ERI Blog

Pay-for-performance for executives is incentive compensation aligned to business objectives that are typically defined prior to the beginning of the performance period. Most pay-for-performance plans are short-term incentive plans that qualify for IRC Section 162(m) tax deduction. The award amounts are derived based on a formula and reported in the Non-equity Incentive Plan Compensation column of the Proxy’s Summary Compensation Table.

Curiously, Microsoft Corporation has a discretionary bonus plan yet sill garnered a high approval vote for their Say-On-Pay, despite shareholder activism related to pay for performance. Let’s review their discretionary plan by taking a closer look at Microsoft’s 2012 Incentive Plan. Unlike the typical attributes just described, Microsoft 2012 Incentive Plan awards are not determined based on a formula or measured against predefined targets; rather, they are based on the executive’s performance across financial, operational, and strategic factors. The qualitative and quantitative factors used to evaluate 2012 performance included the following:

• Compliance and integrity
• Contribution margin
• Corporate citizenship
• Customer acceptance
• Customer satisfaction
• Developer community satisfaction
• Efficiency and productivity
• Innovation
• Operational excellence
• Organizational culture and leadership
• Organizational diversity
• Product development and implementation
• Quality
• Revenue
• Sales and licensing volume
• Strategic planning

The Incentive Plan design includes 20% of the target award payable in cash and 80% payable in stock that vests in four equal installments. The Plan is funded as a percent of Microsoft’s fiscal year 2012 corporate operating income and is capped at 0.3%. The CEO target award is 0% to 200% of base salary, whereas the other Named Executive Officers have 0% to 150% of the incentive target award. Also, the specific business rationale disclosed in the Proxy that supports the discretionary pay-for-performance approach:

• incentivize efforts to create shareholder value that may not produce tangible results within a fixed or predictable time period, which is important given the long-term characteristics of Microsoft’s business

Based on this plan description, let’s take a look at Steven Sinofsky’s 2012 compensation and how this information was disclosed in the Proxy Summary Compensation Table.

Notice that there are three standard columns not included in the table: Option Awards, Non-Equity Incentive Plan, and Pension & Non-Qualified Deferred Compensation. The Bonus amount reported reflects the 20% cash portion of the Incentive Plan awards, and the Stock Award amount reflects the 80% stock portion of the award. Microsoft aligns pay with performance focusing on the long term by not including hard business targets, options awards that may tempt executives to focus on short-term performance of stock price, and tenure-based plans like Pensions. At the same time, they assess the executive performance with a comprehensive set of factors that measures performance holistically. Microsoft shareholders continue to support these executive pay programs, demonstrating that there is more than one way to align interests and maximizing IRC 162(m) deductibility isn’t a necessary requirement.

For more information, analytics. and tools related to executive compensation, visit www.erieri.com.