Incentive Plan Design Practices

Incentive Plan Design Practices Summary Results from 2011 Asia Incentive Plan Design Survey: Regional Report Annual and Long term Incentive Plan Design and Administration To help companies ensure that their annual and long-term incentive plans provide competitive reward opportunities and remain effective in supporting key business and talent goals, Towers Watson conducts ongoing research into incentive plan design practices and operations. Our latest survey highlights the continuing evolution of plan design, along with emerging trends in plan management.

Regional Market Report Key Findings Plan designs are increasingly tied to company performance Multiple performance metrics are commonly used in annual incentive plans with greater usage of non-financial metrics (e.g., strategic objectives and customer satisfaction) than other regions of the world Desired company performance can lead to high upside for annual incentive payout - most common maximum payout is 200% of target, with some plans having higher maximum or no cap at all (especially plans used by Financial Services companies) Performance-based long-term incentive plans have become more popular in Asia, especially for multi-national companies parented outside of Asia. As a result stock option is no longer the dominant type of vehicle in any surveyed market Sales/revenue is the most popular metric in annual incentive plan in across the region, followed by cash flow (including EBIT/EBITDA) and profit-based measures. Total shareholder return is the most popular metric in long-term incentive plan in most surveyed markets Discretion plays an important role in further aligning pay and performance Asia-parented companies apply more discretion in assessing annual performance outcomes and determining individual bonus allocation than western multi-national corporations The pattern of annual incentive payout levels in the past five years generally follow global and regional economic conditions over the period - the prevalence of below target payouts increased from 2006 to 2008 and then declined since. For 2010, 42% of annual incentive plans paid above target and 27% paid at target, while only 31% paid below target Long-term incentive practices continue to evolve Granting of long-term incentive awards has become more frequent - most surveyed plans now grant annually, especially performance-based plans Going forward, some companies are rethinking their long-term incentive plan designs. In particular, Asia-parented companies expect more changes than western multi-national corporations - those changes are likely to be related to vehicle type/mix, performance conditions, eligibility and grant size 2

Asia Incentive Plan Design Survey 2011 Summary Results: Regional Report Introduction In today s uncertain and turbulent economic environment, organizations across the world face unprecedented cost, risk, and talent management issues. Additionally, organisations in Asia continue to struggle to attract and retain top executive talent foreign organisations continue to expand through the region while local organisations begin to expand globally, increasing the demand for experienced and motivated managers and executives. As economic uncertainty continues, annual and long-term incentive plans continue to play a critical role in communicating and reinforcing critical organizational objectives, encouraging desired behaviours and attracting and retaining key employees as critical components of a competitive total remuneration package. Towers Watson s 2011 Asia Incentive Plan Design Survey is based on over 400 responses from 261 organizations in 10 markets. This survey was designed to provide detailed information on how organizations in Asia design and administer their annual and long-term incentive plans for their top executives. Annual Incentive Plans The following section presents summary survey findings with regard to the design of annual incentive plans. Except where noted, all data pertain to the annual incentive plan that all or most senior executives participate in. This plan may cover the whole workforce or, more commonly, only a portion of the workforce. Typically, these plans are used for the top four tiers of executives (CEO as tier 1 executive, his or her direct reports as tier 2 executives and so on so forth) (Figure A). Figure A. Annual Incentive Plan Eligibility CEO / Chairman Percentage of Companies Including Indicated Employee Level in Annual Incentive Plan Direct Reports to CEO 3rd-tier Executives 4th-tier Executives 96% 96% 81% 58% India 83% 83% 92% 92% Indonesia 100% 93% 93% 86% Japan 93% 89% 86% 54% Mainland China 84% 92% 71% 69% 89% 89% 89% 89% The Philippines 92% 92% 92% 92% 88% 81% 88% 94% South Korea 100% 95% 68% 53% 100% 95% 84% 68% Funding Approach Figure B summarizes the types of funding approach used in the annual incentive plan. Across the region, the most popular approach is Sum of Targets approach where the bonus fund is proportional to the 3

sum of the target bonuses of the individual participants. Financial Results Based approach where the amount funded depends primarily on the level of achievement of specific financial objectives at organizational level (e.g., 3% of net income) is more common in Asia than in North America or Europe. Sum of Actual approach where the fund is equal to the sum of individuals actual awards is also often used, especially in Japan and South Korea. Figure B. Annual Incentive Plan Funding Approach 0% 20% 40% 60% 80% 100% India Indonesia Japan Mainland China The Philippines South Korea Sum of Targets Formula Sum of Actual Awards Funding Financial Results Based Formula Discretionary / Qualitative Approach Other Measuring Performance Figure C summarizes, by market, the number of metrics used in annual incentive plans. Figure C. Annual Incentive Plan Performance Metrics Number of Metrics 1 to 3 4 to 6 7 or more 31% 38% 31% India 69% 19% 13% Indonesia 50% 36% 14% Japan 63% 31% 6% Mainland China 27% 39% 34% 33% 29% 38% The Philippines 53% 29% 18% 45% 32% 23% South Korea 43% 39% 17% 43% 33% 23% than other markets. Organisations in Asia use more metrics than organizations in the United States and Europe. Most respondents in each market use around 3 metrics. A noticeable proportion of annual incentive plans use 7 or more metrics. Organizations in India and Japan tend to use less metrics than other markets, whilst Mainland China and tend to use more In most markets across the region, sales/revenue is the most common performance metric in executive level annual incentive plans, followed by cash flow (including EBIT/EBITDA) and profit-based measures (Figure D). While we do not have historical data to compare in Asia, in North America and Europe the use of revenue as a performance metric has become more common as economic uncertainty has encouraged companies to focus on top line growth. 4

Figure D. Common Performance Metrics Most Prevalent Metrics by Market Most Common 2 nd Most Common 3 rd Most Common Sales/Revenues Strategic objectives Net income/earnings/profit India Sales/Revenues Cash flow Earnings before interest and taxes Indonesia Sales/Revenues Cash flow Strategic objectives Japan Sales/Revenues Net income/earnings/profit Operating income/operating profit Mainland China Sales/Revenues Net income/earnings/profit Strategic objectives Sales/Revenues Earnings before interest and taxes Cash flow The Philippines Sales/Revenues Cash flow Net income/earnings/profit Sales/Revenues Cash flow Net income/earnings/profit South Korea Sales/Revenues Cash flow Operating income/operating profit Sales/Revenues Net income/earnings/profit Cash flow Calculating the Award Figure E illustrates, where more than one performance measure is used in annual incentive plans, how organizations define the way these measures are combined to calculate an individual s payout. The most common approach in the region (except India, Mainland China and ) is the additive approach, which calculates performance separately for each measure and then adds the associated incentive awards to determine the final award. Note that under this approach, a zero payout on one measure does not affect other measures. Figure E. Performance Metrics Approach The other two commonly used approaches are multiplicative approach and matrix approach. Under the multiplicative approach, performance under one measure is adjusted by performance under another measure. Under the matrix approach, levels of performance are assigned to each axis of a matrix, and the intersection of the two axes specifies the plan payout. 0% 20% 40% 60% 80% 100% India Indonesia Japan Mainland China The Philippines South Korea Additive approach Multiplicative approach Matrix approach Other An incentive plan s performance incentive zone describes the range of performance outcomes for which incremental increases in performance will result in incremental increase in bonus payouts. Some plans place no hard limits on performance that can earn a bonus, creating unlimited 5

upside opportunities. Other plans have thresholds and maximums, creating an incentive zone that represents all possible performance levels between the floor and the maximum or cap. Figure F. Typical Performance Incentive Zone Where such an incentive zone is % Payout against target 250 200 150 100 50 0 60 80 100 120 140 % Performance against target reported, Figure F presents the typical performance incentive zone and associated incentive plan payouts for the region. At 80% of targeted performance, the payout is typically equal to 60% of the target award (with no payout if performance is less than 80% of target). The most common maximum payout is 200% of target, usually paid for performance equal to 130% of target. Organizations in Indonesia and tend to have higher maximum performance targets (200% of target). Organizations in Mainland China tend to have lower payout at maximum level (150% of target for maximum performance). Deferring the Award Since the recent global economic turbulence, the use of annual incentive deferral has been increasing, especially in the financial services sector. Figure G shows the percentage of companies requiring or offering the deferral of annual incentives across Asia. Organizations in Mainland China are more likely to require bonus deferral than other markets in the region. Figure G. Percentage of Companies with Annual Incentive Deferrals 50% 40% 30% 20% 10% 0% India Indonesia Japan Mainland China The Philippines South Korea Long-Term Incentive Plans This section presents summary survey findings with regard to the design of long-term incentive plans. Long-term incentive (LTI) plans include any incentive plan which is designed to operate over a period of time longer than a year, and often includes equity-based vehicles such as share options and restricted stock as well as cash-based plans. Prevalence of LTI Plans and Plan Vehicles Around 60%-70% of participants in each market indicated that they have at least one longterm incentive plan in place. Organisations in the region typically grant one or two plan 6

vehicles. In North America and Europe, the use of LTI plans is more prevalent, as is the use of two or more vehicles (i.e., a portfolio approach to LTI design). Figure H shows that the most popular types of LTI vehicles are share option, restricted share and performance-based plans (performance cash, share or unit). This suggests that performance-based plans may be more prevalent in Asia than public disclosure might indicate. Figure H. Prevalence of Vehicles 90% 60% 30% 0% India Indonesia Mainland China The Philippines South Korea Taiw an Share Option Restricted Share / Unit Performance Cash Performance Share / Unit Eligibility and Participation In Asia, LTI plan eligibility tends to become prevalent at management level or above. Around 5%-10% of organisations in each market allow Non-Executive Directors to be eligible for LTI awards too. Relative to other regional markets, this practice is more common in and Mainland China (Figure I). Figure I. Long-Term Incentive Eligibility Group CEO / Chairman Direct Reports to Group CEO Percentage of Companies Indicating the Indicated Employee Level is Eligible for LTI Grants 3rd-tier Executive Management Non- Management Clerics / Support Staff Non- Executive Director 97% 97% 83% 50% 30% 20% 13% India 92% 92% 62% 31% 15% 8% 8% Indonesia 95% 100% 75% 40% 20% 15% 5% Mainland China 94% 93% 83% 64% 39% 27% 20% 100% 92% 79% 54% 42% 38% 8% The Philippines 100% 100% 74% 53% 21% 16% 5% 96% 89% 74% 44% 19% 15% 7% South Korea 95% 90% 65% 30% 10% 5% 5% 90% 90% 79% 55% 28% 10% 10% Measuring Performance Roughly 60%-80% of the LTI plans in the region have performance requirements on award vesting. It is less prevalent in (55% of LTI plans have performance conditions) and more prevalent in India and South Korea (82% of LTI plans have performance conditions). 7

Where performance conditions apply, it is typically based on 1 or 2 metrics. Organisations in, Mainland China and tend to use more metrics than other markets in the region, with around 25% of LTI plans in these markets adopt 3 metrics. 4 or more metrics are uncommon in LTI plans across the region. Total shareholder return is the most popular metric in all markets except India, Mainland China and South Korea where economic profit, net income and sales/revenue are most popular respectively. Figure J. Grant Frequency Timing Practices Figure J shows that most LTI plans in the region grant awards to participants annually. In general, full-share plans grant more frequently than share options plans. At market median, awards are typically subject to a three-year performance period. LTI plans in Mainland China tend to have a shorter performance period, with one year being typical. 0% 20% 40% 60% 80% 100% India Indonesia Mainland China The Philippines South Korea Annual Every 2 years Every 3 years One-off / Ad-hoc / Discretionary Other Figure K shows the prevalence of two vesting schedules cliff vesting (100% vesting at one time), and scheduled vesting, (also called ratable vesting, or vesting occurring over several years in equal-sized instalments). These two types of vesting schedule are both common, with cliff vesting being slightly more prevalent, especially in South Korea (76% of LTI plans adopt cliff vesting). Figure K. Vesting Schedule Prevalence Cliff Vesting Scheduled Vesting 58% 42% India 63% 38% Indonesia 67% 33% Mainland China 51% 49% 55% 45% The Philippines 56% 44% 60% 40% South Korea 76% 24% 54% 46% Future Changes Generally across the region, only a minority of organisations (30%- 40%) indicated that they plan on making some changes to their LTI plans in the near future. A slight majority of organisations in Mainland China (54%) and India (55%) indicated that they anticipate making changes. Of those organisations reporting possible future changes, the most popular anticipated changes are related to plan eligibility, performance conditions and vehicle types or mix. 8

About the Asia Incentive Plan Design Survey The 2011 survey was conducted across 10 countries in Asia in October 2011. This report is a summary of some of the major findings. Survey results include many additional details available only to participants, including plan costs, treatment of awards upon termination of employment, deferral practices, plan funding approaches, basis for determining awards and many other design administrative practices. The markets covered in the survey are: China Japan South Korea India The Philippines Indonesia Custom Analyses Detailed survey reports are available to survey participants in each market. In addition, special and custom survey data cuts, including industry and special peer groups, are available to survey participants at extra cost. For additional information or to request a survey questionnaire or a custom analysis, please contact: Toby Kim 6F. Officia Building 163 Sinmunno 1-ga, Jongno-gu Seoul Korea 110-999g toby.kim@ +82 2 3430 2531 Jing Yang 29/F, Sun Hung Kai Centre 30 Harbour Road Wanchai jing.yang@ +(852) 2820 8212 9