The coronavirus pandemic has profoundly shaken the retail sector. Rapid changes in consumer behavior, supply chain disturbances, and government-mandated store closures contributed to a diﬃcult 2020. Companies discarded long-term strategies while management teams and boards pivoted to the “new normal.” “Essential” retailers struggled to keep pace with demand while many “non-essential” retailers focused on survival.
In this context, companies took extraordinary actions to reimagine compensation. With the pandemic’s disruption continuing in 2021, we discuss three critical compensation issues that management teams and boards face in the ﬁrst quarter of 2021.
1. Disclosing 2020 Actions and Outcomes
Retailers enjoyed a small benefit in timing: the typical firm with a February to January fiscal year was better positioned to react to the emerging pandemic in early 2020. The additional month meant that most retailers had not yet finalized their 2020 incentive metrics, goals, and grants. They were able to delay and/or pivot compensation designs, with a number of common approaches: adopting new metrics, recalibrating growth expectations, rebalancing long-term incentive vehicle mixes, and expanding discretion over compensation outcomes.
Yet with 2020 results now being finalized and proxies drafted, many retailers are struggling to reconcile the disclosure of payouts with overall results. Compensation programs rewarded extraordinary efforts by management to deliver on operational priorities that were separate from the usual measures of success. This mismatch is acute for those that prioritized survival by pivoting to controllable measures like liquidity and cash flow; or “retreated to safety” by lowering their growth expectations. Many of these companies now find themselves paying out compensation incentives well above target, despite sales and earnings down significantly from prior years
Windfalls are also an issue at companies that granted equity to executives at market lows in March and April. These equity grants appreciated to multiples of the original intended values, out of proportion with the incremental value created.
Many boards are now in the position of explaining or even defending these outcomes. Contextualizing when and how they made these decisions in 2020 will be critical. Equally important, boards will want to address the outcomes in relation to the experiences of the broader employee population. Many of those employees suffered from furloughs or layoffs, or risked their health on the front line in stores, distribution centers, and factories.
Finally, boards will want to disclose outcomes in a holistic manner. They should highlight that individual decisions are not made in isolation, but rather with consideration to actions taken (or not) for other programs with offsetting experiences. For example, the board might have been more forgiving with their approach to short-term incentives but held steadfast with outstanding long-term incentive cycles harmed by the pandemic.
2. Managing to an Increasingly Fragmented Talent Market
Looking beyond 2020, boards will need to pay special attention to the talent market. With the rise of digital channels and new competitors, retailers have been dealing with structural disruption for most of the last decade. The pandemic intensified this disruption, with a growing divide between those with mature vs. nascent omni-channel capabilities. Fast growing, digitally-native brands—an alluring destination for entrepreneurial talent, generally—and retailers with sophisticated digital businesses better handled the shift to remote buying during widespread store closures and have strong hiring positions.
The market for retail talent has always flowed with the sector’s underlying strength, but the pandemic has also fragmented the talent market between “essential” vs. “non-essential” sellers. Grocers, hardware stores, and other sellers of basic goods saw rising sales, while apparel and other discretionary categories suffered greatly. Essential retailers can compete with more certain and stable compensation opportunities, while most non-essential retailers will have to do more to attract talent. Going deeper, some discretionary categories, such as jewelry and athleisure, have outperformed others and will operate from a position of strength as well.
On a functional basis, the pandemic has only redoubled the marketplace value for top talent in digital/omnichannel and supply chain roles. The sector’s many bankruptcies, along with an influx of private capital, has also fueled increasing demand for strategically-minded finance talent with experience in distressed companies. P&L leaders with a track record of success, who could be lured away into a CEO role, are also getting recruited.
Resource-strapped retailers will need to bring this nuanced view of the talent market to new fiscal year pay decisions, so they direct limited resources effectively. They should also assess whether they have adequate “retention hooks” for critical talent.
3. Establishing 2021 Designs
As for prospects generally in 2021, the pandemic’s lingering impact and associated pace of economic recovery remain unclear. Many retailers are likely to employ seasonal measurement again. This design is well suited for those with significant second-half seasonality, where the potential for over- or under-indexing the goals at the beginning of the year is greater.
As we described in article about goal-setting in 2021, boards can account for uncertainty with a variety of adjustments, including setting wider ranges between threshold, target, and maximum. Companies should also incorporate mechanisms to ensure that any formulaic results are delivered with an eye toward the quality and sustainability of results over time. Were earnings delivered with an appropriate degree of top-line performance? Was inventory well-managed? Some boards will be comfortable with structured, discretionary overlays. Others may prefer a less formal approach, such as a framework to guide discussions with management about performance throughout the year.
As for long-term incentives, many retailers have an eye to the past. They’re using 2019 as a baseline to reset expectations with “on average, over time” aspirations. They’re assuming that by the end of a three-year cycle, the operating environment will revert to a steady state. If 2019 levels are not attainable near-term, goals may need to be set on the path back to prior high-water marks, but with reduced maximum opportunities (e.g., 125% of target).
Other boards are likely to rely heavily on relative TSR constructs, to avoid the challenge of goal-setting altogether. This tactic requires careful selection of comparators both to reflect divergent sector dynamics noted above; and to ensure the design doesn’t disproportionately reward for simply “outliving” a cohort of distressed rivals.
Boards at retailers will face continued noise as they embark on a new fiscal year. But now is the time to make basic decisions on compensation. As 2021 proceeds, boards can still fine-tune their programs. In doing so, they would be well served to talk with investors and other stakeholders to fully appreciate their perspectives and share helpful context. Only then can they best address ongoing volatility in performance outcomes and talent vulnerabilities, while also adapting to evolving markets.
View the full article as it was originally published.