Executive summary

In 2016, IBM emerged as the recognized cognitive solutions and cloud platform company — the result of a multi-year transformation of the business portfolio. IBM reinvented its core hardware, software, and services franchises, while investing to create new ones such as IBM Cloud, IBM Analytics, IBM Security, and the Watson businesses. A strong foundation is now in place.

Specific highlights of performance include:

  • Generated revenue of $79.9 billion and GAAP net income from continuing operations of $11.9 billion (operating non-GAAP net income of $13.0 billion).
  • Delivered GAAP gross margin of 48%, reflecting the investments made in acquisitions and our as-a-Service business.
  • Achieved GAAP diluted earnings per share from continuing operations of $12.39 (operating non-GAAP diluted earnings per share of $13.59).
  • Generated $17.0 billion in cash from operations and $11.6 billion in free cash flow, with a strong realization rate of 97% of GAAP net income, while continuing our investment in research & development and capital expenditures.
  • Executed 15 acquisitions with total spend of nearly $6 billion to strengthen our cognitive, cloud and industry capabilities.
  • Maintained IBM’s industry-leading position in cloud with revenue of $13.7 billion, up 35% year over year. We exited the year with a cloud as-a-Service run rate of $8.6 billion, up 61%.
  • Scaled Strategic Imperatives — cloud, analytics, mobile, security and social — up 13% year over year and contributing 41% of IBM’s revenue. Revenue from analytics increased 9% and mobile, security and social collectively increased 19%.
  • Continued momentum in our high-value businesses, providing world-class innovation to our clients. Software Solutions grew 5%, Technology Services and Cloud Platforms grew 1% and our total Software revenue was flat at actual rates, returning to growth at constant currency.

Our compensation strategy supports IBM’s emergence as the cognitive solutions and cloud platform company. It is designed to ensure that executives balance short-term objectives against long-term priorities, to align executive and stockholder interests, and to attract and retain the leadership needed to deliver strong results. Pay decisions were made in the context of our financial performance relative to our goals, while taking into account the transformation made in the Company’s portfolio and the steps taken to strengthen IBM’s position for the future.

For 2016, at target, 69% of Mrs. Rometty’s pay was at risk and subject to attainment of specific performance goals, excluding the one-time premium-priced option award described below:

For 2016, at target, 69% of Mrs. Rometty’s pay was at risk and subject to attainment of specific performance goals, excluding the one-time premium-priced option award

For 2016 performance, the Board approved an annual incentive payment of $4.95 million for Mrs. Rometty, which represented 99% of target. The payout level considered significant progress in the implementation of IBM’s strategy, with continued growth in Strategic Imperatives, momentum in cognitive, and the creation of new businesses in health care, Internet of Things, and financial regulatory compliance, including several sizeable acquisitions. In addition, the Committee noted significant continued increases in employee engagement, and major steps taken to realign workforce skills and strengthen senior management. Taking into consideration the actual salary, annual incentive payout and longterm incentive award for the period 2014–2016, Mrs. Rometty earned 54% of her annual total target compensation in 2016.

For 2017, the independent members of the Board made no change to Mrs. Rometty’s base salary, target annual incentive or annual long-term incentive award value, relative to 2016.

As disclosed last year in the 2016 Proxy Statement, the Board granted Mrs. Rometty a one-time award of 1.5 million nonqualified stock options that vest three years from the date of grant, are exercisable in four equal tranches at premium prices of 105%, 110%, 115% and 125% of the fair market value of IBM common stock on the date of grant, and expire 10 years from the date of grant.

This premium-priced stock option award demonstrates the Board’s strong confidence in Mrs. Rometty’s leadership of IBM and the momentum of its strategic direction as well as the Board’s desire to ensure her continued service through a critical period in IBM’s multi-year transformation, align her compensation closely with increases in shareholder value over the long-term, and, when combined with her ongoing compensation, deliver a market-competitive performance-based total compensation opportunity.

While one-time stock grants are prevalent in our industry for leaders navigating companies through extraordinary periods of transformation, this grant is unique in several ways. First, it is an option grant with value being derived only when incremental value is created for shareholders. Second, its premium-priced mechanism serves to increase even further the incremental value shareholders must receive relative to a typical option grant in which the exercise price is set at fair market value on the date of grant. This performance-sensitive design ensures that Mrs. Rometty is only compensated if there has been significant appreciation in shareholder value after the time of vesting. Each of the four tranches will expire valueless if the IBM stock price fails to appreciate to the levels described above, thereby ensuring that realized compensation, if any, is tied to the successful business transformation being led by Mrs. Rometty. The Board believes that the transformation is a defining moment not only for IBM, but also for the industry, and this grant reflects that significance and delivers value if, and only if, successful.

Note: In an effort to provide additional and useful information regarding IBM’s financial results and other financial information as determined by generally accepted accounting principles (GAAP), this Compensation Discussion and Analysis and Proxy Statement contains certain non-GAAP financial measures on a continuing operations basis, including software revenue at constant currency, operating earnings per share, free cash flow and operating (non-GAAP) earnings. For reconciliation and rationale for management’s use of this non-GAAP information refer to Appendix A — “Non-GAAP Financial Information and Reconciliations”.​

Stockholder engagement

IBM continually reviews its corporate governance and executive compensation structure. As part of this review, it is IBM’s longstanding practice for our executives to meet with a significant number of our largest investors to solicit their feedback on a variety of topics. In 2016, IBM once again engaged with over 100 institutional investors.

IBM considered the results of the management Say on Pay proposal presented to the stockholders for approval in 2016. In light of the support the proposal received, IBM’s compensation policies and decisions, explained in detail in this Compensation Discussion and Analysis, continue to be focused on long-term financial performance to drive stockholder value. IBM provides an advisory vote on executive compensation (Say on Pay) on an annual basis. The table below highlights practices that IBM embraces in support of our pay-for-performance philosophy:

What we do

What we don't do

  • Tie a significant portion of pay to company performance
  • Mitigate risk taking by emphasizing long-term equity incentives, placing caps on potential payments, and maintaining robust clawback provisions
  • Require significant share ownership by the Chairman and CEO and Senior Vice Presidents
  • Utilize noncompetition and nonsolicitation agreements
  • No individual severance or change-in-control agreements for executive officers
  • No excise tax gross-ups
  • No dividend equivalents on unearned RSUs/PSUs
  • No hedging/pledging of IBM stock
  • No stock option repricing, exchanges or options granted below market value
  • No guaranteed incentive payouts
  • No accelerated vesting of equity awards for executive officers
  • No above-market returns on deferred compensation plans

Section 1: Executive compensation program design

Trust and personal responsibility in all relationships — relationships with clients, partners, communities, fellow IBMers, and investors — is a core value at IBM. As a part of maintaining this trust, we well understand the need for our investors — not only professional fund managers and institutional investor groups, but also millions of individual investors — to know how and why compensation decisions are made.

To that end, IBM’s executive compensation practices are designed specifically to meet five key objectives:

  • Ensure that the interests of IBM’s leaders are closely aligned with those of our investors by varying compensation based on both long-term and annual business results and delivering a large portion of the total pay opportunity in IBM stock;
  • Balance rewards for both short-term results and the long-term strategic decisions needed to ensure sustained business performance over time;
  • Attract and retain the highly qualified senior leaders needed to drive a global enterprise to succeed in today’s highly competitive marketplace;
  • Motivate our leaders to deliver a high degree of business performance without encouraging excessive risk taking; and
  • Differentiate rewards to reflect individual and team performance.
The specific elements of IBM’s U.S. executive compensation programs are:
Type Component Key Characteristics
Current Year Performance
Salary

Salary is a market-competitive, fixed level of compensation.

Annual Incentive

At target, annual incentive provides a market-competitive total cash opportunity. Actual annual incentive payments are driven by business performance against financial metrics and individual performance, with top performers typically earning the greatest payouts and the lowest performers earning no incentive payouts.

Long-Term Incentive Plan
Performance Share Units (PSUs)

PSU grants are based on performance and retention objectives for each executive. The number of shares granted is adjusted at the end of the three-year performance period based on IBM’s performance against predetermined targets for operating earnings per share and free cash flow. PSU awards are paid in shares of IBM common stock.

Restricted Stock Units (RSUs)
Retention
Stock-Based Grants & Cash Awards

Periodically, the Compensation Committee and/or the Chairman and CEO reviews outstanding stock-based awards for key executives. Depending on individual performance and the competitive environment for senior executive leadership talent, awards may be made in the form of restricted stock units, premium-priced stock options or cash for certain executives. Retention Restricted Stock Unit (RRSU) vesting periods typically range from two to five years. Cash awards have a clawback if an executive leaves IBM before a specified date. Premium-priced stock options may have varying exercise prices.

Supplemental Executive Retention Plan (closed)

In 1995, IBM created a plan to help retain, for their full careers, the caliber of senior leaders needed to turn IBM around, preserve its long-term viability, and position it for growth in the future. To discourage these leaders from joining competitors, their benefits under this retention plan would be forfeited if they left IBM prior to age 60. Because its original purpose had been met, the plan was closed to new participants in 2004. Future accruals under the plan stopped on December 31, 2007.

Pension & Savings Plans

Pension Plans (closed)

In the U.S., accruals under the pension plans stopped on December 31, 2007. The amount of the pension benefit under these plans is based on pay and service and is determined by the same formulas for executives and non-executives.

Savings Plan

The money that U.S. executives save through the IBM 401(k) Plus Plan, as for all U.S. employees, is eligible for IBM match and automatic contributions. The 401(k) Plus Plan is the only tax-qualified retirement program available to IBM’s U.S. employees for future deferrals and employer contributions.

Deferred Savings Plan

IBM has a nonqualified deferred compensation plan established in accordance with U.S. Department of Labor and Internal Revenue Service guidelines to enable employees to defer compensation in excess of limits applicable to 401(k) plans. Employees are eligible for IBM match and automatic contributions similar to the 401(k) Plus Plan.

Other Compensation Perquisites and Other Benefits

Perquisites are intended to ensure safety and productivity of executives. Perquisites include such things as annual physicals, transportation, financial planning, and personal security.

Senior Leadership Team — Personal Stake in IBM’s Future through Stock Ownership Requirements

Investors want the leaders of their companies to act like owners. That alignment, we believe, works best when senior leaders have meaningful portions of their personal holdings invested in the stock of their company. This is why IBM sets significant stock ownership requirements for IBM’s Chairman and CEO and Senior Vice Presidents. The following table illustrates which equity holdings count towards stock ownership requirements:

What counts

What does not count

  • IBM shares owned personally or by members of the immediate family sharing the same household
  • Holdings in the IBM Stock Fund of the 401(k) Plus Plan and the Excess 401(k) Plus Plan
  • Shares of IBM stock deferred under the Excess 401(k) Plus Plan
  • Unvested equity awards, including PSUs, RSUs and RRSUs
  • Unexercised stock options

The Chairman and CEO and Senior Vice Presidents are all required to own IBM shares or equivalents worth three times their individual total target cash compensation within five years of hire or promotion. Unlike the majority of the Fortune 100 companies who establish ownership guidelines using a multiple of only base salary, IBM uses a multiple of base salary plus target annual incentive. This ensures that meaningful ownership levels are accumulated based on each executive’s annual cash compensation opportunity. As of December 31, 2016, as a group, the Chairman and CEO and Senior Vice Presidents owned shares or equivalents valued at over $129 million; in fact, as of that date, this group held, on average, 140% of the amount of IBM shares or equivalents that IBM requires.

Setting performance targets for incentive compensation

Compensation of our senior leaders is linked with IBM’s performance against core business metrics. These metrics and their weightings are aligned with IBM’s financial and strategic objectives and are designed to appropriately balance short- and long-term goals. Targets are set for both the annual and longterm incentive programs at aggressive levels each year. These targets, individually and together, are designed to be challenging to attain and are consistent with our financial model shared with investors each year. As part of IBM’s ongoing management system, targets are evaluated to ensure they do not encourage an inappropriate amount of risk taking.

For 2016, IBM continued to measure five key financial metrics:

  1. Strategic Imperatives Revenue
  2. Operating Net Income
  3. Operating EPS
  4. Free Cash Flow
  5. Operating Cash Flow*

* Net Cash from Operating Activities, excluding Global Financing receivables

Strategic Imperatives revenue supports IBM’s portfolio shift into a cognitive solutions and cloud platform company that will deliver the highest-value opportunities for our clients and shareholders. Operating net income and operating EPS best measure our operational success as a high-value company. Both free cash flow and operating cash flow are important measures of IBM’s ability to reinvest and return value to our shareholders. We believe that these metrics best align the interests of management with shareholders.

IBM shares its financial model each year with investors in the context of its long-term strategy. As such, the financial model is clearly communicated to investors, and our performance targets are based on this model. IBM competes for client business, talent and investment opportunities in a highly dynamic and competitive marketplace. Therefore, we do not disclose specific targets within the annual and long-term plans because such disclosure could disadvantage IBM competitively and impair the Company’s ability to execute our strategic plans. For example, disclosure of our free cash flow targets would provide insight into timing of large capital investments. In addition, IBM has a specific acquisition and divestiture strategy that could be negatively impacted if the specific targets were disclosed.

While we do not disclose specific targets for competitive reasons, the difficulty and rigor of these targets is apparent in our payouts. Since becoming CEO, Mrs. Rometty’s annual incentive payout has ranged from 0% to 108% and Performance Share Unit payouts have ranged from 32% to 113% during that same period. We also describe annual performance in our discussion of named executive officer compensation decisions. Finally, outlined below is a description of the specific metrics and weightings for the Annual Incentive and the Performance Share Unit Programs.

 

Annual incentive program

IBM sets business objectives at the beginning of each year which are approved by the Board of Directors. These objectives translate to targets for IBM and for each business unit for purposes of determining the target funding of the Annual Incentive Program. Performance against business objectives determines the actual total funding pool for the year which can vary from 0% to 200% of total target incentives for all executives. Each year the Compensation Committee and the Board of Directors review IBM’s annual business objectives and set the metrics and weightings for the annual program reflecting current business priorities. The metrics and weightings for 2016 and 2017 are listed below.

Financial metric 2016 and 2017 weighting in overall score
Operating Net Income 40%
Strategic Imperatives Revenue 20%
Operating Cash Flow 40%

At the end of the year, performance for IBM is assessed against these predetermined financial targets. The performance results against these targets may be adjusted for extraordinary events if deemed appropriate by the Chairman and CEO and Compensation Committee. This adjustment can be either up or down. For example, adjustments are usually made for large divestitures and acquisitions. In addition, the Chairman and CEO can recommend an adjustment, up or down, based on factors beyond IBM’s financial performance, for example, client experience, market share growth and workforce development. Taking such matters into account for 2016, no such adjustment was made. The Compensation Committee reviews the financial scoring and qualitative adjustments and approves the Annual Incentive Program funding level. Once the total pool funding level has been approved, a lower-performing executive will receive as little as zero payout and the most exceptional performers are capped at three times their individual target incentive (payouts at this level are rare and only possible when IBM’s performance has also been exceptional).

For 2016, IBM’s Annual Incentive Program’s financial performance score was slightly below par. Strategic Imperatives revenue, operating net income, and operating cash flow attainment fell slightly below target.

 

Performance Share Unit Program

For Performance Share Units, the two metrics are operating EPS and free cash flow. The targets for the Performance Share Unit program are set at the beginning of each three-year performance period, taking into account IBM’s financial model shared with investors and the annual budget as approved by the Board, including the impact our share buyback program has on operating EPS. In addition, for Performance Share Unit awards starting in 2016 and beyond, the Committee has determined that actual operating EPS results will be adjusted to remove the impact of any difference between the actual share count and the budgeted share count. This method formalizes the Committee’s longstanding intention of not having unplanned share repurchase practices affect executive compensation. Additionally, the scoring for the Performance Share Unit Program takes into account extraordinary events. For example, in 2014 and 2015, operating EPS reflected the impact of the Microelectronics divestiture. At the end of the three years, the score is calculated based on results against the predetermined targets, with the following weights:

 

Financial metric 2016 and 2017 weighting in overall score
Operating Earnings Per Share 70%
Free Cash Flow 30%

The Compensation Committee approves the determination of actual performance relative to pre-established targets, and the number of Performance Share Units is adjusted up or down based on the approved actual performance from 0% to 150%. There is no discretionary adjustment to the Performance Share Unit program score.

For the Performance Share Units granted in 2014, the final performance score was well below par. Both operating EPS and free cash flow for the three-year period (2014–2016) were below target.

Section 2: How and why compensation decisions are made

At any level, compensation reflects an employee’s value to the business — market value of skills, individual contribution and business results. To be sure we appropriately assess the value of senior executives, IBM follows an evaluation process, described here in some detail:

1. Making commitments

All IBM employees, including the Chairman and CEO and Senior Vice Presidents, develop goals, both qualitative and quantitative, they seek to achieve in a particular year in support of the business. Beginning in 2016, IBM adopted a more nimble and real-time approach to managing employee performance. Employee’s performance goals are discussed with each individual’s manager regularly and updated as necessary throughout the year. The Chairman and CEO’s performance goals are reviewed directly by the Board of Directors. As part of this process, many factors are considered, including an understanding of the business risks associated with the performance goals.

2. Determining compensation for the chairman and the CEO — research, recommendations and review

The chair of the Compensation Committee works directly with the Committee’s compensation consultant, Frederic W. Cook & Co., Inc. (FW Cook), to provide a decision-making framework for use by the Committee in determining incentive plan payouts and setting target compensation opportunities for the Chairman and CEO. This framework considers the Chairman and CEO’s self-assessment of performance against commitments in the year, both qualitative and quantitative, and also considers progress against strategic objectives, an analysis of IBM’s total performance over a multi-year period, a competitive benchmark analysis, and other relevant information. The Committee considers all of this information in developing its recommendations, which are then presented to the independent members of the IBM Board of Directors for further review, discussion and final approval.

3. Determining compensation for senior vice presidents

Evaluation of Results by the Chairman and CEO

Employees at all levels, including executives, work with their managers throughout the year to evaluate their own results against their stated goals.

The self-assessments of the Senior Vice Presidents are reviewed by the Senior Vice President of Human Resources (SVP HR) and the Chairman and CEO, who evaluate the information, along with the following:

  • Comparisons to market compensation levels for cash compensation and total direct compensation;
  • Potential for future roles within IBM; and
  • Total compensation levels relative to internal peers before and after any recommendations.

Following this in-depth review and in consultation with the SVP HR, the Chairman and CEO makes compensation recommendations to the Compensation Committee based on an evaluation of each Senior Vice President’s performance and expectations for the coming year.

Evaluation of results by the compensation committee

The Compensation Committee decides whether to approve or adjust the Chairman and CEO’s recommendations for the Senior Vice Presidents.

The Committee evaluates all of the factors considered by the Chairman and CEO and reviews compensation summaries that tally the dollar value of all compensation and related programs, including salary, annual incentive, long-term compensation, deferred compensation, retention payments and pension benefits. These summaries provide the Committee with an understanding of how their decisions affect other compensation elements and the impact that separation of employment or retirement will have.

4. Ensuring competitive pay — approach to benchmarking

IBM participates in several executive compensation surveys that provide general trend information and details on levels of salary, target annual incentives and long-term incentives, the relative mix of short- and long-term incentives, and mix of cash and stock-based pay. Given the battle for talent that exists in our industry, the benchmark companies that are used by the Compensation Committee to guide its decision making have included a broad range of key information technology companies, to help us identify trends in the industry. We also include companies outside our industry, with stature, size and complexity that approximate our own, in recognition of the fact that competition for senior management talent is not limited to our industry. The surveys and benchmark data are supplemented by input from the Compensation Committee’s outside consultant on factors such as recent market trends. The Committee reviews and approves this list annually.

The Compensation Committee re-examined the benchmark group for 2016 and determined that companies which meet the following criteria should be included in the 2016 benchmark group:

  • Companies in the technology industry with revenue that exceeds $15 billion, plus
  • Additional companies (up to two per industry if available) in industries other than technology, with revenue that exceeds $40 billion and that have a global complexity similar to IBM.
2016 benchmark group
Accenture EMC Oracle
Amazon.com ExxonMobil PepsiCo
Apple Ford Pfizer
AT&T General Electric United Technologies
Boeing Google UPS
Caterpillar Hewlett-Packard Verizon
Chevron Intel Xerox
Cisco Systems Johnson & Johnson
Dow Chemical Microsoft

For 2017 compensation decisions, the Committee approved the following benchmark group using the criteria above and reflecting changes in the corporate structure of certain competitors.

2017 benchmark group
Accenture Dow Chemical Microsoft
Alphabet ExxonMobil Oracle
Amazon.com Ford PepsiCo
Apple General Electric Pfizer
AT&T Hewlett-Packard Enterprises United Technologies
Boeing HP Inc. UPS
Caterpillar Intel Verizon
Chevron Johnson & Johnson Xerox
Cisco Systems

The data from compensation surveys and related sources form the primary external view of the market. In consideration of size and complexity, IBM’s philosophy is to generally target the 50th percentile of the market for cash and total compensation. Owing to the size and scope of our business overall, some roles are compared to a size-adjusted market rate.

For individual compensation decisions, the benchmark information is used together with an internal view of longer-term potential, individual performance relative to other executives and recognizing that the skills and experience of our senior executives are highly sought after by other companies and, in particular, by IBM’s competitors. Because factors such as performance and retention, as well as size and complexity of the job role, are considered when compensation decisions are made, the cash and total compensation for an individual named executive officer may be higher or lower than the target reference point of the relevant benchmark group.

5. Compensation committee consultant

The Committee enters into a consulting agreement with its outside compensation consultant on an annual basis. The Committee has retained FW Cook as its compensation consultant to advise the Committee on market practices and specific IBM policies and programs. FW Cook reports directly to the Compensation Committee Chairman and takes direction from the Committee. The consultant’s work for the Committee includes data analyses, market assessments and preparation of related reports. From time to time, the Committee seeks the views of the consultant on items such as incentive program design and market practices. The work done by FW Cook for the Committee is documented in a formal agreement which is executed by the consultant and the Committee. FW Cook does not perform any other work for IBM, other than services provided to IBM’s Directors and Corporate Governance Committee. The Committee determined that there is no conflict of interest with regard to FW Cook.

The Compensation Committee made recommendations for Mrs. Rometty’s 2016 and 2017 compensation following the process and using the pay components described above.

2016 Annual incentive decision for the chairman and CEO

In addition to the overall IBM performance detailed in the Executive Summary, the Compensation Committee noted the following personal leadership achievements for Mrs. Rometty, all of which are clear sign posts of the successful business portfolio shift:

  • Directed investments to Strategic Imperatives — cloud, analytics, mobile, social and security — growing revenue to $33 billion. The Strategic Imperatives contributed 41% of IBM’s total revenue.
  • Established Watson as the premier artificial intelligence platform for business. Extended the reach of Watson on the IBM Cloud, open to millions of clients, developers, partners and users.
  • Expanded IBM’s cloud capabilities and broadened the ecosystem with over 50 cloud datacenters.
  • Launched the Watson Financial Services unit and entered the global regulatory compliance market, enabled by the acquisition of Promontory Financial Group. The newly launched unit brings clients an industry-specific combination of Watson, IBM Cloud, IBM Systems, blockchain, deep domain expertise and ecosystems of partners and developers.
  • Accelerated the creation of cognitive-driven value based solutions by acquiring Truven Health Analytics. IBM Watson Health is the world’s leading commercial healthcare technology platform, with solutions available to more than 200 million patients worldwide.
  • Established IBM as the global leader in applying blockchain technology to business, with more than 300 client projects underway.
  • Ranked #1 in patents for the 24th consecutive year, continuing our leadership in technology and innovation. IBM was the first company to exceed 8,000 patents in a year.
  • Drove significant productivity savings through work redesign and the deployment of cognitive solutions across IBM’s internal operations, and positioned IBM for future growth by realigning workforce skills with the new portfolio and strengthening all levels of management, including senior management.
  • Continued to build on employee engagement momentum, with increases across virtually all markets and business units.

For 2016 performance, the Board approved an annual incentive payment of $4.95 million for Mrs. Rometty, which represented 99% of her target opportunity. This payout considered her outstanding personal leadership through a landmark transformation and the significant growth in new business areas, balanced against underperformance in some other areas, such as Global Business Services. Taking into consideration the actual salary, actual annual incentive payout and actual long-term incentive award for the period 2014–2016, Mrs. Rometty earned 54% of her annual total target compensation in 2016.

Taking into consideration the actual salary, actual annual incentive payout and actual long-term incentive award for the period 2014–2016, Mrs. Rometty earned 54% of her annual total target compensation in 2016

2017 Compensation decisions for the chairman and CEO

For 2017, the independent members of the Board made no change to Mrs. Rometty’s base salary or target annual incentive. She was granted an annual long-term incentive award valued at $13.3 million, flat compared to the prior year. This grant is comprised 65% of 2017–2019 Performance Share Units and 35% of Restricted Stock Units. For 2017, 69% of Mrs. Rometty’s annual total target compensation is tied to performance-based incentives.

2016 Annual incentive decisions for Mr. Schroeter, Mr. Jetter, Dr. Kelly and Mr. Clementi

The Compensation Committee also made decisions for the following named executive officers, noting overall corporate performance as described in the Executive Summary and the following key points:

Martin J. Schroeter,

Senior Vice President and Chief Financial Officer

  • Shifted IBM’s spending profile to focus on Strategic Imperatives. Invested $15 billion across research & development, capital spending and 15 acquisitions, adding to our capabilities in the high-growth areas of cognitive and cloud with industry focus.
  • Returned $8.8 billion, or approximately 75% of free cash flow, to shareholders through $3.5 billion in gross share repurchases and $5.3 billion of dividends, with an increase in the quarterly dividend of 7.7%.
  • Implemented new segment reporting structure that aligns to IBM’s emergence as a cloud platform and cognitive solutions company.

Martin Jetter,

Senior Vice President, IBM Global Technology Services

  • Delivered revenue growth in Global Technology Services and grew revenue backlog.
  • Grew Technology Services & Cloud Platforms Strategic Imperatives revenue 39%, with Cloud revenue up 49% and an as-a-Service annual exit run rate of $5.8 billion.
  • Shifted the business from systems integration to services integration, assisting our clients as they move to enterprise-grade cloud solutions that are secure, agile, and that leverage the data and investments in their core systems.

John E. Kelly III,

Senior Vice President, IBM Cognitive Solutions & IBM Research

  • Led Solutions Software which had revenue growth of 5% and drove an as-a-Service annual exit run rate of $1.8 billion.
  • Embedded cognitive capabilities in Commerce, Analytics, Security, Watson Health, Internet of Things, and financial services solutions; and drove the integration of the Watson and IBM Cloud platforms.
  • Completed five Cognitive Solutions acquisitions, including assets of The Weather Company, whose high-volume data platform serves as the foundation for IBM’s Watson Internet of Things Cloud platform.
  • Achieved #1 patent position for the 24th consecutive year, with over 8,000 patents in areas from bioinformatics to nanotechnology. Launched the first ever commercial program for universal quantum computing.

Erich Clementi,

Senior Vice President, IBM Global Markets

  • Re-organized IBM’s go-to-market resources and established a management system across IBM business units to deliver the breadth of the IBM portfolio tailored to 12 global industries.
  • Enabled IBM to deliver $33 billion of Strategic Imperatives revenue, up 13%, with strong contributions from IBM’s two biggest geographic markets.
  • Deployed a new operating model, which increased the productivity of IBM’s sales force, fostering speed in addressing new markets and making investments in emerging opportunities.

Following the process outlined above and based on business and individual performance, the Compensation Committee approved the 2016 annual incentive payouts below for these named executive officers:

Name 2016 Annual Incentive Payouts
M.J. Schroeter $1,046,430
M. Jetter 901,890
J.E. Kelly III 927,350
E. Clementi 889,200

Taking into consideration the actual salary, annual incentive payout and long-term incentive award for the period 2014–2016, these named executive officers earned from 50%-67% of their annual total target compensation in 2016.

2017 compensation decisions for Mr. Schroeter, Mr. Jetter, Dr. Kelly, and Mr. Clementi

The Committee also approved the following compensation elements for 2017: base salary, annual incentive target, Performance Share Unit (PSU) and Restricted Stock Unit (RSU) grants under the Long-Term Performance Plan. As previously disclosed in the 2016 Proxy Statement, for Long-Term Incentive Plan grants beginning in 2016, the mix of vehicles is now set at 65% PSUs and 35% RSUs, to align better with market practice. This mix provides competitive pay, while at the same time ensuring a strong link between pay and performance, and creates a better balance relative to peers with which we compete for talent. For 2017, based on the compensation decisions detailed below at target, 63% of the NEOs’ (excluding the Chairman and CEO) pay is at risk.

For 2017, based on the compensation decisions detailed below at target, 63% of the NEOs’ (excluding the Chairman and CEO) pay is at risk.

2017 Cash(1) 2017 Long-Term Incentive Awards(2)
Name Salary rate Annual incentive target Performance share units Restricted stock units
M.J. Schroeter $874,000 $1,181,000 $3,575,000 $1,925,000
M. Jetter 723,000 977,000 3,250,000 1,750,000
J.E. Kelly III 852,000 1,148,000 3,575,000 1,925,000
E. Clementi 777,000 1,048,000 3,575,000 1,925,000

(1) The 2017 salary rates for Mr. Schroeter, Mr. Jetter, Dr. Kelly and Mr. Clementi will be effective July 1, 2017 and the 2017 annual incentive targets were effective January 1, 2017.

(2) PSUs and RSUs will be granted on June 8, 2017 to the named executive officers, including the Chairman and CEO. The actual number of units granted on this date will be determined by dividing the value shown above by a predetermined, formulaic planning price for the second quarter 2017. The performance period for the PSUs ends December 31, 2019, and the award will pay out in February 2020. The Restricted Stock Units will vest 25% per year on each anniversary of the date of grant.

Section 3: Additional information

Compensation program as it relates to risk

IBM management, the Compensation Committee and the Committee’s outside consultant review IBM’s compensation policies and practices, with a focus on incentive programs, to ensure that they do not encourage excessive risk taking. This review includes the cash incentive programs and the longterm incentive plans that cover all executives and employees. Based on this comprehensive review, we concluded that our compensation program does not encourage excessive risk taking for the following reasons:

  • Our programs appropriately balance short- and long-term incentives, with approximately 71% of 2017 annual total target compensation for the Chairman and CEO and Senior Vice Presidents as a group provided in equity.
  • Our executive compensation program pays for performance against financial targets that are set to be challenging to motivate a high degree of business performance, with an emphasis on longer-term financial success and prudent risk management.
  • Our incentive plans include a profit metric as a significant component of performance to promote disciplined progress toward financial goals. None of IBM’s incentive plans are based solely on signings or revenue targets, which mitigates the risk of employees focusing exclusively on the short term.
  • Qualitative factors beyond the quantitative financial metrics are a key consideration in the determination of individual executive compensation payments. How our executives achieve their financial results, integrate across lines of business and demonstrate leadership consistent with IBM values are key to individual compensation decisions.
  • As explained in the 2016 Potential Payments Upon Termination Narrative, we further strengthened our retirement policies on equity grants for our senior leaders beginning in 2009 to ensure that the long-term interests of IBM continue to be the focus even as these executives approach retirement.
  • Our stock ownership guidelines require that the Chairman and CEO and each Senior Vice President hold a significant amount of IBM equity to further align their interests with stockholders over the long term.
  • IBM has a policy that requires a clawback of cash incentive payments in the event that an executive officer’s conduct leads to a restatement of IBM’s financial results. Likewise, IBM’s equity plan has a clawback provision which states that awards may be cancelled and certain gains repaid if an employee engages in detrimental activity. To further reinforce our commitment to ethical conduct, the IBM Excess 401(k) Plus Plan allows the clawback of certain IBM contributions if a participant engages in detrimental activity.

We are confident that our compensation program is aligned with the interests of our stockholders, rewards for performance and represents strong executive compensation governance practices.

Equity award practices

Under IBM’s long-standing practices and policies, all equity awards are approved before or on the date of grant. The exercise price of at-the-money stock options is the average of the high and low market price on the date of grant or, in the case of premium-priced stock options, for example, 10% above that average, or as specified by the Compensation Committee.

The approval process specifies the individual receiving the grant, the number of units or the value of the award, the exercise price or formula for determining the exercise price, and the date of grant. In the case of planned grant value, the number of shares granted are determined by dividing the planned value by the predetermined, formulaic planning price in effect for the quarter. IBM’s planning price is computed each quarter using a consistent statistical forecasting procedure based on historical IBM stock price data. IBM uses the quarterly planning price to aid in establishing the overall size of the equity plan and to give more consistency across equity grants made at different points in the quarter.

As with all compensation decisions, the independent members of the Board approve all equity awards for the Chairman and CEO and ratify all equity awards for the Chief Financial Officer. In addition, all equity awards for Senior Vice Presidents are approved by the Compensation Committee. All equity awards for employees other than the Chairman and CEO and Senior Vice Presidents are approved by the Chairman and CEO and Senior Vice Presidents pursuant to a series of delegations that were approved by the Compensation Committee, and the grants made pursuant to these delegations are reviewed periodically with the Committee.

Equity awards granted as part of annual total compensation for senior leaders and other employees are made on specific cycle dates scheduled in advance. IBM’s policy for new hires and promotions requires approval of any awards before or on the grant date, which is typically the date of the promotion or hire.

IBM does not have any plans, programs or agreements that would provide any payments to any of the named executive officers upon a change in control of IBM, a change in the named executive officer’s responsibilities or a constructive termination of the named executive officer.

Ethical conduct

Every executive is held accountable to comply with IBM’s high ethical standards: IBM’s Values, including “Trust and Personal Responsibility in all Relationships,” and IBM’s Business Conduct Guidelines. This responsibility is reflected in each executive’s performance goals, and is reinforced through each executive’s annual certification to the IBM Business Conduct Guidelines. An executive’s compensation, including annual cash incentive payments, is tied to compliance with these standards; compliance is also a condition of IBM employment for each executive.

IBM’s equity plans and agreements have a clawback provision — awards may be cancelled and certain gains repaid if an employee engages in activity that is detrimental to IBM, such as violating IBM’s Business Conduct Guidelines, disclosing confidential information or performing services for a competitor. To further reinforce our commitment to ethical conduct, the Excess 401(k) Plus Plan allows the clawback of certain IBM contributions if a participant engages in activity that is detrimental to IBM.

In addition, approximately 2,000 of our key executives (including each of the named executive officers) have agreed to a noncompetition, nonsolicitation agreement that prevents them from working for certain competitors within 12 months of leaving IBM or soliciting employees within two years of leaving IBM.

The Committee has also implemented the following policy for the clawback of cash incentive payments in the event an executive officer’s conduct leads to a restatement of IBM’s financial results:

To the extent permitted by governing law, IBM will seek to recoup any bonus or incentive paid to any executive officer if (i) the amount of such payment was based on the achievement of certain financial results that were subsequently the subject of a restatement, (ii) the Board determines that such officer engaged in misconduct that resulted in the obligation to restate, and (iii) a lower payment would have been made to the officer based upon the restated financial results.

Hedging and pledging practices

IBM has two senior leadership teams: the Performance Team and the Growth and Transformation Team (G&TT). The Performance Team consists of approximately 70 of our senior leaders who run IBM business units and geographies and includes the Chairman and CEO and each Senior Vice President. The team is accountable for business performance and the development of cross-unit strategies. The G&TT, which includes all members of the Performance Team, consists of a select group of approximately 350 executives. This team is charged with supporting IBM’s continued transformation through their leadership initiatives to engage their teams and promote innovation, speed and simplicity in service of our clients.

IBM does not allow any member of the G&TT, including any named executive officer, to hedge the economic risk of their ownership of IBM securities, which includes entering into any derivative transaction on IBM stock (e.g., any short-sale, forward, option, collar). Further, IBM does not allow any member of the G&TT to pledge IBM securities at any time, which includes having IBM stock in a margin account or using IBM stock as collateral for a loan.

Tax considerations

Section 162(m) of the U.S. Internal Revenue Code of 1986, as amended, limits deductibility of compensation in excess of $1 million paid to IBM’s CEO and to each of the other three highest-paid executive officers (not including IBM’s chief financial officer) unless this compensation qualifies as “performance-based.” Based on the applicable tax regulations, taxable compensation derived from certain stock appreciation rights and from the exercise of stock options by Senior Vice Presidents under IBM’s Long-Term Performance Plans should qualify as performance-based. The IBM Excess 401(k) Plus Plan permits an executive officer who is subject to Section 162(m) and whose salary is above $1 million to defer payment of a sufficient amount of the salary to bring it below the Section 162(m) limit. In 1999, IBM’s stockholders approved the terms under which IBM’s annual and long-term performance incentive awards should qualify as performance-based. In 2014, as required by the Internal Revenue Code, the stockholders approved the material terms of the performance criteria under which long-term performance incentive awards should qualify as performance-based. These terms do not preclude the Committee from making any payments or granting any awards, whether or not such payments or awards qualify for tax deductibility under Section 162(m), which may be appropriate to retain and motivate key executives.