The level of understanding of when an STI should be used and how its design features should be constructed seem not to be well understood by many stakeholders. Here we seek to provide clarity as to the fundamentals of STI plans. The market practice information quoted has been extracted from the 2014 GRG Incentives Guide.
GRG Remuneration Insight 63
by Denis Godfrey & James Bourchier
30 July 2014
Short term incentives (STIs) are a common element of key management personnel (KMP) remuneration. However, the level of understanding of when an STI should be used and how its design features should be constructed seem not to be well understood by many stakeholders. This GRG Remuneration Insight seeks to provide clarity as to the fundamentals of STI plans. Market practice information quoted in this GRG Remuneration Insight has been extracted from the 2014 GRG Incentives Guide.
What is an STI Plan?
STI plans, often a key component of key management personnel (KMP) remuneration, typically involve target-based incentives. These are designed around key performance indicators (KPIs), where each KPI is selected, weighted, and assigned specific goals with attached award opportunities. This structure differentiates them from profit share plans and discretionary bonuses, where rewards are based on company profits or Remuneration Committee discretion, respectively.
STIs in different company stages
The simple answer is no. Not all ASX-listed companies should use short term incentive plans for their KMP. Companies yet to achieve profitable operations might find long-term, securities-based incentives more suitable. However, for businesses in more stable phases, well-structured STI plans can effectively align executive efforts with company goals.
Understanding when to implement short term incentive plans (STIs) is crucial and varies depending on a company’s life cycle stage. Here’s a closer look at how different types of companies might approach STIs:
Startups and early-stage companies
In these dynamic environments, the focus is often on growth and adaptation. For startups or companies not yet profitable, traditional cash-based STI plans may not be the most suitable choice. Instead, long-term, equity-based incentives can align better with their goals. These incentives conserve cash while aligning the interests of key management personnel (KMP) with long-term company success.
Established, profitable companies
For companies in a stable, profitable phase, STI plans can be an effective tool. They can incentivise KMPs to achieve short-term operational goals that are in line with the company’s strategic objectives. In these cases, the use of a well-structured STI plan, with clearly defined targets and performance metrics, can drive desired business outcomes.
Companies in transition or undergoing restructuring
Companies undergoing significant changes, such as mergers, acquisitions, or strategic pivots, might find that rigid STI plans are less effective. In such situations, more flexible incentive structures, possibly combining short-term and long-term elements, could be more appropriate. These structures can accommodate rapidly changing business priorities and goals.
Mature companies in stable industries
For these companies, STI plans can be a staple of their remuneration strategy, rewarding KMPs for sustaining performance and achieving steady growth. The design of STI plans in such environments can afford to be more predictable, with a focus on maintaining and gradually increasing market share and profitability.
Companies facing market disruptions or high competition
In highly competitive or rapidly evolving markets, companies need to strike a balance in their STI design. The plans should be flexible enough to allow quick responses to market changes, yet structured enough to provide clear performance incentives.
The appropriateness of STI plans depends on the company’s stage of growth, its market dynamics and its strategic goals. It’s important for companies to regularly assess their incentive structures to ensure they remain aligned with their evolving business context and continue to effectively motivate and reward their key personnel.
Design features of an effective STI plan
- Measurement period: Aligning with the financial year, the measurement period of an STI plan is crucial for consistency with annual financial results and shareholder expectations.
- Key performance indicators: These are performance measures like economic profit, EBITDA, and health & safety, among others. Note that certain KPIs, like revenue, may not be suitable for director-level STI plans.
- Performance goals: These include threshold, target, and stretch levels, each incentivizing different degrees of achievement.
- Weightings and award opportunities: Proper weighting of each KPI is essential, reflecting its importance. The STI award opportunities should be linked to the role’s target remuneration profile, expressed as a percentage of the Base Package.
Payouts and employment termination considerations
- Payouts: Typically, STI awards are paid fully or partly in cash, with increasing trends towards deferring parts of the awards.
- Termination of employment: The treatment of STIs upon employment termination varies based on the circumstances of the departure.
Ensuring robust STI policies and plan rules
An effective STI policy is an integral part of a company’s Remuneration Governance Framework. It is crucial that companies have comprehensive documentation for their STI plans, which aids in conflict resolution and ensures continuity as the Remuneration Committee evolves.
Partnering with GRG for tailored STI solutions
Align your executive pay to performance effectively with GRG’s expert advice on short-term incentive compensation. Our services are designed to be clear, precise, and transparent, helping you manage your STI plans strategically and cost-effectively.
