Image source: Intel.
Intel (INTC +2.97%) just published its proxy statement for the 2014 fiscal year, preparing shareholders for the company's annual meeting on May 22. In the document, the semiconductor giant also reported on 2013 compensation for its directors and named officers -- and made some big changes to their bonus plans, starting in 2014.
In short, the Dow Jones Industrial Average (^DJI 0.13%) tech giant has given its leaders more motivation than ever to deliver strong shareholder returns.
Read my lips: no more stock options
The company will no longer pay its leaders in stock options. Fourteen percent of each named Intel executive's total compensation came in the form of options grants in 2013. Going forward, that percentage drops to zero.
Instead, Intel will expand its use of more direct stock awards -- with a twist.
The company won't simply issue bonus shares to its executives every year. It will provide a mix of two kinds of restricted stock units -- 40% as fairly straightforward restricted stock, and 60% of a more unique model known as outperformance restricted stock units.
Restricted stock will simply vest in portions over the next three years. This is a common practice, and is meant to give people an incentive to stick around. All restricted stock units may vest immediately in some cases, such as when a board member retires after turning 72 years old or serving on the board for at least seven years.
The outperformance units are different. This model is more commonly known as performance shares, and I can't for the life of me find another company besides Intel that uses the "outperformance" terminology. March to your own drummer, right?
Anyway, Intel has been using these outperformance units since 2009. The difference is that OSUs will now become the standard bonus procedure. The lion's share of every named executive's total compensation will arrive in this form.
In the OSU plan, Intel's performance is annually measured against a peer group in terms of total shareholder returns. That means looking back at stock returns and dividend payouts over the last three years, doing some math to balance out the peer group averages, and then checking whether Intel's stock did better or worse than the peers.
Delivering more than 100% of the comparison returns increases the bonus by several times the margin of outperformance. Doing worse reduces the bonus by a smaller multiplier. For the visual thinkers out there, this is how Intel explains it, comparing the old rules from 2013 to a revised 2014 version:
Image source: Intel.
Take note that the OSU plan used to guarantee at least a 50% payout of the basic bonus award. That floor has been taken arway, and Intel's leaders may get no OSU units at all if the stock performs poorly over the next three years.
This peer group is more important than ever
For fiscal year 2013, this plan worked out to a 3.4% outperformance. Intel delivered a 24.8% return from 2010 to 2013, while the peer group stopped at 21.4% by Intel's calculations. At the end of Intel's calculations, its executives ended up with a 23.1% performance-based boost to the basic bonus awards from 2010.
If you're curious how Intel composed its peer group for these comparisons, it's hardly a bunch of pushovers. The bar is set high, with 10 of Intel's peers drawn from the Dow Jones. It's not just the Dow's tech stocks, either.
Sure, Microsoft, Google, and the other standard tech giants are all there, but it's not all about bits and bytes. For example, drug titans Merck (MRK 1.49%) and Pfizer (PFE 0.78%) are in because they match Intel's business model in other ways. Intel and the drug industry share very high operating margins, and these companies all produce tens of billions in annual revenue from global operations on a massive scale. So Intel's board added them to the peer mix.
The company had to make some adjustments in 2014 to the peer list, which now stands at 25 companies. Dell went private last year, so it's no longer possible to compare share price performance against the computer systems builder anymore. In its place, Intel added a trio of smaller companies from the tech sector that match up with Intel's scale and research and development investments.
Here are the big changes to Intel's bonus plan in a nutshell:
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Options are all gone, taking an easily manipulated paper off the table entirely. This is good.
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The peer group is now slightly more focused on tech industry comparisons, a little bit less like a loose proxy for the Dow Jones Industrial Average. No biggie, but this change helps Intel focus on outperforming the tech sector above all else.
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Performance-based share awards make total shareholder returns more important than ever. That includes strong dividends. Will this adjustment finally inspire Intel to start raising its dividend payouts again? I sure hope so.
