Assessing Executive Pay Plans in the Current Environment

April 28, 2020

Daniella Gama-Diaz

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Amidst a rapidly evolving landscape, executive compensation has come into the spotlight more than ever before. As corporate America races to address the ongoing COVID-19 outbreak, many companies are weighing their options—furloughing employees, closing their doors for good and altering executive pay plans.

Equilar recently hosted a webinar with panelists Shelly Carlin, Executive Vice President, Center On Executive Compensation, Jessica McDougall, VP, Investment Stewardship & Corporate Governance, BlackRock, and Michael Palermo, Director, Investor Education, E*TRADE Financial Corporate Services, Inc. to discuss the changes and trends to come in executive compensation in light of the changing economy and market conditions.

ESG on the rise

In recent years, there has been an increase in environmental, social and governance (ESG) metrics. As shareholders push for corporations to be more transparent on issues that investors value, ESG has gained a spot at the table. Although historically some industries, such as energy or mining, were more likely to have ESG tied into their business activities, more companies are including ESG into pay plans. Palermo explains that “executive goals need to be aligned with shareholder goals,” and therefore, they must be set in a way that fits the business strategy. ESG shouldn’t be considered in a vacuum, but rather as fundamental part of a business. As a result, Palermo shares that it has recently been found that “one in four dollars is held in assets chosen according to ESG criteria.” McDougall adds that this proxy season has seen an increase in environmental shareholder proposals. “This is indicative of a broader focus on these issues and the long-term success of companies,” McDougall explains. In terms of coronavirus provisions, companies are reevaluating how they conduct business.

How COVID-19 has changed the market

Despite the coronavirus still being new, the market has already seen changes that need to be addressed in long-term incentive plans this year. One change that has already come to fruition is the use of TSR metrics. Because of current market conditions, TSR metrics may be more than risky to use. “TSR doesn’t always correlate with management’s performance due to many external and macro factors that impact it,” explained Palermo. With the current market volatility, the timing can be very difficult. Palermo asserts that companies should be mindful to not “sacrifice long-term success for near-term innovation and agility.”

And even if the conditions are right, McDougall warns that “public perception of shareholders receiving large payouts in a downturned economy may be negative.” TSR may therefore be a risky metric to use in the current market. However, if TSR metrics are used correctly, “the current environment will be the model for gauging how management performed compared to its peers,” McDougall says. Relying on TSR as a metric at the moment may be a high risk, high reward situation.

In terms of performance periods, three years continues to be most common. “As general performance increases, it becomes easier to set longer periods,” Carlin explains . However, the COVID-19 uncertainty will become problematic for setting longer periods. Because companies may need to shift their sights to navigating through the short-term, they may not be thinking of future years for setting longer performance periods. “To compromise, companies will be well advised to return to long-term plans that set goals within the plan", asserts Carlin. “This can allow leadership to focus on navigating the short-term while still sticking to long-term strategy.”

A major change brought on by COVID-19 is how companies are protecting their employees. McDougall explains that companies have been responding to the crisis depending on how they were impacted. “Overall, companies need to do a cost-benefit analysis of needing to rehire or retrain employees versus keeping them on” explains McDougall. This is because business decisions made in the short-term need to be made with the long-term results in mind. McDougall emphasizes companies need to find a balance between the short-term and overall strategy. “Companies that are doing this well are being very transparent such as how they’re addressing employees, prioritizing their health and safety, answering all questions about job security and more.” Increasingly, human capital has become a company’s most important asset.

Conveying compensation messaging

The hottest topic for corporate governance amidst the crisis is executive compensation. As companies are forced to close their doors for safety, unable to maintain profit levels and furlough employees, the executive suite has come under the spotlight. The panelists were in agreement that the responsible thing to do is to make changes to executive compensation that allow for companies to keep more cash on hand.

Companies have several different options they can take for changing executive compensation. From reduction in salary in exchange for shorter vesting periods, to putting equity awards on hold, it may be necessary for executives to take pay cuts in order to not only keep the company afloat, but ensure that employees are not left in crisis. “Companies will most likely not be changing payouts for 2019 performance but they should instead get ahead of the messaging,” Carlin explains. Carlin continues, explaining that companies “need to pair the communication of 2019 compensation with the changing goalposts of 2020 compensation.”

Most importantly, is that all compensation decisions need to be made clear to shareholders and award recipients. While compensation is a case-by-case analysis, McDougall explains, goals need to be clear and included in the proxy statement. In order to craft the right compensation plan, companies need to look to the compensation committee for discretion and actions taken, and see how they align with shareholder value.

Metrics may need to be adjusted as well. As the near-term strategy is adjusted to navigate for the remainder of the year, McDougall explains, companies “need to be mindful that the previous criteria for performance may no longer be effective and relevant in the changing environment.” This is especially certain for some industries, including the entertainment industry. In terms of equity, companies that are not cash rich may be granting more shares. McDougall warns that while there has been an uptick in companies adopting shareholder rights plans, it may not be best to keep these poison pills in the long-term. Instead, a stock option exchange program may be a better option.

The new normal

Overall, the COVID-19 outbreak has affected all parts of life, including corporate America. The notion of “business as usual” will just not cut it in this environment. With the looming possibility of a recession, corporate governance is more important now than ever before. As companies move to make a variety of changes to ensure safety, from closing doors, moving general meetings online and adjusting executive compensation, the business world is moving into uncharted territory.

As companies adjust to this new normal, it is likely we will see major changes in the corporate governance landscape to come.

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Equilar conducted a survey at the beginning of this webinar broadcast to see how companies were making changes. While most companies have not yet made changes, we expect to see changes in the coming weeks. Several companies have already included COVID-19 provisions in their disclosures, as seen in an ongoing Equilar study.

Please contact info@equilar.com or your account manager to view results from the survey.

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