Components of executive compensation

All senior positions in ABB have been evaluated using a consistent methodology developed by the Hay Group, whose job evaluation system is used by more than 10,000 companies around the world. The Hay methodology goes beyond job titles and company size in assessing positions. It considers the know-how required to do the job, the problem solving complexities involved, as well as the accountability for results and the freedom to act to achieve results.

This approach provides a meaningful, transparent and consistent basis for comparing remuneration levels at ABB with those of equivalent jobs at other companies that have been evaluated using the same criteria. The Board of Directors uses Hay’s data from the European market for positions based in Switzerland and from the North American market for jobs based in the US. Compensation for Executive Committee members at ABB is around or slightly above the median values for the market in each region, reflecting ABB’s success in outperforming its peers in recent years.

In addition to being aligned with the market in this way, the compensation of Executive Committee members is also designed to support three principles:

  • performance against specific and measurable Group targets;
  • shareholder value, measured as the performance of ABB’s shares against those of the company’s peers;
  • retention of executives and their expertise.

The compensation of Executive Committee members currently consists of the following elements which, taken together, reflect these principles: a base salary and benefits, a short-term variable component dependent on Group performance criteria, and a long-term variable component designed to reward the creation of shareholder value and an executive’s commitment to the company. These are described in detail in the remainder of this section.

The base salary and benefits are fixed elements of the annual compensation packages, while the other components vary with performance. In 2010, fixed compensation represented 32 percent of the CEO’s remuneration and about 50 percent for most of the other members of the EC. The ratio of fixed to variable components in any given year will depend on the performance of the individuals and of the company against predefined criteria.

The main components of executive compensation in 2010 are summarized in the following chart and explained in more detail below:

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Base salary

Cash

Paid monthly

Competitive in respective labor markets

Annual increases, if any, partly based on performance

Short-term variable
compensation

Cash

Conditional annual payment

Payout depends on performance in previous year against predefined targets

Long-term variable
compensation
(Long-Term
Incentive Plan)

Cash
and shares

Performance component:

Conditional grant made annually

Payout is in cash and depends on performance
of ABB shares against those of peers over a three-year period

Retention component:

Conditional grant made annually

Payout is in shares and requires executive
to remain at ABB for full three-year period
(30 percent may be drawn in cash principally to help meet tax obligations)

In addition, members of the Executive Committee are required to build up a holding of ABB shares that is equivalent to a multiple of their base salary, to ensure that their interests are aligned with those of shareholders. The requirement, as of 2010, is five times base salary for the CEO and four times base salary for the other members of the Executive Committee. New members of the Executive Committee should aim to reach these multiples within four years of their appointment. These required shareholding amounts are reassessed annually based on salary and share price developments.

Annual base salary and benefits

The base salary for members of the Executive Committee is set with reference to positions with equivalent responsibilities outside ABB as determined using the Hay methodology described above. It is reviewed annually on the basis of Hay’s annual Top Executive Compensation in Europe survey for executives based in Europe, and of the Top Executive Compensation in the US for positions based in the US. In addition, the executive’s performance during the preceding year against individual targets is taken into account when considering increases.

Members of the Executive Committee receive pension benefits, payable into the Swiss ABB Pension Fund and ABB Supplementary Insurance Plan (the regulations are available at www.abbvorsorge.ch), except for Veli-Matti Reinikkala who is insured under comparable plans in the US, where he is based. ABB targets a level of pension benefits that is among the top 25 percent of Swiss companies. The current level of pension benefits was set following a survey of Swiss companies that ABB commissioned from Towers Watson, a consultant, in 2007.

Executive Committee members also receive social security contributions and other benefits, as outlined in the compensation table in the “Executive Committee compensation in 2010” section of this remuneration report.

Short-term variable compensation

Payment of the short-term variable component is conditional on the fulfillment of predefined annual targets that are specific, quantifiable and challenging. In any given year, this element of an Executive Committee member’s compensation therefore reflects the company’s performance against targets for the preceding year.

In 2010, the targets were Group-wide objectives that were aligned with financial measures communicated to shareholders: orders received, revenues, earnings before interest and taxes, operating cash flow, and cost savings. The first two measures had a weighting of 12.5 percent each, while the other three each accounted for 25 percent.

The payment for fully achieving the targets is equivalent to 150 percent of the base salary for the CEO and 100 percent of the base salary for other members of the Executive Committee. Underachieving the targets results in a lower payout, or none at all if performance is below a certain threshold. The Board may approve a higher payout if the targets are exceeded.

Long-term variable compensation

An important principle of executive compensation at ABB is that it should encourage the creation of value for the company’s shareholders and enable Executive Committee members to participate in the company’s success. Value creation is measured in terms of total shareholder return (TSR), which is the percentage change in the value of the ABB share plus dividends over a three-year period.

The company’s Long-Term Incentive Plan (LTIP) is the principal mechanism through which members of the Executive Committee and certain other executives are encouraged to create value for shareholders. Awarded annually, LTIPs comprise a performance component and a retention component.

Performance component

The first element is designed to reward participants for achieving a TSR that is superior to that of a group of reference companies in related businesses. The peer group is selected by the GNCC on recommendations from an independent third party (a global investment bank), and is reviewed annually. The group currently consists of Alfa Laval, Alstom, Aspen, Atlas Copco, Cooper, Emerson, GE, Honeywell, Invensys, Legrand, MAN, Rockwell, Sandvik, Schneider, SKF, Siemens, Smiths Group, Yaskawa and Yokogawa.

Under each three-year plan, members of the Executive Committee are conditionally granted a number of shares whose value at the launch of the plan is equal to a certain percentage of their base salary. In 2010, the percentages were 67 percent for the CEO, 50 percent for the CFO and head of Global Markets, and 42 percent for the other members of the EC.

The award will be made after three years if ABB’s total shareholder return meets certain criteria. For example, no payout will be made if ABB’s performance is weaker than half of its peers. The payout is 33 percent if ABB’s performance over the evaluation period is positive and equal to the median of the peer group, and rises on a proportional scale to 100 percent if ABB’s performance is positive and at least equal to three-quarters of its peers.

If ABB’s performance is negative but better than half of its peers, the number of shares awarded under the Long-Term Incentive Plan launched in 2010 will be reduced.

In addition, there is no payout if ABB is unprofitable in the calendar year preceding the end of a three-year LTIP. The measure of profitability used for this purpose is operating net income, which is ABB’s net income adjusted for the financial impact of items considered by the Board to be exceptional (such as divestments, acquisitions, etc.).

The assessment of ABB’s performance against its peers for each three-year period is carried out by an independent third party. As of the 2010 LTIP, the payout will be made in cash.

Retention component

The second component of the Long-Term Incentive Plan is designed to retain executives at ABB and forms a larger part of the plan launched in 2010 than of those launched in previous years. Plans launched prior to 2010 include a co-investment component under which each participant, at the start of the three-year cycle, could set aside shares from their personal holding equivalent in value to 33 percent of the short-term variable compensation received that year. If the shares are held for the entire three-year period, ABB will award the participant the same number of shares.

Starting with the 2010 LTIP, members of the Executive Committee are conditionally granted shares which, at the start of each three-year plan, are equal to a certain percentage of their base salary. In 2010, the percentages were 100 percent for the CEO, 75 percent for the CFO and head of Global Markets, and 65 percent for the other members of the Executive Committee. The award may be lower if an executive does not reach the personal targets they were set for the previous calendar year.

The shares are awarded after three years to executives who are still working for the company. Executives can choose to receive 30 percent of the payout in cash, principally to help them meet their income tax obligations. Under the terms and conditions of the plan, executives forfeit the shares if they leave ABB voluntarily, while those who retire or are asked to leave the company are awarded shares on a pro rata basis.

Severance provisions

Employment contracts for Executive Committee members contain notice periods of up to 12 months, during which they are entitled to salaries and short-term variable compensation. In addition, if the company terminates the employment of a member of the Executive Committee and that member does not find alternative employment within the notice period that pays at least 70 percent of the member’s annual compensation, then the company will continue to pay compensation for up to 12 additional months.