Background
From a fear of collapse last year to a welcomed rebound in recent months, volatility in the oilfield services industry has been profound.
As for annual incentive plans in 2020, the pandemic’s shutdown of travel and large segments of the economy led to a dramatic decrease in drilling and production activities, and thus, performance goals established before the pandemic were not aligned with real-world conditions. Companies struggled to rationalize approaches to goal setting and the importance of some annual incentive payouts measurable achievements. The resulting strategies generally fell into three camps:
- Allowed plans to play out as originally designed, which generally resulted in zero or below target bonus payouts;
- Used discretion, whereby committees considered the uncontrollable impact of the economic slowdown and rationalized some payout based on a discretionary assessment of performance in context; and
- Relied on a more formulaic approach, in which performance was considered pre- and post- pandemic (reset goals for the second half of 2020) and potential payouts were generally calibrated accordingly.
With respect to long-term incentives, the consensus approach was to not amend any outstanding grants. For context, institutional investor groups such as ISS were very clear that amending outstanding grants would face significant scrutiny and rationalizing any adjustments would be extremely difficult.
Current Observations
Based on research from prominent oilfield services companies (individual conversations with current clients and researching public filings), we share the following statistics:
Annual Incentives:
- On average, annual incentives for 2020 performance paid out around 50% of target.
- The most common approaches among these companies was to either pay no bonus or to pay out between threshold and target.
- The central tendency was to pay around threshold (most plans pay 50% of target for threshold performance).
- The majority of companies reported no change to annual incentive design, but there is a continued trend of adding free cash flow and an emerging trend of adding ESG measures as formal measures in 2021.
Long-Term Incentives:
- None of the sample made a change to outstanding long-term incentives.
- As for 2021 grants, for those that disclosed:
- Target Value of 2021 Grants
- The vast majority (~80%) are planning no changes to the target value of 2021 grants;
- A few are planning a reduction in the value of 2021 grants; and
- Fewer are planning an increase in the value of 2021 grants.
- Design Changes for 2021 Grants
- No clear trend in design changes;
- Most reported no change to design; and
- Two reported introducing free cash flow as a measure for performance shares.
Conclusions
Market practice, based on this research, is to continue incentive plans in 2021 with similar target values and design as in 2020. If we supplement this research with our client conversations, we make the following observations:
- For companies that lack significant weighting in current plans, we see an increased emphasis on earnings and cash flow in annual incentive plans;
- Relative TSR continues to dominate as a measure in performance share plans, but we see a continuing 3-5 year trend to add measures of earnings, cash flow, and return measures (e.g., ROCE) as a supplemental measure to relative TSR;
- Target annual incentive values will be largely unchanged; and
- The target value of long-term incentives in 2021 will be flat, with a slight positive bias when compared to 2020. With a slight upward bias driven by companies looking to compensate for a lack of annual incentive payouts for the 2020 performance year.
With the sector seeing some improvement in 2021, payouts for 2021 may well be closer to or even above target. We anticipate more companies adding ESG measures to their incentive plans in 2021 and beyond, and for future LTI plan payouts to adjust when the sector does poorly relative to the broader market (including an additional discount tied to absolute performance or the addition of non-energy companies to the performance peer group).
