Managing Incentive Plans In A Cyclical Business

Cyclical businesses cannot fully insulate themselves from uncertainty. In fact, most cyclical businesses set themselves apart from the competition by how they manage those uncertainties. A successful company takes better advantage of beneficial periods, and protects itself better in down markets.

Boards face a growing challenge to set increasingly specific performance targets in both short-term and long-term incentive compensation programs. Institutional investors and proxy advisors usually criticize a board when it uses the benefit of hindsight to evaluate past performance, expecting boards to fix all performance parameters at the outset of a performance period.

What to do? In the video above, Corporate Board Member recently sat down with Jim Wolf, Managing Partner at Meridian Compensation Advisors to talk about successful incentive strategies for these kind of businesses. Three key takeaways from the discussion:

  1. Compare relative performance. It’s fashionable today to criticize relative TSR plans, but in cyclical industries a relative comparison among similarly situated companies typically yields a credible benchmark for performance.
  2. Balance both returns and growth. The oil industry offers a great example of extremes – companies that focused almost solely on growth during an extended period of high oil prices, and now an intense push from investors to focus almost solely on returns in the current period of low oil prices. Value creation requires both growth and returns, and incentives should motivate that balance.
  3. Communicate your approach. Investors often misinterpret the context or conditions underlying commodity-based incentive plans. In oil and gas today, investors seem to believe that management teams can tap a limitless capital pool to hit growth targets. In fact, growth targets at most oil and gas companies are conditioned upon a specific capital budget – i.e. the incentive is to maximize profitable growth relative to the budgeted capital spend. Investor presentations and proxy statements should convey more clearly a company’s discipline in capital spending, allocation and performance incentives.