Morningstar : Our answers on Morningstar’s stock price performance and incentive compensation.

Answer

We have not changed our metrics for annual incentive compensation. Our company-wide bonus pool is based on a combination of adjusted revenue and adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization), with each of these metrics receiving a weighting of 50%. At the beginning of the year, our board's compensation committee establishes specific financial goals for the bonus funding formula. If the company meets these goals, we fully fund the bonus pool. We increase or decrease bonus funding based on a specific formula if our financial performance differs from the bonus targets, as described in more detail on page 18 of our proxy statement.

Please refer to the table below, which should give you a better understanding of the major components of our executive compensation program. Our board's compensation committee reviews all elements of our compensation program at least annually and strongly believes in rewarding executives based on their performance and contribution toward building long-term value for Morningstar and our shareholders. From time to time, we've also engaged independent consultants to obtain an outside view on our compensation program. In 2016, for example, we engaged Willis Towers Watson to conduct a competitive market review of our executive compensation program, including a competitive compensation analysis for the chief executive officer role.

Summary of Executive Compensation

In addition to base salary and annual incentive compensation, equity awards that vest over time are an important part of how we reward our executive officers and other employees. We pay a meaningful portion of executive officer compensation in the form of equity awards to help align the economic interests of our executive officers with those of our shareholders. We also believe it's important for our executives to have a long-term stake in the success of the business. The compensation committee generally targets the value of annual equity grants for our named executive officers at approximately 36% to 50% of total compensation.

For our executive officers and most other senior leaders, we use two main forms of long-term incentive compensation: restricted stock units (RSUs) and, starting in May 2017, market stock units (MSUs). The restricted stock units we grant vest ratably over a four-year period, so the ultimate value of these incentives is tied to Morningstar's stock price performance over time. We also view the vesting requirement applicable to these units as a valuable retention tool.

In May 2017, our compensation committee approved a new equity award program under which our executive officers and other senior leaders will be eligible for awards in the form of MSUs. The first awards under this program were made in May 2017. MSUs are stock units that are eligible to vest three years from the date of grant. The extent to which the units actually vest is based on our total shareholder return (TSR) over that three-year period, as shown in this table:

We chose to use total return as a metric for vesting because we believe it incentivizes our management team to create long-term shareholder value. We also wanted to avoid redundancy with the metrics used for the annual bonus plan. We chose the 10% threshold to reduce the risk of setting unachievable multi-year goals and encourage retention for our senior executives. At the same time, the vesting scale is designed to provide both upside and downside leverage. That means our executive officers will be rewarded proportionately more than the average shareholder for higher total returns and less for lower total returns.

Regarding Kunal's equity grants, the compensation committee approved a one-time grant of $2.5 million in RSUs when he became our chief executive officer in January 2017 that will vest over a period of five years. He will also receive performance shares in the form of MSUs with a target fair market value market share units of approximately $833,000 per year in 2017, 2018, and 2019 (subject to any additional performance conditions specified by the compensation committee) and minimum ongoing equity grants with a target fair market value of $750,000 per year beginning in 2018 as long as he remains our chief executive officer.

Consistent with our overall compensation philosophy, the compensation committee and board believe that variable incentive pay and equity awards should make up a larger portion of Kunal's compensation as chief executive officer to align his interests with the long-term interests of our shareholders. The board established Kunal's target total compensation at the levels it felt appropriate for a new and first-time chief executive officer, with an emphasis on recognizing his promotion to chief executive officer with increases to his target variable incentive pay levels and equity levels rather than base salary adjustments. The compensation committee will continue to monitor and manage Kunal's compensation over time based on his performance.

You also asked about our analysts' views of our compensation programs. We seek out their opinions on various matters from time to time and believe they would be supportive of a pay-for-performance equity vehicle such as MSUs, where more equity is delivered for outperformance and less equity is delivered for underperformance. In addition, we believe total compensation for our named executive officers is not above the normal range for other companies in our peer group. In fact, because we emphasize equity-based compensation, cash compensation (for base salaries and annual incentive compensation) for some of our executives may be lower than that of some executives in similar positions employed by other companies in our peer group.

Finally, the board has adopted stock ownership requirements for our executive officers and directors. These guidelines are designed to encourage our executive officers and directors to increase their equity stakes in Morningstar and more closely link their economic interests with those of our shareholders. We require each of our executive officers and directors to hold either shares with a value of $5 million or generally speaking, a number of Morningstar shares and share equivalents that is at least the sum of 12.5% of the total number of exercisable stock options and 25% of the total number of vested restricted stock units and vested performance shares that he or she has been granted.

At the end of the day, we are open to criticism about our performance and (as mentioned in our response to the previous question) fully accept the notion that there are things we can improve. However, we want to emphasize that we put a great deal of thought into our compensation programs. We value equity and don't believe in making excessive equity grants that would be overly dilutive to other shareholders. We are judicious in how we think about pay and performance and would take issue with any criticism that suggests we're not attempting to align our compensation plans with shareholder interests.