Compensation Report summary

Novartis delivered strong performance in 2018 as it continues its transformation into a leading, focused innovative medicines company. We continued to engage with shareholders and proxy advisors to gather feedback on the proposed evolution of the compensation system. It has helped shape the changes, enhancements and simplifications we are making, effective January 1, 2019, to further align our compensation systems and disclosures with our strategy and best practice.

2018 CEO pay for performance

Novartis delivered strong performance in 2018, with net sales up 5% in constant currencies (cc), core operating income up 8%, and free cash flow up 12%. All these were ahead of targets set by the Board of Directors at the start of the year. Operating income declined 5%, mainly due to the impact of M&A transactions made to transform Novartis into a leading, focused medicines company, and of restructuring to drive major productivity programs. Net income increased 64%, primarily due to the one-off gain from the sale of the OTC joint venture.

Strong performance was also achieved against the five strategic objectives. Key highlights include performing above target on the delivery of the innovation pipeline; optimizing the business unit portfolio through the Alcon spin-off and other divestments and acquisitions; achieving good commercial execution; establishing a new culture vision and taking steps to simplify processes globally; and prioritizing corporate responsibility projects, including the renewed commitment to malaria and leprosy.

The 2018 total realized compensation for the CEO was CHF 6 680 288. This incorporates a 2018 Annual Incentive payout at 145% of target, within the payout range of 0% to 200%. It also includes the 2016-2018 Long-Term Performance Plan (LTPP) award vesting at 136% of target, within the payout range of 0% to 200% (based on the award made prior to the CEO’s appointment). The 2016-2018 Long-Term Relative Performance Plan (LTRPP) award lapsed in full (0% payout), despite Novartis 2018 total shareholder return (TSR) of 4.5%, and three-year TSR for 2016-2018 of 8.5%.

2019 Executive Committee compensation system

Every year, the Compensation Committee conducts a review of the Executive Committee compensation system. The 2018 review focused on the structure and performance measures of the Long-Term Incentive plans, taking into account a desire for simplification and the principle of compensating executives more directly on performance linked to our strategic priorities of accelerating top- and bottom-line growth.

This led to the decision to combine the existing LTPP and LTRPP into a single Long-Term Incentive plan and to replace Novartis Cash Value Added (NCVA) with net sales growth and core operating income growth for the 2019-2021 performance cycle onward. This will align the Long-Term Incentive with the evolving Group strategic imperatives of accelerating growth and margin expansion to drive long-term value. The Compensation Committee decided to retain the long-term innovation and relative total shareholder return performance measures, and an equal weighting will apply to each of the four performance measures. The performance targets will be set at the beginning of each three-year cycle.

The Compensation Committee considered the use of another return-based performance measure and determined it not to be appropriate at this time. This is to ensure that decisions on research and development and future acquisitions and divestments are based on long-term value creation.

Current Executive Committee compensation system

Fixed pay and benefits

Performance related variable pay

Annual base salary

Pension and other benefits

Annual Incentive

Long-term share awards

LTPP¹

LTRPP²

¹ LTPP = Long-Term Performance Plan
² LTRPP = Long-Term Relative Performance Plan
³ Executive Committee members may elect to receive more of their Annual Incentive in equity instead of cash.
⁴ Strategic objectives are aligned with the five strategic pillars: innovation, operational excellence, data and digital, people and culture, and building trust with society.
⁵ For the 2018-2020 performance cycle, the peer group of 15 global healthcare companies applies, as listed in the Compensation Report within the 2018 Annual Report.

Purpose

Reflects responsibilities, experience and skill sets

Provides retirement and risk insurances (tailored to local market practices/regulations)

Rewards for performance against short-term financial and strategic objectives, and Values and Behaviors

Rewards long-term shareholder value creation and innovation in line with our strategy

Form of payment

Cash

Country/individual-specific

50% cash
50% equity³ deferred for three years

Equity, vesting following a three-year performance period

Performance measures

–

Balanced scorecard comprising:

Financial measures (60%)
Strategic objectives⁴ (40%)

Novartis Cash Value Added (75%)
Innovation milestones (25%)

Relative TSR versus global sector peers (100%)⁵

Alignment with company strategy

The Novartis strategy is to reimagine medicine to improve and extend people’s lives. We use innovative science and technology to address some of society’s most challenging healthcare issues. We discover and develop breakthrough treatments and find new ways to deliver them to as many people as possible. We also aim to reward those who invest their money, time and ideas in our company. The Novartis strategy is underpinned by five strategic pillars: innovation, operational excellence, data and digital, people and culture, and building trust with society. To align the compensation system with this strategy and to ensure that Novartis is a high-performing organization, the company operates both a short-term Annual Incentive and two Long-Term Incentive plans with a balanced set of measures and targets. This includes strategic objectives within the Annual Incentive balanced scorecard, which align with the five strategic pillars of Novartis. The Board of Directors determines specific, measurable and time-bound performance measures for the Annual Incentive and the two Long-Term Incentive plans.

Executive Committee compensation governance

A summary of the compensation decision authorization levels within the parameters set by the Annual General Meeting is shown below, along with an overview of the risk management principles.

Decision on	Decision-making authority
Compensation of CEO	Board of Directors
Compensation of other Executive Committee members	Compensation Committee

Executive committee compensation risk management principles
Rigorous performance management process Balanced mix of short-term and long-term variable compensation elements Performance evaluation under the Annual Incentive includes an individual balanced scorecard Performance-based Long-Term Incentives only, with a three-year performance period All variable compensation is capped at 200% of target Contractual notice period of 12 months	Post-contractual non-compete limited to a maximum of 12 months from the end of employment (annual base salary and Annual Incentive of the prior year only) as per contract, if applicable Good and bad leaver provisions apply to the variable compensation of leavers No severance payments or change-of-control clauses Clawback and malus principles apply to all elements of variable compensation Share ownership requirements; no hedging or pledging of Novartis share ownership position

2018 CEO pay for performance – outcomes

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2018 Annual Incentive

Measure

Target

Achievement versus target

The Board concluded that the achievement for Group operating income versus target was ‘met’ following adjustments mainly for M&A transactions made to transform Novartis into a leading, focused medicines company, and for higher restructuring to drive major productivity programs, which were not known at the time of target setting.

Financial measures – 60% of total Annual Incentive, comprising:

Group net sales (cc) (30%)

USD 50 447 million

Above

Group operating income (cc) (30%)

USD 8 504 million

Met*

Group free cash flow as a % of sales (cc) (20%)

20%

Significantly above

Share of peers for Novartis Group (USD) (20%)

9.3%

Met

Overall assessment of Group financial targets in constant currencies

Above

Strategic objectives – 40% of total Annual Incentive, comprising:

Innovation (20%)

Significantly above

Operational excellence (20%)

Above

Data and digital (20%)

Met

People and culture (including Values and Behaviors) (20%)

Above

Building trust with society (including access to healthcare and reputation) (20%)

Met

Overall assessment of strategic objectives

Above

Overall assessment of CEO balanced scorecard

Above Target

TOTAL Annual Incentive:

145% of target (payout range 0% – 200%)

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2016-2018 long-term incentives
Measure	Target	Achievement versus target
Long-Term Performance Plan (LTPP )
Novartis Cash Value Added (cc) (75%)	USD 5.1 billion	Above
Key innovation milestones (25%)		Above
TOTAL LTTP :	136% of target (payout range 0% – 200%)
Long-Term Relative Performance Plan (LTRPP )
Relative TSR against a global healthcare peer group (USD)		Below Threshold
TOTAL LTRPP :	0% of target (payout range 0% – 200%)

2018 total realized compensation for the CEO

The 2018 total realized compensation for the CEO was CHF 6 680 288, and includes the payouts of the Annual Incentive, LTPP and LTRPP based on actual performance assessed for cycles concluding in 2018.

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Fixed pay and benefits

Variable pay − performance-related

Annual base salary¹

Pension and other benefits

2018 Annual Incentive¹

LTPP 2016-2018²

LTRPP 2016-2018²

Total realized compensation

¹ Base salary and Annual Incentive reflect the compensation relating to Vasant Narasimhan’s roles in 2018 as Head of Global Drug Development (January 1, 2018 – January 31, 2018) and CEO (from February 1, 2018).
² The shown amounts represent the underlying share value of the total number of shares vested (including dividend equivalents) to the CEO for the LTPP and LTRPP performance cycle 2016-2018, which were granted before Dr. Narasimhan was appointed CEO.

Vasant Narasimhan (CEO from February 1, 2018)

1 492

203

3 190

1 796

6 680

2018 Board of Directors compensation

All fees to Board members are delivered at least 50% in equity and the remainder in cash. Board members receive no variable or performance-based compensation, no share options, and no additional fees for attending meetings. Board members do not receive any company pension or insurance benefits.

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CHF 000	AGM 2018-2019, annual fee
Compensation of Chairman	3 800
Board membership	280
Vice Chairman	50
Chair of the Audit and Compliance Committee	130
Chair of the Compensation Committee	90
Chair of the following committees: Governance, Nomination and Corporate Responsibilities Committee Research & Development Committee Risk Committee	70
Membership of the Audit and Compliance Committee	70
Membership of the following committees: Compensation Committee Governance, Nomination and Corporate Responsibilities Committee Research & Development Committee Risk Committee	40

Total actual compensation earned by Board members in the 2018 financial year was CHF 3 804 336 for the Chairman of the Board and CHF 4 430 625 for the other 12 members of the Board (one of whom stepped down at the 2018 AGM).

2019 Annual General Meeting (AGM)

In line with our Articles of Incorporation, at the 2019 AGM, shareholders will be asked to approve the maximum aggregate amount of compensation for the members of the Executive Committee of CHF 92 million. This is the same level as 2018. There is also no change in the maximum aggregate amount of compensation for members of the Board of Directors, at CHF 8.2 million. Full details on compensation for the CEO, other Executive Committee members and Board members can be found in the Compensation Report of our Annual Report 2018, and in the 2019 Say-on-Pay Brochure.