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back to index backGLOBALtalk April,  2005

Multinationals revising long-term incentive programs for executives outside the U.S.

U.S. multinationals are overhauling their long-term incentive (LTI) programs for non-U.S. executives. This is a departure from the recent practice of relying on LTI plan features that were uniform worldwide, with the same vehicle -- stock options -- and the same plan terms and award sizes. Now a growing number of companies are shifting to customized approaches.

These changes, which represent a substantial shift in practice in long-term incentive policies from only a few years ago, are described in a Towers Perrin survey of 75 large U.S. multinationals with at least $1 billion in annual revenue outside the U.S. The companies, including 33 from the Fortune 100, reported median revenues of $16 billion. 

According to the survey, 39% of companies have or will move to an approach of differentiating option grant sizes by geography. A Towers Perrin survey carried out four years ago found that only 5% of companies adopted a geographically tailored approach, with an additional 14% exercising discretion when determining non-U.S. awards. Now U.S. firms are now linking awards to employees located in other countries closer to local rates, which in most cases results in a reduction in award size.

U.S. multinationals' traditional approach to award sizes -- granting all executives U.S.-sized grants wherever they are located -- is arguably not optimal:

They have been overpaying their non-U.S. executives by local market competitive standards. Grant values are larger and participation is broader than what local companies and European multinationals provide in competing compensation packages for their executives.

Since annual cash compensation for non-U.S. executives tends to be lower than for their U.S. counterparts, the traditional LTI approach results in a total compensation mix for the non-U.S. executives that places too much emphasis on long-term, equity based incentives.

Management ends up sending a distorting set of signals in their efforts to link pay and performance. This is especially the case for non-line positions such as those in finance, legal and HR, which can usually be sourced from local or non-U.S. multinationals.

The New Game: Differentiation
The survey found that leading U.S. multinationals are abandoning the traditional approach to global grant guidelines in exchange for LTI awards that are more closely aligned with their executive's geographic and competitive criteria. Specifically, 42% establish guidelines by tiers (clusters of countries with similar competitive values); 29% bundle LTI guidelines by region (i.e., Western Europe, Asia); and 29% of survey respondents have separate grant guidelines for each country.

Predominantly, companies that successfully customize their LTI plans begin by examining data from both local companies and multinationals with a presence in the region. Frequently, these plans are adjusted for non-U.S. employees as a percentage of the U.S. award. According to Towers Perrin's research, the median award size, as a percentage of U.S. awards, was shown to be: Europe 71%; Asia 60%; and the rest of the world 55%.

Shift From Options
Global LTI programs for U.S. multinationals are also changing in terms of the total compensation mix. The number of companies with incentive plans featuring stock options is expected to decline from 90% to 76% over the next few years. During the same period, the use of restricted stock is expected to increase slightly from 71% to 74%, and the use of performance share plans is expected to rise from 35% to 43%. Most companies indicated they plan to extend these newer approaches to their reward plans to executives outside the U.S. (see Exhibit 1 ).

The shifting LTI grant practices at U.S. companies reflects a variety of pressures, including the desire to control the cost of stock options following the introduction of mandatory expensing and the need to limit share usage, a major concern of shareholders. These trends also provide an opportunity for companies to align awards closer to competitive levels and ensuring that awards are focused on the top performers.

However, at the same time, companies are retaining some long-standing design features of their LTI plans. Notably, eligibility is still typically determined by position or level in the organization and does not vary significantly by geography. Such internationally consistent criteria are expected to remain in place for the future.

Look, Don't Leap
While developments in the U.S. have raised questions about the traditional arguments for a uniform worldwide grant policy, important arguments for maintaining some degree of global consistency in LTI plan designs remain valid. There is no question that global plans with consistent features from one country to another can be instrumental in encouraging a global team outlook among employees, maintaining internal equity among senior executives and facilitating international transfers. They're also easier to administer.

Accordingly, companies are advised to look carefully before they lunge into any new alternative LTI vehicles for their non-U.S. executives. They will also have to continue to adjust plan design for local market practices, tax and regulatory considerations and other factors in their efforts to sustain effective incentive plans that attract and retain local talent. Ultimately, the best approach for global companies will require a balanced assessment that takes into account many considerations, both local and corporate, in fashioning the most effective grant guidelines for all executives participating in their long-term incentive programs.

Source: Towers Perrin - GAI

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