Finding the Bullseye – FY2024 Target-setting in a Less Buoyant Economy
As the economic boom times of the post-COVID era subside and some companies enter into a holding pattern in a higher interest rate environment, we explore how subdued earnings growth may impact a Board’s FY2024 approach to financial target-setting in executive bonus plans.
What is the issue?
For companies expecting headwinds from lower consumer spending and / or increased costs of borrowing, growth in company earnings may be hard to achieve. However, the need to retain high performing executives and incentivise these individuals to achieve the company’s budgets and long-term strategy remains.
As proxy advisors have Suspicious Minds towards companies paying out the same amounts for lower levels of financial performance or lower dividends, it may be a juggling act to appease external stakeholders and continue to motivate executives with the setting of ‘challenging yet achievable’ targets. Year-on-year earnings growth expectations may generate A Little Less Conversation this year and no longer be realistic for some, so what are alternative ideas?
1) Maintaining flat earnings and capping non-financial outcomes
Generating a similar level of earnings as last year may be a sufficiently challenging task. Setting a target of maintaining flat earnings in this case would ensure the carrot remains within sight for executives. However, to counter proxy advisor (and potentially investor) criticism of paying out for lower or flat financial performance, Boards may consider capping payouts on non-financial measures to ‘at-target’ if a minimum financial threshold is not met. This aims to ensure that STI awards are not dominated by non-financial outcomes as The Devil in Disguise.
2) Lower growth targets accompanied by lower payout levels as a trade-off
In industries which benefitted from the influx of consumer spending in the COVID era but are likely to be increasingly crunched by reduced household disposable income, setting lower targets than last year may be the only realistic solution. Where earnings are expected to decline from last year, paying out the same bonus amounts for lower performance is unlikely to be a Good Luck Charm in passing the external stakeholder ‘pub test’.
Boards may consider changing the amount of STI awarded at threshold (e.g. reducing it to 25% from 50%), or increasing the threshold level of performance (to a number closer to target than historically, such as 97.5% of target rather than 95%). Changing the payout range ensures management will still be rewarded for meeting a minimum level of budgeted financial performance, however, to receive the cherry on top in the form of higher bonus payouts, executives will still need to achieve challenging growth targets.
3) Change in financial measures – greater focus on maintaining margins
In industries subject to significant inflationary pressures driving up costs (e.g. wages, equipment, materials, etc), replacing existing earnings growth measures with those focused on maintaining margins may be appropriate. Instead of incentivising executives to solely drive bottom line growth, Boards may elect to hone in on cost management.
Conclusion
For companies expecting headwinds in a low growth economy, the FY2024 annual target-setting process has been complicated as existing measures may become obsolete or just hard to sell. While this requires a rethink on whether last year’s measures and targets are realistically attainable by executives in FY2024, it presents Boards with a blank(er) slate to refresh and get creative – It’s Now or Never.