</p>
<p>Other Market–Based Considerations of Market–Based Consideration 75</p>
<p>Market Practices and Presumptions 77</p>
<p>Chapter 4 The New Standards 83</p>
<p>Common Sense 91</p>
<p>Bias is the Boil Weevil of Value Creation 92</p>
<p>Get Cynical 93</p>
<p>Incentivization and its Discontents 95</p>
<p>Leading Chartcter 97</p>
<p>Guidelines for Incentive Design 99</p>
<p>Chapter 5 Risk and Executive Incentive Pay 107</p>
<p>Risk Management Policy and Incentives 108</p>
<p>Sheep in Wolves Clothing 113</p>
<p>Investors versus Management 113</p>
<p>The Risk Trade 115</p>
<p>Risk and Incentive Calibration 119</p>
<p>The Wages of risk: Estimating the Cost of Capital 121</p>
<p>Beta Coefficients and the Capital Asset Pricing Model 121</p>
<p>Financial Leverage and the Cost of Capital 123</p>
<p>Other Methods and Evidence for Attaching a Cost to Capital 125</p>
<p>Chapter 6 Motive, Means, and Method: Evaluating Incentive Performance Metrics 131</p>
<p>Role of Individual Performance in Incentive Pay 132</p>
<p>Nonfinancial Goals 133</p>
<p>Evaluating Financial Metrics 137</p>
<p>Revenue, Volume, and Gross Margin 138</p>
<p>Using Valuation Criteria to Choose Metrics 141</p>
<p>Context for Evaluating Financial Metrics 142</p>
<p>Operating Income, EBIT, and Return on Invested Capital 143</p>
<p>Two Wrongs Can Make a Right 146</p>
<p>On the Importance of Being Earnest 149</p>
<p>Pretax Income, Net Income, EPS, and ROE 149</p>
<p>Debt, Share Repurchases, EPS, and Stock Price Gains 150</p>
<p>Remedying Issues with Pretax Income, Net Income, EPS, and ROE 154</p>
<p>Cash flow Metrics 155</p>
<p>Indexation and Immunity 158</p>
<p>Overall Perspectives 160</p>
<p>Chapter 7 Value–Based Performance Measures 163</p>
<p>Value–Based Measurement 165</p>
<p>Economic Profit or Economic Value Added 167</p>
<p>Use the Metric, Lose the Rest 169</p>
<p>Total Business Return 170</p>
<p>Shareholder Value Added 174</p>
<p>Cash Value Added 174</p>
<p>Cash Flow Return on Investment 175</p>
<p>Real Value Added 177</p>
<p>Common Values 179</p>
<p>Metric Adjustments and Business Governance 180</p>
<p>Metric Adjustments: Compulsories Only 185</p>
<p>Risk–Based Capital Requirements and Return on Economic Capital 188</p>
<p>How Not to choose Among Value–Based Metrics 191</p>
<p>Chapter 8 Ownership, Not Gamesmanship: Setting Targets and Ranges for Performance–Based Plans 195</p>
<p>Best of Both Worlds 196</p>
<p>Trifold guide to Benchmarks 197</p>
<p>The Past is Prologue 198</p>
<p>Not to Insult Chimpanzees 203</p>
<p>Interpreting the Oracle 205</p>
<p>Multiple Personalities 206</p>
<p>Full Reconciliation to Market Value 209</p>
<p>Setting Targets Based on Total Business Return 215</p>
<p>Run Away! 219</p>
<p>Range and Domain: setting Intervals for Performance and Pay 222</p>
<p>Weightings, Award Leverage, and Participant Influence 227</p>
<p>Incentive Risks, Calibration, and Testing 228</p>
<p>Chapter 9 Business Units and Private Companies, Phantom Stock and Performance Plans 231</p>
<p>Private Companies 233</p>
<p>Phantom Stock and Subsidiary Equity 234</p>
<p>Phantom Stock Plan Example Using Total Business Return 235</p>
<p>TBR Phantom Stock Grant Structure and Leverage 239</p>
<p>Dilution Guidelines and Competitive Award Levels 241</p>
<p>Valuation Approaches for the Phantom Stock Plan 242</p>
<p>Market Valuation Techniques 243</p>
<p>Discounts for Lack of Marketability and Control 244</p>
<p>Valuation Accuracy versus Incentive Efficacy 245</p>
<p>Reconciling and Funding Market Value and Formula Value 246</p>
<p>Market–Indexed and Performance–Based Valuation formulas 248</p>
<p>EBITDA as a Valuation Yardstick 251</p>
<p>Equity–Based Incentive Plans Based on Book Value 252</p>
<p>Tale of Three Cities 252</p>
<p>Adjusting Valuation Results 253</p>
<p>Performance Plans 254</p>
<p>Value–Based Incentives versus Private Equity Incentives 259</p>
<p>Where the Rubber Hits the Road 262</p>
<p>Chapter 10 Using Stock to Create Effective Incentives 265</p>
<p>From the Top 266</p>
<p>Off to the Races 269</p>
<p>Pros and Cons of Major Approaches to Stock–Based Incentive Design 271</p>
<p>All–In–One 273</p>
<p>Let Them Eat Risk 275</p>
<p>Purely Stock–Based LTI Approaches 278</p>
<p>Keeping the Horses in the Barn 280</p>
<p>Granting and Leverage 282</p>
<p>Equity–Based Incentives in Venture–Stage Companies 284</p>
<p>Ownership Effects 287</p>
<p>A Whole New Ball Game 287</p>
<p>Chapter 11 The Medium Is the Message 289</p>
<p>Incentive and Financial Governance 290</p>
<p>Human Resource Perspectives 293</p>
<p>Glossary 301</p>
<p>Index 305</p>