Changes to executive compensation structure

Guiding principles

The new executive compensation system is designed to support the achievement of financial targets and improvements in key operations, and to drive focused change and the related leadership behaviors required.

To help achieve these goals, the Board has further developed ABB’s key principles of executive compensation:

  • Linked and balanced: Compensation is linked to the Next Level strategy and performance through ambitious objectives, robust performance monitoring and a sound balance between Group and individual performance

Stronger linkage of pay to performance

The Board has adapted executive compensation to take into account feedback from stakeholders and align performance objectives with those of the company’s Next Level strategy. All performance metrics support the interest of shareholders by driving earnings per share and cash return on invested capital.

  • Competitive: Annual base salaries of top management are set between the market median and upper quartile in order to attract suitable talent
  • Performance driven: Ambitious objectives are set in ABB’s planning processes, and variable pay is aimed at the upper quartile level when these objectives are met
  • Comprehensive KPIs: All performance metrics support the development of earnings per share and cash return on invested capital, and cover financial, operational, change and behavioral performance
  • Market tested: Compensation mix and levels are tested annually against benchmarks that include selected ABB peers and appropriate markets in which the company operates

These principles represent an evolution of the principles that governed executive compensation at ABB until 2014 (see Principles and governance), and their adaptation to the requirements of the company’s new strategic objectives.

Compensation link with Next Level strategy and performance

Following the revision of the key principles of executive compensation, the Board has changed the design of certain elements to strengthen the focus on performance that directly supports the Next Level strategy’s goals. The system therefore places greater emphasis on an individual’s objectives than in the past, and introduces a broader set of performance metrics (see Chart 4). These changes will help management ensure that the results are achieved in a sustainable way.

Base salary

The annual review of individual performance assesses each EC member’s results and behavior with respect to the Next Level strategy’s objectives.

Short-term variable compensation

Formerly based entirely on ABB Group’s performance, short-term variable compensation for each EC member will from 2015 be based on a balance between the Group’s results and the member’s individual performance. The change reflects the Board’s aim to align incentives more closely to the role of each EC member in implementing the Next Level strategy in his or her areas of responsibility, to strengthen rewards for outstanding individual performance, and to achieve a better balance in compensation between company and individual performance.

Individual objectives will cover key performance indicators that go beyond the Group’s results. They will include metrics that help the management to assess whether the results are achieved in a sustainable way, and with the appropriate processes and changes required to deliver the intended long-term results. These individual objectives will include the following types of objectives aligned with the Next Level strategy:

Financial
eg, drivers of earnings per share and cash return on invested capital

Operational
eg, improvements in costs, cash, customer satisfaction and safety

Change
eg, contribution to implementation of the Next Level strategy and its attendant change programs

Leadership
eg, behavior that supports strategic direction

Chart 4: Short-term variable compensation linked to clearly defined objectives
Revisions taking effect in 2015 – Short-term variable compensation linked to clearly defined objectives (graphic)Revisions taking effect in 2015 – Short-term variable compensation linked to clearly defined objectives (graphic)

The short-term variable compensation component will be based on a balance between Group and individual performance as of 2015.
Payout, if any, is proportional to the calculated performance up to the level at which it is capped.

Payment will continue to be conditional on the fulfillment of predefined annual objectives that are specific and challenging. Performance that is below these objectives results in a lower payout, or none at all if performance is below a certain threshold. If the objectives are exceeded, the payout may be up to 50 percent higher. However, the short-term variable compensation payout for 2015 will be directly proportional to the degree of performance achieved up to the level at which it is capped. Previously, the size of the payout for exceeding the objectives was at the Board’s discretion, up to the cap of 150 percent.

Long-term variable compensation

ABB has also revised the structure of LTIP, starting with the plan to be launched in 2015, to improve the emphasis on performance measures (see Table 8).

Performance component 1 (P1)

The size of this component at the grant date will continue to depend on ABB’s performance in the preceding three years and on the individual’s performance in the preceding year, but its weighting has been reduced to 50 percent from 60 percent. The vesting of this component is subject to ABB achieving a net income threshold in the financial year prior to the year in which the plan vests.

This component will continue to be settled in shares (70 percent) and cash (30 percent), although beneficiaries can elect to receive 100 percent in shares.

Performance component 2 (P2)

The component based on earnings-per-share performance has been given a larger weighting of 50 percent (previously 40 percent).

This component, previously settled in cash, will be settled in shares (70 percent) and cash (30 percent), although beneficiaries can elect to receive 100 percent in shares, to further strengthen the alignment of EC members’ interests with those of shareholders.

Table 8: LTIP components with increased emphasis on performance

Design up to 2014

Retention component...

Performance component...

As of 2015 the weighting of the component based on EPS performance has been increased and a net income threshold has been introduced for the other component. More of the LTIP will be settled in shares to better align the interests of EC members with those of shareholders.

Weighting

60%

40%

Delivery

Shares and cash

Cash

Design as of 2015

... becomes Performance component 1 (P1)

... becomes Performance component 2 (P2)

Weighting

50%

50%

Delivery

Shares and cash

Shares and cash

Illustration of compensation amounts in 2014, 2015 and 2016

Relative size of compensation components

The components of EC compensation can vary in size. Chart 5 shows the relative proportions of the components under minimum, target and maximum scenarios under the revised EC compensation system taking effect in 2015.

Chart 5: Size of compensation components under different scenarios
Revisions taking effect in 2015 – Size of compensation components under different scenarios (graphic)Revisions taking effect in 2015 – Size of compensation components under different scenarios (graphic)

Considerations in shareholder proposal

Chart 6 illustrates the considerations in the proposal for the maximum aggregate compensation for the EC for 2016, which will be submitted to shareholders for their approval at the 2015 AGM.

The maximum aggregate compensation amount submitted to shareholders for approval will almost always be higher than the actual payout, as it must cover the potential maximum value of each component of compensation.

Chart 6: Overview of considerations in calculation of maximum aggregate EC compensation
Revisions taking effect in 2015 – Overview of considerations in calculation of maximum aggregate EC compensation (graphic)Revisions taking effect in 2015 – Overview of considerations in calculation of maximum aggregate EC compensation (graphic)