Executive Committee compensation

Compensation principles

ABB’s compensation system reflects the commitment to attract, motivate and retain people with the talent necessary to strengthen ABB’s position as a pioneering technology leader for utility, industry, and transport & infrastructure customers.

The compensation system is designed to provide competitive compensation and to encourage executives and employees to deliver outstanding results and create sustainable shareholder value without taking excessive risks. The compensation system balances:

  • fixed and variable compensation elements;
  • short-term and long-term incentives;
  • the recognition of Group and individual performance.

The compensation system has been refined in recent years in line with ABB’s Next Level Strategy, so that it rewards the achievement of financial and operational objectives and drives the leadership behaviors required for the long-term and sustainable success of ABB. The compensation system is based on the following principles (Exhibit 5).

Exhibit 5: Principles of EC compensation

Strategic alignment

Compensation is directly linked to the Next Level Strategy through ambitious performance objectives and robust performance monitoring.

Performance orientation

Ambitious goals are set in ABB’s planning processes and variable pay is aimed at the upper quartile level when these objectives are met.

Comprehensive and balanced KPIs

Performance metrics support the development of earnings per share and cash return on invested capital. They also include measures of operational and behavioral performance that are critical in the current change process of the Next Level Strategy. Performance metrics are well-balanced as they reflect both Group and individual performance, as well as short-term and long-term results.

Competitiveness

Compensation mix and levels are reviewed annually against benchmarks that include relevant peer companies in the markets in which ABB operates. Annual base salaries of EC members are set between the market median and upper quartile in order to attract suitable talent.

Alignment with ABB’s business strategy

The Board defines the strategic direction of the company and regularly reviews the progress made on the strategy. Based on these reviews, the Board sets performance targets and annual budgets, and ensures that the company’s compensation programs support the implementation of the strategy by appropriately rewarding performance (see Exhibit 6).

Exhibit 6: Annual review of the business and performance cycle
Annual review of the business and performance cycle (graphic)Annual review of the business and performance cycle (graphic)

*AR – annual results; QR – quarterly results

To effectively align strategy, performance and compensation, the target setting and review processes are directly linked to the financial and budget processes.

The Board designs the overall EC compensation so that it is aligned with our Next Level Strategy. In addition, short-term targets are aligned with our external targets (including revenues, operational EBITA, cash generation, and earnings growth).

Market competitiveness and benchmarks

All EC and other senior positions at ABB have been evaluated using the job evaluation methodology of the Hay Group, which is used by more than 10,000 companies around the world. This approach provides a meaningful, transparent and consistent basis for evaluating roles and for comparing compensation levels with those of equivalent jobs at other companies.

The General Pan-European Market data of Hay’s annual survey Top Executive Compensation in Europe is primarily used to benchmark EC compensation, which is targeted to be above the median values for the market. Other references include Hay’s data on the Swiss and European industry markets and on US peers (see Exhibit 7).

Exhibit 7: Compensation benchmarks

REFERENCE

COMPOSITION

RATIONALE

 

 

 

Main benchmark

General Pan-European Market

360 largest European companies of the FT Europe 500 listing

Continuity and
stability of data points

 

 

 

References to stress-test main benchmark

Global Industry Group

Peer companies selected based on business, geographic presence and size

Specific peer group to benchmark compensation design

Swiss market

SMI and SMIM companies that are included in Hay’s General Pan-European Market data

Comparison with other multinational Swiss companies

US market

US peers of similar size and industry

Comparison with other multinational US companies

Components of EC Compensation

The compensation of EC members consists of an annual base salary, benefits, a short-term variable component based on annual performance objectives and a long-term variable component based on long-term performance (see Exhibit 8).

*

 

Changes are foreseen for 2017 grants, please refer to section “Outlook: changes to compensation system in 2017”.

 

 

 

 

 

Exhibit 8: Structure of EC compensation

 

 

Fixed compensation

 

Variable compensation

 

 

Base salary and benefits

 

Short-term

 

Long-term

Compensation component

 

 

 

 

 

Performance component 1
(P1) 50%

Performance component 2 (P2) 50%

Purpose

 

Compensates EC members for the role. Based on the scope of responsibilities, individual experience and skillset

 

Rewards annual performance

 

Encourages creation of long-term, sustainable value for the shareholders

Performance measures affecting amount/ allocation

 

When considering changes in base salary, the executive’s performance during the preceding year against individual objectives is taken into account

 

n.a.

 

ABB’s performance (preceding three years); Individual performance (preceding year)*

n.a.

Performance measures affecting payout

 

n.a.

 

Group and individual objectives in the relevant financial year

 

Net income threshold in the financial year prior to vesting*

Cumulative EPS target over the 3-year vesting period

Payment

 

Cash and benefits in kind

 

Cash

 

Shares (70%) and cash (30%)
Beneficiaries can elect to receive 100% in shares

The main components of EC compensation are directly linked to performance.

The Board considers several factors when reviewing and setting the individual target compensation of each EC member:

  • Market value of the role (external benchmark);
  • Individual profile of the incumbent in terms of experience and skillset;
  • Individual performance and potential; and
  • Affordability for the company.

The compensation that is effectively paid depends on the performance of the Group and of the individual members of the EC. Exhibit 9 illustrates the relative proportions of the components of EC compensation under the scenarios of minimum performance, target (expected) performance and maximum performance.

Exhibit 9: Compensation components under various scenarios
Compensation components under various scenarios (graphic)Compensation components under various scenarios (graphic)

Fixed compensation – annual base salary and benefits

The fixed compensation of EC members includes the fixed annual base salary and benefits. Benefits consist mainly of retirement, insurance and healthcare plans that are designed to provide a reasonable level of income for the employees and their dependents in case of retirement, disability or death. Benefits plans vary in line with the local competitive and legal environment and are, at a minimum, in accordance with the legal requirements of the respective country.

EC members are also provided with certain fringe benefits such as a company car according to competitive local market practice. Tax equalization is provided for EC members resident outside Switzerland to the extent that they are not able to claim a tax credit in their country of residence for income taxes they paid in Switzerland. The monetary value of these benefits is disclosed in Exhibits 21 and 22.

Short-term variable compensation

The short-term variable compensation is designed to reward EC members for the Group’s results and their individual performance over a time horizon of one year. It allows the EC members to participate in the company’s success while being rewarded for their individual contributions.

Group objectives are aligned with the strategic targets of ABB’s Next Level Strategy that have been communicated to shareholders and have a weighting of 80 percent for the CEO and 65 percent for the other EC members. For 2016, the Group objectives included revenues, operational EBITA margin, operational net income, operating cash flow, cost savings and Net Promoter Score (NPS).

Individual objectives are set as part of the annual performance management process and support the implementation of the Next Level Strategy in the respective area of responsibility of each EC member. They include metrics that help the management to assess whether the results are achieved in a sustainable way in four different categories: financial performance, operational performance, strategic initiatives and leadership performance. Individual objectives have a weighting of 20 percent for the CEO and 35 percent for other EC members (see Exhibit 10).

(1)

Changes are foreseen for 2017, please refer to section “Outlook: changes to compensation system in 2017”.

Exhibit 10: Short-term variable compensation objectives and weighting in 2016

 

Explanation

 

Weighting

 

 

 

CEO

Other EC
members(1)

Group objectives

Six financial and non-financial parameters: revenues, operational EBITA margin, operational net income, operating cash flow, cost savings and Net Promoter Score

 

80%

65%

Individual objectives (tailored to function and area of responsibilities)

Include:
– Additional financial objectives
– Operational execution metrics
– Strategic goals
– Leadership objectives

 

20%

35%

For each performance objective, a target is set corresponding to the expected level of performance that will generate a 100 percent payout. In order to strengthen the company’s market position and to continuously strive for superior performance, stretch targets are determined in line with the company’s ambitious financial plan and with the Next Level Strategy. Further, a minimum level of performance, below which there is no payout (threshold) and a maximum level of performance, above which the payout is capped at 150 percent of target (cap), are also defined. The payout percentages for achievements between the threshold, the target and the cap are determined by linear interpolations.

Fully achieving all the objectives (target performance) results in a payout equivalent to 150 percent of the annual base salary for the CEO and 100 percent of the annual base salary for other EC members.

Long-term variable compensation

The long-term variable compensation for EC members consists of an annual conditional share grant under the Long Term Incentive Plan (LTIP), which is aimed at driving long-term shareholder value creation in a sustainable manner. It rewards the achievement of predefined performance goals over a three-year vesting period.

The LTIP is split in two performance components:

  • a P1 component which is tied to ABB’s achievement of a threshold net income in the financial year prior to the end of the vesting period, and
  • a P2 component which is tied to the achieved weighted cumulative earnings-per-share (EPS) over the vesting period.

The P1 and P2 components are equally weighted in terms of the target fair value at grant.

Determination of grant size

The number of shares conditionally granted under the LTIP is determined as follows:

  • A reference value for the LTIP is first established as a multiple of the annual base salary. In 2016, the multiples were 200 percent for the CEO and 107 percent for the other EC members. As the P1 and P2 components are equally weighted, the reference value of these components for the CEO and the other EC members for the 2016 LTIP were as follows:

     

    P1 component

    P2 component

    Total

    CEO

    100%

    100%

    200%

    EC

    53.5%

    53.5%

    107%

     

  • The reference value for the grant size of the P1 component for the CEO as an individual and the other EC members as a pool may be increased or decreased by the Board by up to 25 percent. The increase or decrease is based on the Board’s assessment of ABB’s performance over the three financial years preceding the grant, both in absolute terms and relative to a peer group comprising Alstom, Eaton, Emerson, GE, Honeywell, Legrand, Schneider and Siemens. The allocation from the pool to each individual EC member is determined by the Board based on an assessment of the individual’s performance.
  • The reference value of the P2 component is not subject to any adjustment.
  • The number of shares conditionally granted under P1 and P2 to each EC member is determined by dividing the respective grant value by the average closing prices of ABB shares over the 20 trading days following the Board’s decision to launch an LTIP grant.

Determination of payout at vesting

To vest at the end of the three-year vesting period, the following performance conditions must be met:

  • For the P1 component, ABB has to achieve the threshold net income level set by the Board at the beginning of the vesting period. The component will not vest if this threshold is not achieved and will vest at 100 percent if this threshold is met or exceeded. Therefore there is either no payout or 100 percent payout.
  • Exhibit 11: Payout formula for P2 (EPS performance)

    Payout % of reference number of shares under the P2 performance component

    Payout formula for P2 (EPS performance) (graphic)Payout formula for P2 (EPS performance) (graphic)

    The LTIP rewards participants for increasing EPS over a three-year period. The payout of the P2 component is based on ABB’s weighted cumulative EPS performance against predefined objectives.

    For the P2 component, the percentage of shares that may vest (the payout percentage) is based on ABB’s EPS performance against an EPS objective set by the Board at the beginning of the vesting period. This EPS objective is based on an outside-in view, taking into account the growth expectations, risk profile, investment levels and profitability levels that are typical for the industry. This outside-in approach in setting EPS objectives for the LTIP assumes that investors expect a risk-adjusted return on their investment, which is based on market value (and not book value) and translates such expected returns over a three-year period into EPS targets. The weighted cumulative EPS result is calculated as the addition of the EPS in the first financial year (weighted at 33 percent) plus the EPS in the second financial year (weighted at 67 percent) plus the EPS in the third financial year (weighted at 100 percent). This formula gives more weight to the EPS achieved in the later years of the vesting period. There is no payout if the lower EPS threshold is not reached and the payout is capped at 200 percent if EPS performance exceeds the pre-defined payout cap. The payout formula is shown in Exhibit 11.

To further strengthen the alignment of EC members’ interests with those of shareholders, both P1 and P2 components are settled in shares (70 percent) and cash (30 percent), although participants can elect to receive 100 percent in shares.

Key contractual provisions

Share ownership requirements

The Board aims to align EC members’ interests with those of shareholders. To maintain focus on the long-term success of the company, EC members are required to build up a holding of ABB shares that is equivalent to a multiple of their annual base salary (see Exhibit 12).

Exhibit 12: Share ownership requirements for EC members

Chief Executive Officer

5 x annual base salary

Other EC members

4 x annual base salary

Only shares owned by an EC member and the member’s spouse are included in the share ownership calculation. Vested and unvested stock options are not considered for this purpose.

The CC reviews the status of EC share ownership on an annual basis. It also reviews the required shareholding amounts annually, based on salary and expected share price developments. As the level of the shareholding requirement is high relative to market practice, the Board has determined that members of the EC should generally aim to reach these multiples within five years of their appointment.

Notice period, severance provisions and non-competition clauses

Employment contracts for EC members include a notice period of 12 months, during which they are entitled to their base salary, benefits and short-term variable compensation. In accordance with Swiss law and ABB’s Articles of Incorporation, the contracts for EC members do not allow for any severance payment.

Non-compete agreements have been agreed with EC members for a period of 12 months after their employment. Compensation for such agreements, if any, may not exceed the EC member’s last total annual compensation.

Malus and clawback

Any long-term incentive compensation awarded to members of the EC is subject to malus and clawback rules if a plan participant has been involved in any illegal activity. This means that the Board of Directors may decide not to pay any unpaid or unvested incentive compensation (malus), or may seek to recover incentive compensation that has been paid in the past (clawback).