The following is an excerpt from Ice Miller's Pathways to Success for Utilities Guide
which provides insights on a variety of topics potentially impacting utility service providers.
Compensation plans of utilities, like all employers, should be designed to attract and retain key employees and motivate those employees to achieve the objectives established by the utility’s board and management. A poorly designed compensation program will fail to achieve its objectives to the detriment of both customers and shareholders. A balanced approach to a compensation plan that focuses on “controlling costs and efficiently serving customers can both improve a utility’s bottom line and benefit ratepayers in the short- and long-run.” Re Northern Indiana Public Service Company, Cause No. 43526, 284 P.U.R.4th 369, 2010 WL 3444546 (IURC August 25, 2010)
Utilities, like other employers, need to assure that their short-term and long-term incentive compensation programs “pay for performance.” In other words, a significant portion of key employees’ compensation should be based on the achievement of appropriate performance measures. For many publicly-traded employers, “total shareholder return” or some similar factor is the most important, if not the only, factor used to measure the performance of top-level employees. However, utilities have a broader constituency than most employers, including regulators and the communities and customers they serve. Therefore, “total shareholder return” may not be the most important factor or the only factor used to measure the performance of top-level employees.
The Indiana Utility Regulatory Commission (IURC) recognizes the value of incentive compensation plans as part of an overall compensation package to attract and retain qualified personnel. In order for the cost of an incentive compensation plan to be recoverable in a utility’s rates, the plan must meet certain well-established criteria. The IURC allows incentive compensation costs to be reflected in rates when: (1) the incentive compensation plan is not a pure profit-sharing plan, but rather incorporates operational, as well
as financial performance goals; (2) the incentive compensation plan does not result in excessive pay levels beyond what is reasonably necessary to attract a talented workforce; and (3) shareholders are allocated part of the cost of the incentive compensation program. Northern Indiana Public Service Company, Cause No. 43526, 2010 Ind. PUC LEXIS 294, at *195-96 (IURC Aug. 25, 2010). Expenses associated with compensation plans that are tied largely to financial performance goals have generally been required to be borne by shareholders—not ratepayers. Re Indiana-American Water Company, Inc., Cause No. 44022, 2012 WL 21542418 (IURC June 6, 2012).
Depending on the type of utility and the responsibilities of a particular employee, pay-for-performance factors may include:
Reliability of service,
Net operating income,
And/or any other factor that the board or compensation committee deems appropriate in light of the utility’s objectives.
The IURC has authorized the recovery of the cost of incentive compensation plans in rates where some of these performance factors are taken into account. For instance, the IURC found that a utility’s incentive plan was not a “pure profit-sharing plan” and thus its costs were recoverable in rates where it included non-financial measures such as safety, customer satisfaction (inclusive of call center service levels), and generation unit availability. Re Southern Indiana Gas & Electric Company d/b/a Vectren Energy Delivery of Indiana, Inc., Cause No. 43839 289 P.U.R.4th 9, 2011 WL 1690057 (IURC April 27, 2011). The IURC also has found service reliability to be an appropriate incentive plan metric. Re Northern Indiana Public Service
Company, Cause No. 43526, 284 P.U.R.4th 369, 2010 WL 3444546 (IURC August 25, 2010). Where net operating income or profitability are used as factors, shareholders will be required to pay for a greater portion of the cost of the plan.
Utilities may want to consider equity-based forms of compensation, such as restricted stock, incentive or non-qualified stock options, stock appreciation rights, and/or performance shares for key employees. Different types of equity-based compensation have different tax and accounting consequences. As a result, a utility may use more than one type of equity-based compensation for motivating and rewarding key employees.
In addition to incentive compensation programs, many utilities provide supplemental retirement programs, enabling them to appropriately structure benefits to retain key employees. Often, utilities will provide change-of-control protections for senior-executives in order to encourage those employees to consider and, if appropriate, pursue beneficial transactions—even if those transactions could result in the executive losing his or her position. Experienced counsel can help structure key elements of utility employee compensation packages.
A clearly-stated purpose and implementation provisions are essential to the success of any incentive compensation program and to the communication of that program to key constituencies, including regulators. Specific details should be released in annual reports to highlight the accomplishments of the employees and to help consumers understand how those accomplishments benefit them.
To learn more, download the Pathways to Success for Utilities Guide
or contact any member of Ice Miller's Energy and Utilities Law