Incentive Plan Payout Curves: A Primer

In a new primer called Factors to Consider in the Design of an Incentive Payout Curve, the Center’s Charlie Tharp examines how the shape of a company’s incentive plan payout curve communicates an important message to plan participants about performance and the confidence of the performance targets.

Incentive payout curves show the relationship between performance (against preset incentive targets) and the corresponding incentive pay level, with the slope of the curve reflecting the percentage change in payout for each percentage change in performance.  The actual slope of the curve is a form of communication to incentive participants as to how the company values alternative levels of achievement of the targets.

The primer highlights four payout curves along with the implications of the performance messages each sends. Practitioners should consider the implications of the payout curves in their plan design and ensure they are based on the underlying economics of the relationship between performance and returns to the company. For more details, make sure to read the full primer linked above.

• Linear Curves. Selected when there is not a reason to disproportionately reward performance that exceeds target or to disproportionately punish performance that falls short of target.
  
  
• Asymmetrical Positive Curves. Selected to incentivize overachievement of targeted goals, this curve is one where payouts for exceeding targeted performance increase at a steeper rate than the rate by which payouts decrease for performance below targeted performance.
  
  
• Asymmetrical Negative Curves. This curve has a steeper penalty for falling short of targeted performance which may reflect the importance of meeting performance objectives communicated to investors.
  
  
• Flat Range of Payouts Curves. A variation of the curves described above, these would have a target range above and below 100% of target (i.e., 95% - 105% of targeted performance results in 100% payout).

Additional resources for setting performance targets during periods of uncertainty and volatility are available in our memo, Setting Incentive Targets in a Time of Economic Volatility, available on our website.