Coronavirus and Compensation What Should Companies Do Now?
Published March 26, 2020
Published March 26, 2020
The sudden acceleration of the Coronavirus pandemic, with substantial economic damage to many industries, has companies scrambling to respond. The priorities obviously are to protect employees’ health, first and foremost, and to manage the risk to the business. But after taking those steps, some companies will ask, “How do we appropriately motivate and reward employees now?”
For companies near the beginning of their fiscal year, their incentive goals have likely become impossible to reach already. Performance-based equity grants may be hopelessly unearnable. As for companies preparing to set goals for the upcoming fiscal year, they face enormous uncertainty, making it difficult to work with the regular incentive plan cycles. How should companies respond to this unprecedented situation?
As a starting point, companies should establish clear guidelines for changes to incentive plans in light of the pandemic. These should include:
If you have already made grants and set your plans for the year, do nothing right now, other than agree that you will look at this issue over the coming weeks and months. Make sure to communicate this intent to your employees. Today there simply is not enough information on the depth and length of the economic impact for your company, so any decisions made now would likely need to be unwound.
Expect liberal use of judgement and adjustments at year end or a ‘reset’ for the year, but likely not one that protects current incentives completely. This is a difficult environment where shareholders are losing money and employees are losing jobs, so compensation cannot be business-as-usual. Most companies in most industries should plan for a lower than normal outcomes for the year, including the possibility of no incentive pay.
Balance the decisions for executives with the experiences of the broader employee population. Executives may need to lead by example, taking reduced pay across multiple dimensions to help mitigate the impact on employees least able to weather the storm, and share in the pain felt by the organizations they lead.
Maintain strong governance. For senior leaders in particular, shareholders will want a meaningful relationship between pay and performance. Use caution before leaning in on retention, and be careful about windfalls for limited populations if there is a stronger than expected recovery. Shareholder engagement will matter more than ever.
Get ahead of your shareholder communication. Continually track the pandemic’s effects on your business so that you base your compensation decisions on facts. Shareholders will need a justification for any adjustments for the senior leaders. Make your decisions with a clear rationale in mind.
Assess your worst-case scenario. For some companies, the crisis may be an existential threat to their business or industry. Where this risk is high, Boards and senior leaders will need to be extra cautious about any incentive plan payouts. The company may need to focus on substantial cuts instead. Many hotels and 2020airlines, and some companies in other industries, have already greatly reduced executive salaries, forfeited or reduced bonuses for the prior year, and reduced Board pay as well. More will follow suit if the economy tips into a full-blown recession.
Many companies are likely to want to adjust their compensation to reflect the new environment. The issues involved will vary by company, but depend most on whether they have already approved their incentive plans for the current fiscal year.
For those companies that have already approved incentive plans for the current year, the key issues include:
Financial objectives for the annual incentive plans will likely be unattainable already, even with only a quarter to the year completed; non-financial objectives may also be of limited value as companies are focused on crisis response.
Long-term incentive plans have lost significant value. Performance-based shares tied to financial results, like annual incentive plans, may be unattainable, especially for cycles ending in the near term. Performance share unit (PSU) cycles ending in 2021 and 2022 should be carefully assessed as there is a longer runway for success. Options are likely underwater, and restricted stock units are worth a fraction of their value at grant.
Companies may worry about executive turnover from rapidly falling share prices and declining pay for participants. But it seems premature to focus on this issue when every industry is being affected and most employees will be eager for stability rather than change.
Here are some alternatives for companies with plans already approved for the year:
Alternatives for approved plans
Annual Incentive Plans
Let the plan play out as is, and communicate your intent to evaluate performance and exercise discretion at year-end. Establish a framework for this use of discretion, with factors such as relative performance and historical performance. Track all the impacts of Coronavirus as facts to drive the decisions, such as sales rates, production margins, raw materials availability, logistics costs, and people costs.
Make no immediate changes, but communicate your intent to reset goals once you have clarity into the near future. This approach presumes that there will be sufficient stability by mid-year to allow for adjustment and reset. You might include a half-year plan with pro-rate payout opportunities, but reduced upside, given the “second chance.”
Establish and additional plan with stretch but realistic targets. This plan would be intended not to replace the existing STI opportunity, but to motivate executives to still work towards hitting important strategic or financial goals, once those are able to be set. This additional plan might include quarterly or biannual goals. Make sure to net the payouts earned against any payouts from the original plan.
Performance-share cycles ending in 2020: Wait until the end of the year and consider the viability of exercising discretion at that time. As with annual incentives, you will want to track the pandemic’s impact and support your discretion with data, along with balancing the impact on participants with shareholders’ concerns. Note that the use of discretion will result in an accounting modification, and the appearance of a second grant in the Summary Compensation Table.
Performance-share cycles ending beyond 2020: Consider adjusting the performance goals only after you have a better understanding of the pandemic’s impact on business and economy. Given the long-term nature of these awards, it may be more appropriate to simply let the plan play out. Any modification to the goals will constitute a new grant for accounting purposes, with and additional accounting cost and reporting for executives as if a new award were made.
Address engagement and motivation concerns through future award cycles. When adjustments for outstanding cycles are difficult or unwarranted for governance reasons, consider using the 2021 incentive cycle to help re-engage leaders and encourage them to drive for recovery and future growth.
Note: there are significant barriers to using discretion to determine PSU payouts (accounting modification, disclosure requirements, investor reactions, etc.) which cannot be taken lightly.
For those companies that have not already approved incentive plans for the year, the key issues are quite different:
Goal-setting for either annual or long-term incentive plan cycles will be extremely difficult given the high degree of uncertainty.
Significant reductions in share prices could dramatically increase the dilution from equity incentives if target grant levels are maintained without adjustment.
At the same time, delays in establishing the incentive plans or making awards will add to the uncertainty for plan participants.
Here are alternatives if you have not already approved your plans for the year:
Alternatives for plans not yet approved
Annual Incentive Plans
Set goals based on the current operating plan or best available projections, to provide participants something to shoot for. Acknowledge to participants the issues with goals, as well as your intent to review outcomes and exercise discretion as appropriate (discussed above). Consider wider payout/performance ranges, and possibly lower upside as a tradeoff (e.g. 150% maximum payout vs. 200%).
Switch to metrics less likely to be affected by the pandemic, such as margin, relative performance, or “strategic”/stabilization metrics, for at least part of the award opportunity. Consider metrics directly related to effectively responding to the current crisis.
Adapt the program to quarterly or biannual target, to provide some hope and opportunity of hitting some targets. Consider reducing the maximum payout opportunity or capping awards, due to the shorter-time frame, the potentially grater certainty of goals, and the overall expected declines for the year.
Pay less than 100% for target performance (e.g. 75%), to acknowledge that targets are lower and affordability is an issue for the year.
Long-Term Incentive Plans – Addressing Burn-rate
Delay the LTI awards until later in the year. You may still need to modify the award approach if share prices do not recover.
Move to quarterly or biannual grants, with “dollar cost average” grant prices, while anticipating that the stock price will recover
Replace LTI equity awards with LTI cash awards, either performance-based cash or deferred cash (particularly lower in the organization).
Use an average price or some other fair value to convert the target award values to a number of shares, such as the trailing three months average.
Reduce grant sizes, either with an explicit haircut, such as 20%, or by granting the same number of shares as the prior year.
Cap the pool of equity: Determine the available equity on a burn rate/top-down basis and reduce participants’ grants proportionately.
Long-Term Incentive Plans – Setting the PSU Goals
Grant time-based awards now (restricted stock units and stock options), and delay grants of performance stock units until such time as goals can reasonably be set. Reduce the PSU participants for this year only, to make the delay more palatable. Others would receive only time-based awards.
Grant all awards now, including PSUs, and delay setting goals or determining whether to approve adjustments to the goals; you will need an accounting modification when setting or resetting the goals.
Reduce PSU weighing and make all the grants now.
Dispense with PSUs altogether for the year, granting LTI in only time-based awards (RSUs and stock options). Communicate an intent to return to a more normal grant mix in subsequent years.
Modify PSU metrics to relative performance or absolute stock price appreciation.
Adjust your approach to setting PSU goals, such as measuring the second and third years of the PSUs on the basis of growth from the prior year’s results.
These are only initial considerations in a fast-moving environment, and will need to be judged with careful consideration of employee and shareholder experiences. We therefore urge caution when making any commitments in the near term and before taking any action. We also urge you to acknowledge to employees that the company’s plans and programs for the year have been upended and will likely need to be reconsidered as the future becomes clearer.
To read this article by John Borneman, Blair Jones and Kathryn Neel as it was published in Directors & Boards, download the PDF.
John has nearly 25 years of experience as an executive compensation advisor, with broad expertise in consulting to boards of directors and senior management on compensation and related governance issues. His clients range in size from Fortune 100 enterprises to small- and mid-sized companies. John is a thought leader in helping companies manage the pay-for-performance relationship and navigate emerging trends in environmental, social, and governance (ESG) issues related to executive pay. He has extensive experience working with companies in transition (e.g., M&A, IPO, spinoffs, turnarounds, leadership changes). John is a graduate of the University of Chicago’s Booth School of Business and the University of Michigan. He is a Certified Executive Compensation Professional (CECP).
John is a lecturer for the WorldatWork Faculty, teaching Executive Compensation and Business Acumen for HR Professionals.
Blair Jones has 30 years of executive compensation consulting experience. She has worked extensively across industries and has depth of expertise working with companies in transition. Prior to joining Semler Brossy, Blair was the practice leader in Leadership Performance and Rewards at Sibson and an Associate Consultant at Bain & Company. Blair holds the designations of Certified Benefits Professional (CBP), Certified Compensation Professional (CCP), and Certified Executive Compensation Professional (CECP). Blair has been named to the D100, NACD Directorship Magazine’s annual list of the most influential people in the boardroom community, including directors, corporate governance experts, regulators, and advisors, for ten consecutive years (2013–2022).
Named to the D100, NACD Directorship Magazine’s annual list of the most influential people in the boardroom community, including directors, corporate governance experts, regulators, and advisors, for eight consecutive years (2013–2020).
Kathryn has 15 years of experience in executive compensation and leads Semler Brossy’s New York office, located in the iconic Empire State Building. Her clients include Fortune 500 companies, privately-owned and/or private equity financed companies, those undergoing IPO/spin-offs, and recently public companies. She draws on her diversified client experience to identify the right solution for each client. Previously, Kathryn was a partner at FW Cook. Prior, Kathryn was a CPA with Ernst & Young, and she brings that financial acumen to her clients today.