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The impact of COVID-19 is beyond what typical business continuity and resilience plans have contemplated. As a result, all parts of the business, particularly human resources, have had to evolve their thinking and react rapidly to an ever-changing landscape.

Near-term considerations

In the near term, companies may have limited ability to alter executive compensation arrangements due to contractual restrictions. The two most straightforward approaches companies are considering is cutting executive base salaries and/or bonus targets for the year. These actions generally do not require executive or shareholder approval (unless contractually required), and may be the quickest actions the company can take. The following table highlights a few considerations when contemplating these actions.

Approach Advantages Disadvantages
Cut base salary
  • Can align executives with broader employee actions
  • Immediate cash flow savings
  • Shareholders generally do not give much credit
  • Can backfire when salaries are restored and companies report pay increases
  • Risks angering executives
Cut/eliminate annual incentives
  • Longer-term cash flow savings
  • Immediate accounting impact/expense savings
  • Potentially demotivating to team; particularly if performance improves at an accelerated pace
  • Removes (if eliminated) tool for CEO to galvanize team and drive behaviors

Any company considering immediate cuts to executive compensation should also consider whether commensurate reductions - especially to cash compensation - should be made for the independent board members.

For companies preparing to provide annual equity grants, it may be prudent to delay the grant to provide more time to gather facts and adjust the award size and desigh parameters to appropriately account for the ongoing disruption. Companies could also consider reducing grant value to preserve shares and minimize the account expense in the near term if the company's situation warrants. It is important to take into consideration the impact of any delay or reduction of grant size on retention of key executives.

Longer-term considerations

Over the longer term, companies should also determine how best to address annual and long-term incentive programs if the economic uncertainty continues. With time, companies can address the contractual obligations (including gaining shareholder support, if applicable) needed for a wider-range of alternatives. Companies should also factor in any additional regulatory limitations that may be in place over the coming pay cycles.

For non-calendar year companies, this may mean taking action in the next two to three months. Calendar-year companies may have until early next year, unless a decision is made to reset performance goals for 2020.

Annual or long-term cash incentives

For cash incentives, companies generally have more flexibility when it comes to setting (and potentially modifying) goals for the year. While accounting, tax, and legal experts should be involved, the following approaches are generally available to companies:

Approach Advantages Disadvantages
Reset in-cycle incentives
  • Increases ability to motivate and reward performance for balance of performance period
  • Provides flexibility to change metrics, targets, timeframe, leverage, and/or pay opportunities
  • Creates a disconnect with shareholders, who do not get to re-set
  • Risks backfiring if reset goals become irrelevant as the crisis continues to evolve
Discretionary goals
  • Avoids need to set explicit goals in a time of uncertainty
  • Provides maximum flexibility when it comes to setting and shifting, strategic priorities
  • Generally disliked by shareholders and proxy advisors unless process and considerations are thoroughly disclosed
  • Can lead to disconnect and negotiations between CEO and Board at year end
  • Can create more accrual/expense variability given subjective nature of payout
Quarterly or semi-annual goals
  • Maintains explicit goals
  • Allows for course correction in terms of both metrics and targets as the performance period progresses
  • Shareholders and proxy advisors generally disapprove of performance periods <1 year
  • Can result in outsized payments for year when evaluated against annual financial and market performance
Flatten & lengthen payout curve
  • Provides more opportunity for payout
  • Decreases pressure on goal setting
  • Rewards lower levels of performance than may have been historically acceptable
  • Potentially demotivating at higher performance levels
Pay in equity
  • Increases alignment with shareholders
  • Conserves cash
  • Increases dilution and uses shares quicker
  • Decreases cash flow to participants

As companies contemplate any of these changes to their annual incentive plans, two additional considerations should be taken into account: whether target opportunities should be lowered to reflect the current situation, and how the changes will be communicated (both internally, and externally).

Long-term equity incentives

Given legal and accounting considerations, it can be challenging to make changes to outstanding equity awards. Further, making changes to prior awards risks creating concerns among shareholders, who are not afforded the luxury of re-setting their investments to undo losses. For companies that do want to consider making changes to prior awards, potential approaches include:

Approach Advantages Disadvantages
Modify performance share goals
  • Re-calibrates goals to targets that may be more attainable
  • Avoids having lost performance cycle
  • Requires employee consent
  • Generally disliked by shareholders and proxy advisors
  • Potential accounting implications
Stock option exchange: Replaced with new options
  • Brings exercise prices to current market levels
  • Increases retentive and motivational power of stock options
  • Generally requires shareholder approval and tender offer
  • Shareholders will generally disapprove of executives participating
  • Potential accounting implications
Stock option exchange: Replaced with cash or RS(U)s
  • Increases retentive power of awards
  • Provides more downside protection during market volatility
  • Generally requires shareholder approval and tender offer
  • Shareholders will generally disapprove of executives participating
  • Less shareholder friendly than replacing options with options
  • Potential accounting implications

While the above actions may be appropriate at times, legal, tax, and accounting experts should be involved from the beginning of the decision making process to limit unintended consequences.

For the majority of companies, it may be best to focus on potential future actions, instead of adjusting prior awards. Potential future actions include:

Approach Advantages Disadvantages
More frequent grants (e.g., smaller quarterly grants)
  • Cost averaging for share grants, potentially mitigating market volatility
  • Increases administrative burden of grant and vesting/tax withholding process
Cash-based awards
  • Helps minimize dilution at lower stock prices
  • Can assist in prolonging share reserves
  • Decreases alignment with shareholders
  • Increases cash spend
  • Limits ability for employees to participate in value creation if not tied to stock price
  • Introduces liability accounting if tied to stock price
Relative financial and/or market metrics
  • Eliminates need to set absolute goals
  • Directly ties payouts to out/under performance relative to competitors
  • Assumes all peer companies are subject to same business, customer, and industry factors
  • Does not directly drive behaviors, and instead rewards after the fact
Cap payout at target for negative TSR
  • Increases alignment with shareholders by limiting payout if value created is negative
  • Can be demotivating if financial performance is stronger than expected
Introduce/increase stock option weighting
  • Stock options only provide value to recipients if value is created for shareholders
  • Provides more leveraged opportunity than time-based shares/units
  • Generally depletes share reserve quicker and increases dilution
  • Generally not considered performance-based by shareholders
Time-based awards with longer vesting
  • Eliminates need to set performance goals
  • Longer vesting (e.g., 5-7 years) increases retention and enhances alignment with shareholders over typical market practice (i.e., 3-4 years)
  • Proxy advisors and shareholders generally prefer performance-vested awards
Provide targeted retention awards
  • Increases retention hold for key talent
  • Provides more leveraged opportunity than time-based shares/units
  • Could be negatively received by shareholders and proxy advisors (particularly if granted to CEO)
  • Likely requires Form 4 for Section 16 officers, risking unwanted scrutiny and press

All of the above approaches can be appropriate, but it is important to remember that no single approach works for all companies or in all situations. Companies should continue to have ongoing communication between the board, C-suite, and shareholders to understand current and projected business/market dynamics. In addition, broader employee decisions (e.g., layoffs, furloughs, reduced hours, pay cuts) should be aligned with changes made for senior executives. Indeed, while some boards and CEOs may feel increased pressure to act and change incentive programs soon, the most prudent approach may be to wait and act once more facts are known.

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