4. Compensation components and system
4.1 Overview of compensation components
The table below provides an overview of the compensation components for the Board of Directors and the Management Board, with more details on both included later in the report:
4.2 Board of Directors compensation system
Role, responsibility and commitment
Sonova needs to be able to attract and retain members of the Board of Directors who are highly experienced and motivated to contribute their specific business expertise and perform a critical role in the strategic oversight of the company. Their compensation must enable this, while taking account of the way their contribution to Sonova’s success differs from that of the members of the Management Board.
Requirements, in terms of qualifications, skills, and experience, for directors of international listed companies are becoming ever more stringent. Sonova’s Board of Directors has the relevant and necessary skill set, including international, industry, and subject specific experience, to ensure proper professional supervision.
The structure of fees paid reflects varying responsibilities, committee memberships, workloads and time commitments, so individual levels of pay are not the same. The Chairman of the Board of Directors, for example, devotes a substantial amount of his time to duties including: leading the Board of Directors and committees, coordinating Board and committee meeting agendas and topics with committee chairs, and managing as well as contributing to and participating in committees. As NCC chairman, he takes the lead on topics such as Board and CEO evaluation, Board skill and competence definition and composition, new Board member recruitment and on-boarding, and participating in recruitment of Management Board members – as well as overseeing all compensation related matters.
The Chairman is also responsible for the continued development and adaptation of Sonova’s governance to meet regulatory and corporate requirements, preparing for and conducting the AGM, and overseeing the annual and compensation reports, as well as advising the CEO on key strategic, financial, HR, and operational matters. His role also encompasses third party interactions such as shareholder inquiries and requests about corporate governance and corporate responsibility as well as meetings with proxy advisors. His sound understanding of the company, developed over many years of service, is a unique and valuable qualification that we believe provides a substantial benefit to Sonova and its shareholders.
More details on the Board of Directors’ composition, diversity, competencies, evaluation, risk and compliance management, as well as corporate responsibility, can be found in the corporate governance report.
It is important that compensation components are structured to achieve a strong alignment with the interests of our shareholders. In line with best practice, a significant portion of the compensation for the Board of Directors consists of restricted shares, and they receive no variable or performance-based compensation and are not eligible to participate in the occupational pension plan.
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 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). In addition, members of the Board of Directors receive a committee fee (if applicable), a meeting attendance fee, and a travel allowance.
Compensation structure AGM 2018 to AGM 2019
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.
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.
Sonova Share Ownership Guidelines
To further align the interests of the Board of Directors with those of our shareholders, the Sonova share ownership guidelines require the members to hold a fixed value in shares.
Members of the Board of Directors are required to maintain a minimum shareholding equivalent to CHF 200,000. They have five months from the first grant of restricted shares to achieve 80 percent of the required shareholdings, and one year and five months from the same point in time to achieve the full required shareholdings. The guidelines can be met through shareholdings in the form of the restricted shares awarded as part of compensation and, if applicable, through share purchases on the open market. Compliance with the shareholding requirement is reviewed annually by the NCC.
Changes in compensation
As mentioned, the structure and level of compensation of the Board of Directors was reviewed in the reporting year, and the following amendments were approved:
2018/19 compensation report: The restricted shares were historically disclosed based on their tax value; they are now disclosed based on their market value as at the date of grant. The compensation of the Board of Directors was significantly reduced in 2011 and no changes have been made since. The aforementioned disclosure change could lead to the conclusion that the compensation was increased. However, this is not the case, as changes are purely a result of the combination from the change in reporting as well as the additional member of the Board of Directors (see also section 5.1).
Fees for the next term of office from the AGM 2019 to the AGM 2020 (subject to AGM approval): The meeting attendance fee will be discontinued and the overall compensation will be reduced to approximately offset the higher value due to the change in reporting: The cash retainer for the Chairman as well as the restricted shares for both the Chairman and the other Board members are reduced. The committee fees are increased in alignment with ever increasing requirements and the market.
Compensation structure AGM 2019 to AGM 2020
Further information regarding the planned total compensation amounts of the Board of Directors for the period from the AGM 2019 to the AGM 2020 is provided in the invitation to the AGM 2019.
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:
- A fixed base salary
- A short-term cash incentive award (VCC)
- A long-term equity incentive award (EEAP); and
- Employee benefits, such as pension benefits, flat rate cash car allowance, expense allowance, relocation benefits for certain affected members, as well as social security contributions.
The charts below illustrate the compensation mix excluding employee benefits at target for the CEO, Arnd Kaldowski, and the Management Board in the 2018/19 financial year:
The table below provides an overview of the compensation components of the Management Board, with more details on the following pages:
Fixed base salary
The fixed base salary ensures a recurrent payment in cash in regular instalments. 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 on market developments and the economic environment.
Short-term cash incentive award (Variable Cash Compensation)
Sonova’s VCC aims at aligning a significant part of compensation to budget achievements in a given financial year.
The VCC is an integral component of the compensation for members of the Management Board, defined as a percentage of the annual fixed base salary. At target, it amounts to 89% of fixed base salary for the CEO and up to 50% for the other members of the Management Board.
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 reward for expanding the business, gaining market share, and 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 total weight of the three to five individual performance objectives for each member of the Management Board is generally 20% of the overall VCC. The weight can be increased up to 40% for exceptional reasons, such as supporting key strategic initiatives.
Long-term equity incentive award (Executive Equity Award Plan)
The purpose of the 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 members of 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 PSUs and the other members of the Management Board are awarded 50% in options and 50% in PSUs.
As part of last years’ EEAP review it was decided to continue with a split award with a portion allocated in the form of performance options: This reflects the growth-focused strategy and the desire to further strengthen the alignment of the Management Board compensation with our shareholders’ interests.
Options granted under the EEAP vest in four equal annual instalments 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, and the life of the options is 10 years (grants before the 2017/18 financial year: 7 years).
The fair value of the options is calculated at the grant date by a third party using the “Enhanced American Pricing Model.” Additional information is available in Note 7.4 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 is 34 months. Options have usually been exercised approximately one and a half years after the vesting date. In this way 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 uses ROCE as its performance criterion because it reflects multiple KPIs, including 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
From February 2018 onwards, the EEAP comprises of options and PSUs (the latter replacing the previous Restricted Share Units). PSUs vest based on achieving relative Total Shareholder Return (rTSR). This external criterion, measured against a peer group of relevant companies, provides a performance assessment against these companies designed to incentivize members of the Management Board to achieve strong 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.
- The Swiss Leader Index (SLI) includes the 30 largest and most liquid securities in the Swiss equity market
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) TSR 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 a third party by using the “Monte Carlo Pricing Model.” Additional information is available in Note 7.4 to the consolidated financial statements.
One-time transition arrangement under the previous EEAP
As approved by the AGM 2017, a one-time RSU transition grant was awarded to members of the Management Board in February 2019. The purpose of this transition grant was to compensate affected members of the Management Board in office as of April 1, 2017 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, unvested options and RSUs vest immediately and unvested PSUs according to the regular vesting schedule. The vested options are exercisable within a period of 12 months commencing on the date of death or termination.
- In case of retirement, the unvested options and RSUs 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.
- For PSUs, in case of a qualified retirement as specified in the plan rules and subject to further requirements, any then unvested PSUs will vest on a pro-rata basis. However, the performance assessment will only be determined upon completion of the performance period.
- In case of a termination of employment by a participant or by Sonova (except for termination for cause) for Management Board members in office April 1st, 2017 whose date of termination occurs between the grant date and May 31st, 2021 (transition period), any then unvested PSUs will vest on a pro-rata basis. However, the performance assessment will only be determined upon completion of the performance period.
- 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. 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 clearly comment on the different target achievements and respective payout at the end of the relevant period. The overall target achievement for VCC and EEAP as well as the target achievement of rTSR will be disclosed (see section 5.2 for more information related to the overall quantitative achievements).
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 strategic and financial plans and as communicated to the capital market.
Sonova Share Ownership Guidelines
To further align the interests of the Management Board with those of our shareholders, the Sonova share ownership guidelines require Management Board members to hold a fixed value in shares.
The members of the Management Board are required to maintain a minimum shareholding equivalent to the following amounts:
- CEO: CHF 1,000,000
- Other members: CHF 200,000
They have three years and five months after receiving the first grant as Management Board member to build up the shareholding, with a required progression of one year and five months for a 12.5% achievement, and two years and five months for a 25% achievement. Only shares in the form of fully vested shares awarded as part of compensation and, if applicable, share purchases on the open market are counted. Compliance with the shareholding requirement is reviewed annually by the NCC.
As the Management Board is international in its nature, the members participate in the benefit plans available in the country of their employment contract. Benefits consist mainly of retirement, insurance and healthcare plans that are designed to provide a reasonable level of protection for the employees and their dependents in respect to retirement income, healthcare provision, and coverage against the risk of disability or death.
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 other 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 compensation of members of the Management Board who are under Swiss employment is subject to mandatory employer social security contributions (AHV/ALV).
The benefits and company contributions covered by Sonova are disclosed in the compensation report in compliance with Sonova’s reporting obligations.
The CEO and selected members of the Management Board are entitled to a flat rate cash car 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 AGM if the proposed aggregate compensation of the members of the Management Board is not approved.
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 and there are no change of control provisions other than those highlighted in the EEAP termination provisions.
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.