BorgWarner Inc. is arguably the best long-term performing company in the automotive supply industry. In an industry that has been through great upheavals and challenges, BorgWarner has consistently grown and increased shareholder value since at least the mid- 1990s.
This did not happen by accident. The company has had a strong and steady management team with little turnover and good succession. It has also followed disciplined acquisition and investment strategies that have systematically transformed the company from a parts manufacturer to a supplier of high margin systems and technologies.
So what does this have to do with executive compensation?
I was an executive compensation consultant to BorgWarner back in the 1990s. The incentive plans that the board put in place in the mid-'90s are still in place today, and hopefully have had something to do with the long-term success of the company. (I have not consulted to BorgWarner for at least 10 years, so I was very surprised and pleased to read the proxy and find that the incentive plans were basically unchanged.)
So what was so great about these incentive plans?
1. The annual incentive plan is based on EV or Economic Value. It pays out only if the company generates operating profit in excess of the cost of capital — and increases the amount of the excess return. This is a highly disciplined approach to paying for performance. It requires acquisitions and investments to be value accretive. It pays only for results that will, over time, create increases in shareholder value, and does not pay for results that destroy shareholder value. It is a balanced system that requires profits, growth, margin improvement, and a return on capital in excess of the cost of capital. And BorgWarner has been doing this fairly consistently for over 15 years.
2. The annual incentive plan is based on a three-year set of EV objectives, with threshold, target and maximum performance lines. In other words, the annual plan is tied to the annual achievement of a very clear three-year plan.
3. The long-term performance share plan requires BorgWarner's stock to consistently perform better than a peer group. While this type of plan has become popular as a way to avoid shareholder criticism, BorgWarner was one of the first to adopt such a “relative TSR” plan. Management and the board have been holding themselves accountable to this standard, and winning consistently for a long time.
4. The two plans are coordinated. The annual plan very clearly spells out the results that must be produced to generate long-term value. That value may not be reflected immediately in the stock price, but over time it has resulted in stock performance consistently in excess of other automotive suppliers.
One of the most important results of this combination of plans has been BorgWarner's acquisition and investment strategy. In the 1990s, the automotive supply business was characterized by large, high-priced, high-profile mergers and acquisitions. Not so for BorgWarner, which quietly made a long series of low-profile, low-cost, tactical acquisitions that fit with and enhanced existing businesses. Most were value-accretive and profit and cash flow-accretive very quickly. The company has continued this strategy as well as moving into higher margin systems and technologies.
These incentive plans also empowered the board to hold management accountable to consistent standards. Some of the program elements we put in place, that I assume are still there are:
• Rules of the road. The board insisted that management develop a fairly comprehensive list of all the “extraordinary events” that could take place, and in fact were quite likely to take place. Things like acquisitions and divestitures, plant closings, and reorganizations were defined and standards were set, in advance for how they would be treated for incentive plan calculations. A minimum size was established below which no adjustments would be made.
• Adjustments based on plans at time of transaction. The board would allow an adjustment for a large transaction, but the adjustment was agreed to at the time of the transaction, and was based on the projections used to justify and approve the transaction.
It is gratifying to see an incentive program that appears to have worked so well for so long. Obviously, there are many factors that have lead to BorgWarner's long-term success. But, it appears that a consistently applied, value-based program, with high standards and accountability from the board, is one of the keys to steady long-term value creation. â–
The author can be contacted at ddelves@delvesgroup.com.