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AOL gives 110% __»

Three cheers for performance-based incentive awards! That’s the bedrock of American-style executive compensation, right? Pay for performance: It’s good for shareholders, the tax code encourages it, and such (we imagine) is the stuff of Pay Czar Ken Feinberg‘s dreams.

Take AOL (AOL) and the proxy it filed Tuesday:

In general, the elements of compensation reflect a focus on performance-driven compensation, a balance between short-term and long-term compensation and a combination of cash and equity-based compensation.

But look closer at the company’s cash incentive plans, and you find a few oddities.

The Global Bonus Plan is a one-year deal, implemented because the usual plan had been suspended “in light of the uncertainty with respect to potential transactions.” The first half, with targets set as a percentage of base salary, “was paid to employees who performed at a satisfactory level and were still active employees on July 15, 2009” — in other words, bonus to you if you stuck around and did your job. After all, AOL was about to be spun off from Time Warner (TWX). Top execs collected between $119,000 and $206,250 for the first half.

The second half of the year hinged on performance, including meeting targets for free cash flow and “OIBDA,” or operating income before depreciation and amortization. But in the end, none of the convoluted details mattered. That’s because the board gave Chairman and CEO Tim Armstrong “discretion to award additional amounts based on individual performance or to otherwise modify awards regardless of the actual levels of OIBDA and Free Cash Flow achievement.”

And that’s just what he and a board committee did in January, the proxy notes:

Although our actual OIBDA and Free Cash Flow results would not have triggered a payout for the second bonus period under the GBP, upon the exercise of Mr. Armstrong’s discretion pursuant to the terms of the GBP, Mr. Armstrong recommended, and the Compensation Committee approved, a 110% bonus payout for the second bonus period under the GBP.

In other words: do-over! Three top executives did even better. Chief Financial Officer Arthur Minson, who was guaranteed at least $1 million under his employment contract, wound up getting $1.7 million instead, or 110% of his $1.5 million target plus $60,000 “on a discretionary basis in recognition of individual performance” during AOL’s spin-off from Time Warner. Two other execs got $40,000 added to their 110% for the same reason. (Armstrong wasn’t covered by the plan.)

Why this departure from the conditions and targets originally laid out? Among the reasons listed in the proxy: “Our executives did not receive merit-based salary increases in 2009”; bonus targets had fallen from 2008 levels, so even 110% didn’t reach 2008 targets; and “the original 2009 budget was prepared by the prior management and included a number of aggressive assumptions, including growth in advertising revenue —”

AOL’s Annual Incentive Plan for Executive Officers also departs from a tight link between performance and pay. To start with, it uses a performance measure that seems to have been cooked up in some accounting test-kitchen: “Adjusted Net Income,” defined not just as income or loss from continuing operations — thus stripping any foundering lines of business a management team might manage to shed before year’s end — but also excluding some M&A costs, non-cash impairments, gains and losses on sale of operating assets, restructuring charges over $3 million, litigation and tax-audit reserves of more than $3 million, any amount “related to securities litigation and government investigations” and more.

If that crazy-quilt measure of income is negative, no bonus. Good enough. But if the figure is positive, the bonus defaults to the maximum payout allowable: $4 million or 4% of this Adjusted Net Income figure, whichever is less. The board’s compensation committee has to step in to reduce it. (Curiously, the summary of the program in the proxy doesn’t mention this detail. It just says any award “may not exceed” $4 million or 4%.) It’s not clear what ANI would have been in prior years, so there’s no way of knowing how 4% stacks up to $4 million.

No doubt, it can make sense for some pay to stay separate from immediate performance. That’s what salary is for, after all. But why go to all the trouble of establishing performance measures and bonus targets if you don’t intend to use them?

Image source: RogueSun Media via Flickr