March 19, 2024 Executive Compensation Resilience Articles

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Resilient Rewards Navigating Market Swings in Executive Compensation

Pay for performance is a core principle governing compensation program design. However, excessive market volatility and unfavorable macroeconomic or business-specific conditions can result in investment constraints, lower revenue or profitability, and a depressed equity valuation. This dynamic can create a domino effect throughout incentive plans and a natural tension between retaining employees and aligning pay outcomes with business results and shareholder returns.

Compensation committees will want to balance effective levers with the company’s core compensation philosophy in times of significant stock price decline or financial upheaval. Outlined below are three action items for directors; each includes guiding questions and examples of good governance, effective strategies, and risk mitigation.

1. Review both annual and long-term incentive plans and consider modifications to reflect the new environment.

Incentive plan structures that reward executives for overperformance in typical market conditions can become overly burdensome during periods of excessive volatility. However, core incentive programs should continue to be the primary lever to retain executives and drive business performance through a downturn. Appropriate program modifications that reflect new realities are preferable to one-off pay actions. Compensation committees may wish to ask: Have all opportunities to modify existing incentive design structures been explored?

Annual and long-term incentive (LTI) plans can be adapted to current market conditions by:

  • changing metrics;
  • altering performance periods;
  • widening goals or payout ranges; and
  • adjusting the LTI vehicle mix.

Executives at a public retail company with consistent market value decline discounted the core pay program due to multiple bonus and performance share unit cycles failing to pay out, and stock option awards being underwater. The incentive program required a programmatic overhaul to increase long-term motivation. Stock options were replaced with restricted stock units to provide more stability in payouts and reflect the growth trajectory of the company. For a mature company in a challenged industry, stock options did not have the same upside potential as they may have at an early-stage start-up.

The incentive plans also had unrealistic goals that were disconnected from actual performance. The compensation committee and management collaborated to refine the company’s goal-setting process and philosophy, setting rigorous yet achievable goals to boost motivation. This process included widening goal ranges to limit downside risk and address unfavorable industry headwinds.

2. Revisit the equity strategy with fresh eyes.

Compensation committees should actively manage share pools, especially when faced with share price volatility, as forecasting equity usage becomes more difficult. They can stay abreast of share usage while management oversees the equity strategy by considering the following questions: How will granting annual awards impact burn rate and dilution? How much dilution will be tolerated externally?

Companies granting full-value equity awards with a depressed stock price can face additional scrutiny if the number of shares required to make such grants causes excessive dilution and furthers misalignment between executive rewards and shareholder returns. Committees should understand how dilution outcomes compare to historical levels, business growth, market benchmarks, and proxy advisor expectations, and ask for sensitivity analyses to determine if executives could receive a windfall should the stock price recover.

When one technology company faced a depressed stock price, the compensation committee asked to review annual burn rate metrics relative to corporate growth measures (e.g., market cap and operating profit) in addition to historical practices and market benchmarks.

Companies that maintain a robust, ongoing dialogue among management teams, compensation committees, and advisors will be best equipped to navigate unfavorable market conditions.

Viewing these metrics through multiple lenses helped illustrate that the burn rate exceeded the company’s market cap growth over multiple years and did not align with the shareholder experience. The additional data empowered the committee and management to refine the equity strategy and reduce share usage to levels that were more commensurate with growth.

If annual equity grants need to be reduced, several strategies can be employed, such as the following:

  • Reduce the number of participants.
  • Reduce the dollar value of the annual grant per participant (e.g., focus on the number of shares instead of the dollar value).
  • Substitute performance cash for a portion of equity.
  • Delay the timing of awards.

Particularly in volatile markets, conducting sensitivity testing is imperative to understand how many years of grants a company’s share pool can support at various valuations and replenishment levels. If companies expect to encounter share pool constraints based on these analyses, they should consider adopting one or more of the share mitigation strategies above.

3. Consider if limited special actions are necessary.

In some cases, special pay actions, such as retention awards to address immediate needs or top-ups to navigate organizational or business transformations, are warranted, but the following questions should be discussed to manage external scrutiny and other risks: Are retention efforts targeted toward key employees? What is the current equity hold on the employee(s)? Is the award necessary, and if so, will the award be meaningful? What specific business objectives is the company hoping to accomplish through additional awards?

These questions aim to address potential knock-on effects of special pay actions, such as facilitating a windfall opportunity, creating an internal pay imbalance, and setting an unintentional precedent.

Compensation committees should ensure that special actions are targeted and mitigate the associated risks above. While the entirety of an executive team may experience a diminished realizable pay opportunity, a one-size-fits-all retention program will likely draw external criticism and risks misappropriating compensation dollars. Companies can limit risks of any special actions by restricting the scope or scale of retention programs or orienting them around specific performance hurdles.

For example, the management of a company undergoing a strategic transition amid downward stock pressure proposed a retention award for most of the executive team, citing decreased retentive hold and stability through the transition. The compensation committee reviewed the executives’ current equity holdings and proposed annual awards, finding that the potential windfall opportunity from annual grants afforded a sufficient “carrot” to retain the bulk of the executive team. The committee then approved smaller retention grants for two specific executives overseeing key transition-related projects.

Market volatility highlights the importance of proactive management of compensation programs through stress testing. Companies that maintain a robust, ongoing dialogue among management teams, compensation committees, and advisors will be best equipped to navigate unfavorable market conditions. Even in bull markets, thoughtful questioning and sensitivity testing can create strong annual processes that prepare management and compensation committees for any potential “What if?” scenarios.


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Deborah Beckmann

Sam Askenas

Sara Bourdouane

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