February 10, 2023 Executive Compensation Resilience Articles

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Setting Up Compensation Plans When the Stock Price Is Depressed

Many companies are facing significant challenges developing and implementing compensation programs for 2023 owing to market volatility and continued macroeconomic uncertainty. Decreased valuations put pressure on dilution and equity grant strategies, and calendar-year-end companies are considering modifications to annual incentive designs to recognize uncertainty around the macro environment, interest rates and inflation.

Retaining your best talent may require adjusting for market volatility

Dilution levels for 2023 will likely be up 1% to 3% over pre-dislocation levels (i.e., 2021). In general, companies will begin to focus more on managing the share pool in addition to burn rate and stock-based compensation expense. Many newly public companies will need to manage burn rate within the evergreen provision (i.e., automatic share pool refresh). For dollar-value budgets, current valuations put pressure on share dilution. Companies can try to reduce their dollar-value budgets by pulling various levers, including:

  • Reducing headcount.
  • Reducing equity participation.
  • Differentiating more based on performance.
  • Lowering new-hire guidelines.

These levers are the common starting place for most companies. However, harder-hit companies can also consider other levers, such as lowering grant guidelines, moving to shorter vesting programs (with proportionately reduced grant values) or shifting to share-based guidelines.

For annual incentive designs, companies should consider whether widening performance ranges and/or increasing the prominence of operational, strategic or individual performance measures can help mitigate some of the uncertainty around goal setting. Compensation committees may also need to exercise more discretion than in a typical year to ensure that payouts align with performance and appropriately acknowledge external factors outside the company’s control.

Organizations facing these challenges should focus on identifying, rewarding and locking in the next generation of leaders, differentiating “renters” (individuals focused solely on pay) from “owners” (those who are long-term-oriented) and providing “owners” more in the way of equity compensation as well as leadership and development opportunities. Open and transparent communication about noncompensatory incentives is critical in these circumstances.

A principles-based approach can help companies navigate volatile markets and create more durable programs. The framework below can be a helpful guide in determining the right approach for companies and their specific context.

Articulate and explain the pay philosophy

Develop an easy-to-understand rationale for the approach to equity grants and considerations for awards.

Are grants determined based on grant date value, targeted to an annual vesting amount or denominated in shares?
When is someone eligible for additional grants? How frequently will you make grants, and when is someone eligible for off-cycle grants?

  • How do you determine new-hire and promotional grant values?
  • What is the basis for annual incentive metrics and goals?
  • How do you determine peer companies/competitive market comparisons?
  • How do you approach pay positioning and differentiation?

Be targeted

Many companies lack sufficient resources to take meaningful action across the entire population. Focus actions on the most critical roles and top talent and those most impacted by the decrease in valuation, such as recent new hires or promotions. Rely on the annual programs for the rest of the population.

Consider long-term implications

Any off-cycle actions should be made within the context of a longer-term strategy.

What will you do if the price continues to decrease?
Do you plan to have a one-year spike in dilution, or can you sustain higher levels for multiple years?
Will you need additional share reserves to deal with potential additional challenges down the road?
If you change your approach now, are you willing to adjust again if circumstances change? How will that impact employee communications and expectations?

Anticipate potential secondary effects

Significant actions today will create a precedent and introduce potential longer-term implications.

  • What is the likelihood that a price rebound in the next 12-18 months could lead to a significant windfall for participants?
  • Do you create a precedent of topping up pay when the price declines? Will you reduce future grants if there is a substantial price increase?
  • If you use a targeted approach, how will that impact broader employee engagement?

Be balanced

Double down on the other aspects of your employee value proposition, including transparency, long-term ownership, mission, development and career opportunities, long-term strategy and viability of the business. Not everyone in the organization can be retained. Noncompensatory elements, such as leadership development and coaching, and engagement and inclusion, become ever more important in volatile and fluid talent markets.

There is no “silver bullet” to solve the issues facing companies experiencing a significant and sustained decrease in their stock price. Using a principles-based approach, identifying and rewarding the next generation of leaders and deploying an appropriate combination of reward levers can help companies tackle these challenges. In doing so, ­companies remain competitive in attracting and retaining talent, responsible with respect to dilution and affordability, and aligned with their compensation philosophy and objectives.

View the full article as it was originally published.

Kristofer O’Toole

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