• 4.2 Board of Directors compensation system

Compensation report

4. Compensation components and system

4.1 Overview of compensation components

4.2 Board of Directors compensation system

The compensation of members of the Board of Directors is defined in a regulation adopted by the Board of Directors; it consists of fixed compensation, namely a cash retainer and non-discounted shares with a restriction period of five years and four months (Chairman of the Board of Directors) or four years and four months (all other members of the Board of Directors). In addition, members of the Board of Directors receive a committee fee (if applicable), a meeting attendance fee as well as a travel allowance. There is no performance-related compensation for the Board of Directors and Board members are not eligible to participate in the occupational pension plan.

The compensation of members of the Board of Directors is subject to mandatory employer social security contributions (AHV/ALV). These contributions are paid by Sonova and are disclosed in the compensation report in compliance with Sonova’s reporting obligations.

Further information regarding the planned total compensation amounts of the Board of Directors for the period from the 2018 Annual General Shareholders’ Meeting to the 2019 Annual General Shareholders’ Meeting is provided in the invitation to the 2018 Annual General Shareholders’ Meeting.

To further align the interests of the Board of Directors with those of Sonova’s shareholders, the Sonova share ownership guidelines require them to hold a specified number of Sonova shares (see section 6.1 for more information).

Sonova does not grant contractual severance payments to members of the Board of Directors, nor does Sonova make advance payments or grant loans to them. No loans were granted by Sonova or any other Group company to present or former members of the Board of Directors in the financial year, and no such loans were outstanding as of March 31, 2018. Furthermore, neither Sonova nor any other Group company has granted any loans to related parties of present or former members of Board of Directors.

4.3 Management Board compensation system

The compensation of the Management Board (including the CEO) is defined in several regulations adopted by the Board of Directors and comprises:

  • Fixed base salary
  • Employee benefits, such as pension benefits, flat rate car allowance, expense allowance, and relocation benefits for certain affected members
  • Short-term cash incentive award (VCC)
  • Long-term equity incentive award (EEAP)

The compensation of members of the Management Board who are under Swiss employment is subject to mandatory employer social security contributions (AHV/ALV). These contributions are paid by Sonova and are disclosed in the compensation report in compliance with Sonova’s reporting obligations.

The entire section describes the compensation system for the CEO and the Management Board. Compensation of the COO is excluded and is further described in detailed in section 5.2.

The chart below illustrates the compensation mix excluding employee benefits at target for the CEO, Lukas Braunschweiler and the Management Board in 2017/18 financial year. Due to special reasons as described in detail in section 5.2 Management Board Compensation, the highest paid member of the Management Board was the COO, Arnd Kaldowski; his compensation is not displayed in the compensation mix below.

The fixed base salary and benefits form the fixed compensation component and are based on current market practice. The variable compensation component consists of a short-term cash incentive award, the VCC, and a long-term equity incentive award in the form of options and PSUs awarded under the revised EEAP. Both short and long-term components are performance-based and payout or vest only if multiple challenging performance targets are achieved.

Fixed base salary

The fixed base salary ensures a regular and predictable salary paid out in cash in regular installments. The salary level is based on the scope and complexity of the position, market norms and benchmarks, and the individual’s profile in terms of experience and skills. Salary progression depends primarily on the individual’s performance, as well as market developments and the economic environment.

Short-term cash incentive award (Variable Cash Compensation)

Sonova’s Variable Cash Compensation (VCC) aims to align a significant part of compensation to budget achievements in a given financial year.

The VCC is an integral component of the cash compensation for members of the Management Board, defined as a percentage of the annual fixed base salary. At target, it amounts to 62.5% of fixed base salary for the CEO and up to 50% for the other members of the Management Board, excluding the COO.

The Board of Directors determines annually the target performance level for each KPI for the following financial year, based on the recommendation of the NCC. The targets are generally set in such a way that on an adjusted base, substantial improvements from the previous financial year’s achievement are required, in line with the company’s ambitious mid- and long-term financial plans. Setting demanding and ambitious targets helps Sonova strive to deliver best-in-class performance and stay ahead of the market. Lower and upper performance thresholds are also set, below which the payout percentage is zero, and above which it is capped at 200%. Payout levels between the threshold, the target, and the maximum are calculated by linear interpolation.

The VCC for the Management Board is based on three categories of performance objectives: Group, and/or business unit, and individual performance objectives. The performance objectives that must be met to achieve the target VCC are mutually agreed at the beginning of the financial year.

Group performance objectives are based on the budget; the specific KPIs are sales, EBITA, FCF, and EPS. Business unit performance objectives include sales, EBITA, ASP, and OPEX of the respective business unit. These KPIs have been chosen because they are the key drivers for the long-term success of Sonova; they link reward both to expanding the business and gaining market share and to further increasing profitability through operating leverage.

In broad terms, the rationale for applying these particular Group and business unit performance indicators in determining the VCC is as follows: sales correlate with market success, EBITA reflects profitability, ASP tracks value add and price discipline, OPEX and FCF represent operational and capital efficiency respectively. As for the performance indicators referenced to the external market, earnings per share is important to shareholders and for the determination of the share price.

Group and business unit performance objectives together are weighted at between 60% and 80% of the overall VCC. The individual performance component is based on the achievement of individual objectives defined at the beginning of the financial year between the CEO and individual members of the Management Board – and, for the CEO, between the Board of Directors and the CEO. The three to five individual performance objectives for each member of the Management Board are weighted at between 20% and 40% of the total.

Long-term equity incentive award (Executive Equity Award Plan)

The purpose of the Executive Equity Award Plan (EEAP) is to ensure long-term value creation for the company, alignment of the interests between shareholders and the members of the Management Board, and the long-term retention of talent at Sonova.

The EEAP is offered annually to the members of the Management Board. The Board of Directors determines the individual grant level to the Management Board based on the recommendation of the CEO, and to the CEO based on the recommendation of the NCC. Generally, the grant date is on February 1st each year.

Under the EEAP, the CEO receives an equity compensation mix of 62.5% in options and 37.5% in RSUs for the outgoing CEO and the other members of the Management Board are awarded 50% in options and 50% in PSUs.

Options

Options granted under the EEAP continue to vest in four equal annual installments over a period of 16–52 months depending on ROCE achievement. The first tranche vests on June 1 of the year following the grant year (16 months after grant date). The exercise price of the options is the closing price of the Sonova share on the Swiss Stock Exchange (SIX Swiss Exchange) at the grant date. The life of the options has been increased from 7 to 10 years to further incentivize participants to extended time to exercise.

The fair value of the options is calculated at the grant date using the “Enhanced American Pricing Model.” Additional information is available in Note 30 to the consolidated financial statements. Re-pricing of any out-of-the-money options granted under the EEAP is prohibited.

For reference, the average vesting duration for options amounts to 34 months. In practice, options have been usually exercised approximately one year after the vesting date. In this regard, options align management with shareholder interest, as value creation is only realized in the event of increasing share price (see section 5 for more information on the overall levels of the target achievements as well as other qualitative comments).

Vesting of option grants made under the EEAP to members of the Management Board includes ROCE as performance criterion. Based on the EEAP review and feedback of shareholders, we concluded that ROCE continues to be a very appropriate KPI to incentivize long-term value creation as it combines multiple KPIs namely both the profitability of the company and the efficiency with which Sonova’s capital is being employed. The Board of Directors determines the target level of performance at which the options will vest in full and a minimum performance threshold below which there is no vesting. The target is ambitious, representing a multiple of the weighted average cost of capital. Payout levels on ROCE performance between the threshold and the target are determined by linear interpolation. There is no provision for over-achievement in the EEAP; the proportion of options that can vest ranges from 0% to 100%.

Performance Share Units

The review of the compensation system, which took into account the feedback of shareholders and proxy advisors as well as market practice, resulted in a revision of the EEAP. From February 2018, the EEAP comprises of options and PSUs, which will generally replace RSUs. PSUs will vest based on rTSR achievement. The change to a rTSR basis further aligns the interests of Management Board with those of Sonova’s shareholders. Adding an external criterion to the EEAP assures a more balanced view of performance assessment and provides a comparison to other relevant companies to incentivize the members of the Management Board to achieve a strong rTSR performance.

PSUs granted under the EEAP will cliff vest after three years and four months, depending on the rTSR achievement. Sonova’s TSR is measured against those of the SLI®1) constituents that remain in the index during a performance period of three years and two months from grant. The slightly shorter performance period provides sufficient time to test for performance and receive approval of the calculation prior to vesting. The SLI was selected in order to compare Sonova´s performance to companies with a comparable geographic footprint, providing a relevant and challenging benchmark for Sonova’s value creation.

Depending on the rTSR performance ranking, the cliff vesting of PSUs is as follows:

  • 20th percentile or below: no cliff vesting occurs and granted PSUs are forfeited
  • 50th percentile: 100% of granted PSUs cliff vest
  • 80th percentile or above: 200% of granted PSUs cliff vest (cap)

The number of shares allocated for each vested PSU between the 20th and 80th percentile is calculated by linear interpolation. Furthermore, in the event that Sonova’s (absolute) Total Shareholder Return is negative over the performance period, the cliff vesting is capped at 100%.

The calculation of rTSR target achievement will be conducted using the average closing price for 90 trading days prior to grant and end of performance period respectively. The fair value of the PSUs is calculated at the grant date by using the “Monte Carlo Pricing Model.” Additional information is available in Note 30 to the consolidated financial statements.

  1. The Swiss Leader Index (SLI) includes the 30 largest and most liquid securities in the Swiss equity market

Transition arrangement under the previous EEAP

As approved by the Annual General Shareholders’ Meeting in 2017, a one-time RSU transition grant will be awarded to members of the Management Board in February 2019. The purpose of such a transition grant is to compensate affected members of the Management Board for the reduction in total target earning opportunity that will occur in 2019 and 2020 as a result of the longer vesting periods by changing from RSUs to PSUs.

Summary of the EEAP instruments

Termination of employment under the long-term equity incentive award (Executive Equity Award Plan)

In the event of termination of employment, vested options can be exercised within a 60-day period. Unvested awards (options, RSUs, PSUs) are forfeited on termination, with the following exceptions:

  • In case of death or disability, the unvested awards vest immediately. The vested options are exercisable within a period of 12 months commencing on the date of death or disability.
  • In case of retirement, the unvested awards with a vesting date during the calendar year of the employee’s retirement vest according to the regular vesting schedule. The vested options are exercisable for a period of 12 months. Unvested equity grants with a vesting date after the calendar year of the employee’s retirement are forfeited without any compensation.
  • In the event of termination of employment by Sonova for cause all options, whether vested or not, and other unvested awards become null and void immediately. “Cause” means any act of fraud, embezzlement or dishonesty, unauthorized use or disclosure of confidential information or trade secrets of Sonova or any other misconduct by the employee.
  • In the event of termination of employment by Sonova following a change of control (“double trigger”), unvested equity grants vest immediately on a pro rata basis considering the period from the grant date to the effective date of the change of control compared to the original period at target level, for options, and for PSUs based on actual achievement of the PSU performance conditions as of the date of occurrence of the change of control. Vested options are exercisable for a period of 60 days commencing on an employee’s date of termination. This rule does not apply in the event of voluntary resignation by the employee following a change of control. In such case, equity grants are forfeited.

Disclosure of targets

Internal individual and/or financial targets under the VCC and the EEAP plans are generally considered sensitive information with the exception of information relating to rTSR for PSUs under the revised EEAP. Disclosing internal targets would allow confidential insight into the strategy of Sonova and therefore could create a competitive disadvantage to Sonova. Therefore, the decision was made not to disclose the specifics of the VCC and EEAP internal financial targets at the time of their setting but to comment on overall target achievement and respective payout at the end of the financial year, including the external target achievement of rTSR, which will be disclosed.

As a general rule, on a comparable basis, substantial improvements against the previous year’s achievements are required in order to meet the growth targets, in line with the company’s ambitious financial plan (see section 5.2 for more information related to the overall quantitative and qualitative regional and segmental achievements for the 2017/18 financial year).

The amendments to the EEAP reflect best practice principles as well as market trends. The revised long-term equity incentive award has been developed and designed in cooperation with an external consultant: a leading independent international firm with expertise in the areas of compensation, and value-based management. The option exercise behavior of members of the Management Board already demonstrates a long-term view; the amendments are intended to reinforce and encourage that behavior.

Sonova Share Ownership Guidelines

To further align the interests of the Management Board with those of Sonova’s shareholders, Sonova’s share ownership guidelines require the members to hold a specified number of Sonova shares in order to be eligible to participate in the EEAP (see section 6.1 for more information).

Benefits

Sonova maintains defined-contribution plans under the Swiss occupational pension regulations. Pension benefits are provided through the regular pension plan. Members of the Management Board who are under a Swiss employment contract are eligible for the same benefits as all employees in Switzerland. Members of the Management Board who are under a foreign employment contract receive benefits in line with local current market practice.

The CEO and selected members of the Management Board are entitled to a flat rate car cash allowance as well as an expense allowance in line with the expense regulations applicable to all members of management in Switzerland, which is approved by the Swiss tax authorities.

Employment terms and conditions

As part of its commitment to good corporate governance, Sonova has a forfeiture provision in all employment agreements with the Management Board members. It provides for repayment of any compensation paid or granted prior to approval by the Annual General Shareholders’ Meeting and/or if the AGM does not approve the proposed total compensation of the members of the Management Board.

In addition, Sonova has introduced a claw-back provision allowing the company to reclaim any VCC payment, in part or in full, in the event of an accounting/financial restatement due to non-compliance with financial reporting requirements under the Swiss laws at the time of disclosure. This provision applies to all VCC payments for a period of three years following the financial year related to which the VCC payment has been made.

All members of the Management Board have permanent employment contracts with a notice period of a maximum of six months. The notice period for the CEO is 12 months.

Sonova does not grant contractual severance payments to members of the Management Board, nor does Sonova make advance payments or grant loans to them. No loans were granted by Sonova or any other Group company to present or former members of the Management Board in the financial year, and no such loans were outstanding as of March 31, 2018. Furthermore, neither Sonova nor any other Group company has granted any loans to related parties of present or former members of the Management Board.