The experts in executive compensation consulting.

Pay Governance LLC is an independent firm that serves as a trusted advisor on executive compensation matters to board and compensation committees. Our work helps to ensure that our clients' executive rewards programs are strongly aligned with performance and supportive of appropriate corporate governance practices. We work with over 450 companies annually, are a team of nearly 75 professionals in the U.S. with affiliates in Europe and Asia with experience in a wide array of industries, company life cycles and special situations.

Find out how we work

Current Issues in Executive Compensation

Pay Governance understands that times remain uncertain. Our domain expertise remains executive compensation consulting. Therefore, each week we will continue to provide you with a short newsletter to keep you abreast of developments in the executive remuneration world.

Get that Newsletter here

Featured Viewpoints

Environmental Performance Metrics in Incentive Plans: Incentive Trends and Key Design Considerations


In recent years, global companies have grappled with defining a baseline for environmental metrics, establishing the processes and controls to measure and report progress toward objectives, and setting the goals of ambitious environmental performance metrics (especially if environmental performance metrics are used in executive incentive arrangements). Institutional investors have also been increasingly seeking ways to ensure that the companies in which they invest are actively working towards a sustainable future. In response to these investors pushing for progress on sustainability (among other priorities), the majority of S&P 500 companies have released sustainability reports, and boards of directors, compensation committees, and management teams have been discussing whether a portion of executives’ incentive compensation programs should be tied to corporate sustainability priorities.

From setting greenhouse gas (GHG) emissions reduction targets to promoting circular economy practices (which involve minimizing waste and maximizing the reuse and recycling of resources), some compensation committees have considered if there are specific and actionable performance metrics that should be included in executive incentive plans. Whether environmental incentive metrics will support meaningful sustainability progress depends on how the metrics are created, measured, and evaluated.

In this article, we explore the role “E” in Environmental, Social, and Governance (ESG) priorities has played in executive incentive arrangements, as well as design considerations for including an “E” metric in executive incentive plans.

Heightened Pressure for Environmental Action

The "E" in ESG encompasses a wide range of factors that, in some cases, may have implications for how external stakeholders view a company's long-term sustainability. These “E” factors include a company's energy use, GHG emissions, waste management, water use, resource conservation, and biodiversity impact, among other factors. By considering these factors, investors and other key stakeholders can better understand a company's environmental footprint and assess the potential risks and opportunities that may arise from its sustainability practices.

To date, recent regulations in the U.S. and European Union (EU) are making environmental-related disclosures a compliance requirement, which adds pressure for companies to demonstrate their commitment to sustainability and climate resilience. Such legislation includes:

  • European Parliament and Council of the EU approving the Corporate Sustainability Reporting Directive in December 2022 (effective January 2024), which requires EU businesses and qualifying EU subsidiaries of non-EU companies to disclose their environmental and social impacts as well as how their ESG actions affect their businesses.
  • State of California’s Governor Newsom approving (in October 2023):

          — SB-253 which requires the California Air Resources Board to develop and adopt regulations requiring businesses with total revenues over $1 billion and operating in California to disclose their GHG emissions to an emissions reporting organization, and

          — SB-261 which requires reporting on companies’ climate-related financial risks for California companies with total annual revenues over $500 million.

  • SEC issuing Rule No. 33-11275 The Enhancement and Standardization of Climate-Related Disclosures for Investors (in March 2024), requiring public issuers to disclose climate-related information in their annual reports and registration filings. Such information includes material climate-related risks; activities to mitigate or adapt to such risks; information about the registrant's board of directors' oversight of climate-related risks and management’s role in managing material climate-related risks; information on any climate-related targets or goals that are material to the registrant's business, results of operations, or financial condition; Scope 1 and/or Scope 2 GHG emissions on a phased-in basis by certain larger registrants when those emissions are material; the filing of an attestation report covering the required disclosure of such registrants’ Scope 1 and/or Scope 2 emissions, also on a phased-in basis; and disclosure of the financial statement effects of severe weather events and other natural conditions (e.g., costs and losses).

In addition to approved U.S. legislation within the last 12 months, we observed a 31% year over year increase in the number of 2023 environmental shareholder proposals [1] received by Russell 3000 companies with the three most common proposals related to GHG emissions, reports on climate change, and financial support/lending for fossil fuel development/exploration. The average shareholder support for the 2023 proposals was 21%, with two proposals receiving majority shareholder support (one Energy company and one Financial Services company).

E” Metrics in Executive Incentive Plans Among S&P 500 Companies

Prevalence and Types of Environmental Metrics in Incentive Plans

Based on Pay Governance’s review of the use of environmental performance metrics in executive incentive plans among S&P 500 companies, [2] approximately 32% (n=159) include an “E” performance metric in their incentive plans, with the most common metric being related to Carbon Footprint and Emission (43%). See Figure 2 for the prevalence of all types of metrics identified in incentive plans.

Among the S&P 500, there is significant variation of the prevalence and type of “E” incentive performance metric by industry. To no surprise, Energy (91%) and Utility (81%) companies have the highest prevalence of “E” metrics in their executive incentive plans. Among other industries, prevalence generally is under 50%, with Materials companies at 48% and Industrials and Real Estate companies both at 32% when incorporating an “E” metric in their incentive plans. Financial Services and Information Technology companies were the only industries with “E” incentive metric prevalence below 20% (15% and 16%, respectively). See Figure 3 for a detailed breakdown by industry.

Regardless of industry, Carbon Footprint and Emission is the most common type of “E” incentive performance metric found in plans. This may be

attributable to new U.S. and EU regulatory mandates, which generally require the transparent disclosure of Scope 1, 2, and 3 emissions. In connection with this regulatory shift is a push from some environmentally focused investors looking for “low carbon bargains” — investments offering reduced carbon footprint per revenue.

Additionally, some investors view their financial allocations as extensions of their personal values. These investors are not only driven by financial returns but also by the desire to align their portfolios with their view of an environmentally responsible narrative. If these investors increase in prevalence or investment, the incentivization of senior leadership to fulfill these emerging requirements may become more prevalent across industries.

Generally, the second most common type of “E” performance metric in incentive plans across all industries is related to the area of Energy, with the exception of Consumer Discretionary and Consumer Staples companies.

Energy is a common performance metric, particularly for companies that consume large amounts of electricity, fuel, and natural gas for key operations. Energy consumption directly impacts a company’s GHG profile and can represent a significant operating expense. Executives in energy-intensive industries can enhance corporate value by improving efficiency, thereby reducing operational costs, mitigating risks associated with fluctuating energy prices and peak demand charges, and achieving carbon reductions that support corporate sustainability goals.

Among Consumer Staples companies, Waste-related incentive performance metrics are the second most common type of metric utilized, while Waste- and Water-related metrics were the second most common metrics among Consumer Discretionary companies. Historically, waste and

recycling dominated the landscape of company environmental priorities, reflecting their popularity in environmental discourse and the ability for every employee to make an impact. However, recent revelations and growing public awareness have cast shadows of skepticism on recycling practices, particularly around plastics. Observations suggest a growing awareness among consumers regarding the complexities and challenges associated with recycling claims, which may be perceived as overstated or not fully transparent. This shifting perception appears to influence the role of waste and recycling as key metrics in environmental reporting. Similarly, the focus on carbon offsets and market-based carbon reductions is evolving, with increased attention being paid to their effectiveness and transparency. In response to these shifting perspectives and the broader environmental context, businesses are considering adjustments and enhancements to their reporting frameworks to better align with dynamic consumer expectations and environmental needs. See Figure 4 for a summary of the types of “E” incentive performance metrics utilized by industry.

How companies measure and define the types of environmental metrics varies widely across industries, in part due to the lack of standardization around reporting these metrics. However, we are beginning to see increased consistency in the disclosure of carbon emissions metrics and targets in line with new regulatory requirements.

Types of Incentive Plans Where “E” Metrics Appear

ESG metrics, including environmental metrics, are more commonly found in annual incentive plans than in long-term incentive (LTI) plans in the U.S. Among the S&P 500 companies that include environmental metrics in their incentive plan

design, only 12% include an environmental metric in their LTI design. Of the companies that have included “E” metrics in their LTI design, 47% are in Energy and Utility, 26% are in Consumer Discretionary and Consumer Staples, 12% are in Health Care, 9% are in Materials, and the other 6% are made up of Information Technology and Financial Services companies.

How the Measurement of an “E” Performance Metric is Structured in Incentive Plans

When it comes to the structure used to evaluate “E” performance metrics in incentive plans, 75% of companies utilize a Strategic Scorecard and 25% use a Carve-Out (i.e., stand-alone metric with defined weighting) approach to determine how the metrics will impact the incentive payout.

With respect to the disclosure provided to shareholders on the approach used to assess performance and corresponding incentive payout, the majority of companies do not disclose detailed information about the “E” metric and/or corresponding goals and incentive payout. However, 33% of companies disclosed using a formulaic approach whereby threshold, target, and maximum goals were established and disclosed along with the corresponding payout opportunities.

We also observed 22% of companies with an “E” performance metric incorporating the “E” metric as a modifier, whereby the final incentive payout is adjusted upward and/or downward based on the achievements of the metric. For companies that have a modifier that allows for both upward and downward adjustments in the final payout (majority practice), the modifier range is +/- 5% to 20%, with a 10% modifier being the average. For companies that only apply a downward adjustment in the final payout (minority practice), the modifier range is 10% to 15% and a 10% modifier is the mode. See Figure 5 for the prevalence of how modifiers are used to determine the final incentive payout.

A Guide to Identifying “E” Metrics

For companies considering the inclusion of “E” performance metrics in their incentive plan, they first might want to align planning with the company’s environmental priorities and determine the environmental readiness in the measurability/ quantification of objectives. Four factors that generally influence the development of overall corporate environmental goals include:

1. Materiality Assessment: A materiality assessment helps companies determine the areas where addressing environmental and social impacts can have the most significant positive business impact. By identifying the most material issues, businesses can focus on areas that provide the greatest practical value to both their bottom line and the environment, minimizing threats and maximizing opportunities.

2. Internal Objectives: Companies should set and review internal goals that drive environmental performance and support stakeholder requirements. For example, companies setting internal environmental impact reduction targets, and choosing vendors that report carbon, water, and waste metrics can help companies reduce risk and meet stakeholder expectations. Additionally, pursuing environmental initiatives presents branding opportunities that can boost a company's reputation and demonstrate commitment to sustainability.

3. Compliance with Recognized Frameworks: If a stakeholder or internal preference requires compliance with specific frameworks, such as the Carbon Disclosure Project or the Science-Based Targets initiative (SBTi), companies should consider the metrics required by those frameworks when defining their own. Organizations must navigate these frameworks and select the most relevant metrics to incorporate into their environmental strategies and executive compensation plans.

4. External Influences: Companies should consider the metrics and requirements of their stakeholders — such as investors, regulators, and customers. For instance, if stakeholders require tracking of scope 1, 2, and 3 emissions, companies must establish mechanisms for monitoring and reporting these figures.

Together, the factors above can help define what a company should monitor and target for environmental improvements.

When setting environmental goals, businesses typically follow several approaches to ensure their objectives are both ambitious and achievable. Two standard methods for defining environmental goals are absolute targets and intensity metrics:

  • Intensity metrics look at environmental impacts in relation to a relevant denominator, such as emissions per dollar of revenue or energy consumption per production unit. This approach allows companies to track their environmental performance in the context of their business growth and can help identify areas where efficiency improvements can be made.
  • Absolute targetsinvolve setting a specific percentage reduction in emissions or resource consumption by a defined date. For example, a company may commit to reducing its GHG emissions by 30% by 2030. This approach allows for clear, quantifiable goals that can be easily tracked and communicated to stakeholders.

The SEC guidelines recommend that companies report both absolute and intensity metrics, which can provide a more comprehensive understanding of a company's environmental performance.

Based on a review of proxy disclosures, companies that disclosed their climate-related goals (generally a minority of companies) most commonly reported absolute metrics since they present a single, straightforward number that is easy to explain. Absolute metrics typically capture the entirety of a specific environmental impact, such as total GHG emissions, without adjusting for the company's size or operational scale. The primary goal of these metrics is to track and ideally reduce the overall impact number, signifying a move towards a more sustainable operation.

Intensity metrics offer a nuanced perspective that facilitates comparison across diverse business models and scales. They allow stakeholders to essentially compare "apples to oranges". Among the various intensity metrics available, revenue-based intensity metrics are most frequently used. By relating environmental impact to revenue, this metric provides outside observers with insights into the environmental cost or "carbon cost" associated with every dollar earned. This holds true irrespective of the nature, product, or service of the company.

Frameworks like the SBTi mainly allow targets based on absolute metrics. However, intensity targets for Scope 1 and Scope 2 emissions may be more appropriate to include when they are modeled using an approved 1.5°C sector pathway (consistent with the 2015 Paris Agreement) applicable to companies’ business activities. This approach ensures that businesses consistently focus on their environmental performance and fosters a sense of urgency in achieving their targets.

In our experience, institutional investors and proxy advisors prefer executive incentive designs that are measurable and transparent. This includes clearly detailing the performance metrics and goals used to reward executives (See Figure 6 for an example disclosure). Therefore, when it comes to incorporating “E” performance metrics in incentive arrangements, quantitative metrics (i.e., pre-defined goals are set at the beginning of the performance period and achievement against the goal at the end of the performance period determines a corresponding incentive payout) are often preferable. Additionally, as companies’ environmental reporting capabilities become more robust and automated, this may further lend itself to companies considering whether quantitative “E” performance metrics should be included in their executive incentive designs.

While quantitative metrics are generally preferred, there are situations where qualitative metrics may be more relevant. Early-stage companies at the outset of their sustainability endeavors — such as those undertaking materiality assessments, instituting sustainability teams, or identifying internal benchmarks — require a degree of flexibility. In a company’s early stages, while it's permissible to express goals qualitatively, a natural progression often results in these companies shifting towards more quantitative measures as their strategies mature. Even well-established companies with robust environmental strategies occasionally find qualitative metrics beneficial, particularly when taking their initiatives to the next level. For example, a company with a mature GHG metric may use qualitative metrics before eventually crystallizing into more quantitative goals. Irrespective of where a company stands on its sustainability journey — be it in the nascent stages or further along — qualitative metrics serve as a valuable approach to illuminate a company's commitment and progression.

See Figure 7 for more information on best practices for setting climate compensation metrics.

Incorporating “E” Performance Metrics in Incentive Plans

Once a decision has been made to include an “E” performance metric in the executive incentive plan, as well as the approach used to measure outcomes (quantitative or qualitative), the company will need to determine the following incentive design considerations:


As the external focus on environmental objectives and outcomes grows in the future, we believe companies will continue to assess the value and importance of linking a portion of executive incentive plans to environmental priorities. Incorporating the fundamental factors described throughout this article into a company's environmental incentive design goal-setting process can help ensure that objectives are clear with reasonable metric parameters. Additionally, by setting absolute targets, intensity metrics, and both interim and longer-term goals, organizations can effectively monitor their environmental performance and make meaningful progress toward a sustainable future. For companies that decide to align executive incentives programs with well-defined goals that are reasonable and clear to shareholders, this can further demonstrate the importance of environmental priorities (among other financial and operational goals) and help external stakeholders understand that an “E” performance metric in an incentive plan is not merely “window dressing”.

[1] Data are compiled from ISS Corporate Solutions’ Voting Analytics as of December 31, 2023.
[2] Research was based on information disclosed in ESGAUGE’s incentive database and Pay Governance’s review of S&P 500 proxy filings in 2023.

Read More

Featured Viewpoint

Incentive Design Tailored to Companies Subject to Economic Cyclicality and/or Commodity Exposure


The title of this Viewpoint references two issues that can wreak havoc on company incentive plans. What does “wreak havoc” mean in this context? It means incentive results or payouts that fluctuate significantly, or as many company executives and directors have told us, “Our payouts reflect compensation extremes. We are subject to the ‘boom or bust’ of the cycle.”

This situation can have a profound impact on employee morale and a company’s ability to attract and retain talent. Establishing incentive plan performance goals that reflect an appropriate level of rigor is a daunting task. Are annual business plans or longer-term forecasts developed at or near the peak of the economic or commodity cycle or at the lower trough? The impact of this timing can result in performance goals that are either overly challenging (and, in some cases, unachievable) or quite the opposite, lacking rigor and just plain too easy in hindsight.

The impact of this timing is especially pronounced when establishing goals for performance-based equity incentives, whose measurement period is most often 3 years in length. An unanticipated sharp drop-off in economic activity or a steep decline in commodity prices at any time during the 3-year cycle can negatively impact (or eliminate) payouts under these plans, resulting in a “hole” in compensation in the year of payout. This situation does not bode well for either retaining highly skilled and mobile employees or attracting necessary skill sets. So, what can be done in anticipation of these situations, which arguably are based on events or activities that fall outside of management’s control?

While nearly all companies are subject to the whims of economic activity and — to some degree — commodity prices, others are impacted on a much more significant level. To illustrate this point and establish the basis for our analysis, we examined two separate groups of companies that reside mainly in the industrial and energy sectors.

  • “Less cyclical” company group— 66 companies with median 5-year beta 1 of 0.93 that provide a baseline of contemporary incentive design among less cyclical companies.
  • “Cyclical” company group— 66 companies with median 5-year beta of 1.72 (companies with high betas and within cyclical industries) that were selected to identify the practices used by highly cyclical companies.

When analyzing incentive practices of the “less cyclical” versus the “cyclical” companies, we found several differences in incentive practice and design. When coupled with our own experience of addressing cyclicality, the approaches discussed below provide a variety of methods to soften the compensation extremes brought on by cyclicality without jeopardizing the alignment of executive pay and company performance.

Annual Incentive Plan

Performance Metric Considerations

Cyclical companies tend to use more metrics than less cyclical companies to measure performance under their annual incentive plan. Based on our research and consulting experience, cyclical companies are more likely to use four, five, or even more performance metrics than less cyclical companies. Consistent with the theme of mitigating compensation extremes in the pay system, the use of a greater number of metrics reduces the focus on one or two metrics and therefore reduces the likelihood of a zero or maximum bonus payout. In addition, the use of non-financial measures — such as operational, safety, and environmental metrics — is more common among cyclical companies. These metrics are often assigned to a “strategic” category of metrics (applicable to all executives) or within an individual performance category (applicable to individual executives). The weighting assigned to the non-financial metrics is often higher among cyclical companies than in less cyclical companies. The rationale for using more performance metrics and non-financial performance metrics in general includes the following:

Performance Range Considerations

Cyclical companies typically use wider performance ranges to accommodate swings in commodity prices and economic volatility, thus reducing the frequency of maximum or zero payouts. For example, a cyclical company might use a performance range for an earnings-based metric that establishes threshold performance at 60% to 70% of targeted performance and maximum performance at 130% to 140% of targeted performance. In contrast, less cyclical companies are more likely to use a “traditional” performance range for earnings-based metrics with threshold performance set at 80% of targeted performance and maximum performance set at 120% of targeted performance. Thus, management must outperform the target goal to a greater degree to merit a maximum payout, while greater forgiveness is provided on the downside if target results are not achieved.

The rationale for using wider performance ranges includes the following:

Performance Measurement Considerations

Truly cyclical companies understand the uncertainties related to economic and commodity price assumptions that drive annual and long-term business plans. These business plans most often serve as the basis for establishing incentive performance goals. Further, the COVID pandemic and its subsequent recovery created an unusual whipsaw in the business environment in 2020 and 2021, prompting some companies to experiment with new incentive design approaches. For some companies, these methodologies have become a standard component of ongoing practice.

The use of partial year performance goals provides an alternative to establishing annual goals when the business outlook for the full year is uncertain. This typically involves the implementation of two shortened performance periods, or “First Half” and “Second Half” goals, to mitigate the uncertainty of setting full-year goals while still maintaining a single annual payout. For example, a calendar year-end company would measure performance for the period from January 1 st through June 30 th and then measure performance for the period from July 1 st through December 31st.

This allows the Compensation Committee to evaluate more current information about the company’s prospects when establishing goals for the upcoming 6-month period. While performance is evaluated at the end of the first 6-month period and then independently at the end of the second 6-month period, payouts are almost always made after the end of the year, consistent with annual incentive plans based on full-year goal setting.

Performance Goal Setting Considerations

An alternative approach is the use of a “target performance range.” Under this method, a company establishes a range around the target performance goal reflecting insights regarding expected commodity price volatility or economic performance. The following example illustrates this approach for a company that uses Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) as a performance metric, which is highly sensitive to a commodity price. The company believes that the commodity price could fluctuate between 90% and 110% of the price assumption selected for the annual business plan that is used to establish the target EBITDA performance goal. Assuming the use of a wider performance range (60% to 140% of target for threshold and maximum performance) the target range would be illustrated as follows:

This example illustrates a modestly increasing slope to differentiate payouts between the low target range and the high target range (i.e., incremental changes in performance impact incentive payouts). Alternatively, some companies use a “flat” target range where the payout is 100% of target regardless of where performance falls within the range.

Among companies who utilize either the partial year performance goals or the target range approaches illustrated above, we see little to no negative feedback from proxy advisor firms.

Long-Term Incentive Plan

Long-Term Incentive Vehicle Considerations – Number, Type, and Mix

Our analysis of the cyclical versus less cyclical company data suggests some differences in terms of the number and type of long-term incentive (LTI) vehicles used to deliver equity compensation. Cyclical companies more frequently use two LTI vehicles with greater use of time-based restricted stock and less use of stock options as illustrated below.

Further, since cyclical companies are less likely to use stock options, they tend to deliver a larger portion of LTI through time-based restricted stock. However, we observed no discernable difference in the mix of value assigned to LTI vehicles when analyzing the use of two LTI vehicles, the most prevalent approach. This value was generally assigned 60% to performance awards and 40% to restricted stock among both the cyclical and less cyclical companies.

The rationale for greater use of restricted stock includes the following:

LTI Performance Metric Considerations

Given the challenges that cyclicality brings to annual incentive goal setting, establishing multi-year performance goals for LTI awards can be an even more daunting exercise. For this reason, cyclical companies are more likely to use relative metrics, most often Total Shareholder Return (TSR), than absolute internal financial metrics, as illustrated in the table below.

The use of relative TSR:

LTI Performance Measurement Considerations

Long-term performance plans often deliver the majority of the total LTI opportunity for senior executives. These programs typically measure performance over a single 3-year period. As noted above, given the volatility and uncertainty associated with operating in cyclical or commodity-sensitive industries, it is often challenging to set 3-year financial goals. Therefore, as an alternative to setting single 3-year performance goals, some cyclical companies establish 1-year performance goals at the start of each calendar year of the 3-year performance period and also set a 3-year cumulative “wrap-around” goal. For those companies that use relative TSR as a metric, a similar approach can be used: three separate 1-year measurement periods and a single 3-year TSR measurement period (as illustrated below). Awards under this approach are determined using an average of results for the four measurement periods and are settled at the end of year 3 in order to maintain the retention value of the LTI.

When analyzing companies with this design, we find that both proxy advisors and some investors scrutinize the plan as being “short term” in nature. However, as long as there is no evident pay for performance misalignment, this design in and of itself does not seem to lead to an “Against” Say on Pay (SOP) vote recommendation or a low SOP vote result. As always, we recommend a fulsome disclosure of the reasons why such an approach is beneficial to the company and its shareholders.


Economic or commodity-induced cyclicality can impact incentive arrangements in a meaningful way. Contemporary market data can provide meaningful insights to companies and their directors on broad industry incentive designs and practices. However, these broadly adopted practices rarely address the problem of compensation extremes inherent in highly cyclical companies. We find the implementation of one or more of the approaches highlighted above begins to mitigate these extreme incentive outcomes. Rarely will the approaches above lead to situations where incentives are paid out at or above target when company performance is below expectations. This situation is more likely due to the establishment of performance goals that fail to reflect growth and execution of business strategies. For companies who have contemplated their unique situation and adopted some of the methodologies above, the result is a highly customized incentive approach that leads to a motivated and engaged executive team.

General questions about this Viewpoint can be directed to Steve Pakela ( or Jim Dickinson (

Featured Viewpoint

"Everything Should Be On The Table"

It’s been said before in our business lifetimes – in 1987, 1990, 2000, 2001, and 2008 – that “urgent action needs to be taken to address the morale and continued motivation of executives and employees in a time of crisis.” In each case, though with different recovery times, the economic shock and downturn ultimately abated, and most companies and their employees found themselves on solid ground again.

This one feels different. A black swan pandemic suddenly sweeping the globe, a financial market reaction so severe as to be described as “violent,” and a looming recession triggered by strategies necessary to flatten the coronavirus curve have all combined to create a crisis unprecedented in modern times.

Hundreds of thousands of people have contracted COVID-19, and a significant number will die. We are acutely aware of the trillions of dollars evaporating and the worries of employees and retirees. We all know service workers and retailers who, along with millions of people in the energy, manufacturing, and travel industries, may soon be unemployed as businesses of all sizes struggle with lost revenue and liquidity issues. Whether we’re executive compensation consultants, compensation committee members, senior executives, or human resources professionals, we all must consider these larger societal issues and support federal, state, and local government responses as we reexamine rewards program effectiveness and changes in this trying time.

Of course, Pay Governance’s domain expertise is compensation consulting with a particular focus on executives and boards of directors. Concerning executive compensation, two things make this crisis different from those in the past: the timing of events and the rigidity of Say on Pay protocols.

Timing. This crisis has been no September or October surprise like several of the last economic shocks. In those instances, companies with calendar-fiscal years were able to adjust budgets, forecasts, and performance goals to economic uncertainties, and many assessed the optimal use of long-term incentive vehicles to be used in the following year. Indeed, some companies found it necessary to take drastic measures to control compensation expense, conserve shares, and ensure sufficient flexibility for awards in future years, but calendar-year companies generally had more lead time to develop reward strategies for a changed environment. Fast-forward to 2020: most calendar-year companies have been hit with this crisis after goal-based annual and long-term incentives (LTI) were approved and grants were made. Even companies that presented incentive plan targets and objectives for approval in mid-March tended to rely on Board-approved budgets ratified in January. As one CEO told their Compensation Committee on Friday morning, “there’s no chance of our hitting these goals.” Goals were nonetheless approved.

Say on Pay Protocols. Say on Pay wasn't legislated in 2008, let alone the shift toward the homogenized incentive approaches that many companies have implemented to comply with the preferences of shareholder advisory firms and governance reviewers at large institutional shareholders. Goal-based, formulaic, and fully disclosed annual incentive plans and three-year performance share unit / performance cash plans now dominate executive reward systems at most companies. In fact, it’s common for CEOs to have 70% or more of their total direct compensation tied to how well companies perform against pre-set goals that emanate from a budget or strategic plan. If discretion exists, its impact has generally been modest, either by design or in application — perhaps just 10-20% of an executive’s annual incentive award. Some find the use of non-GAAP metrics and exceptions in determining awards to be suspicious. But, the rigor upon which today’s incentive plans were built did not anticipate the extreme volatility of the current crisis.

So, what should be done?

In Pay Governance’s view, everything should be on the table. But as with any well-set table, the dishes need not be handled immediately — with one exception. Every company should assess whether its compensation committee can exercise its business judgment to address current conditions should they continue. Some companies may take comfort in administrative powers that allow the compensation committee to unilaterally assess performance and determine incentive plan results. Others may wish to go further, adding into the meeting minutes or even including in a Compensation Discussion & Analysis (CD&A) disclosure that “the Committee may consider the effect of the global pandemic and other linked economic and environmental pressures that may negatively impact results.” Consider the adage that people work harder during times of crisis, even if circumstances and shared sacrifice make it challenging to fully recognize those efforts through remuneration.

What else should we have on the table? Each company’s circumstances will be different, but all should be cognizant that any executive reward solutions must be considered in the context of the pain being felt by shareholders, employees, customers, and society in general. At its essence, what remains on the table will be determined by how well the executive compensation programs that matured during the 11-year bull market can now endure evolving business priorities, transformed operating environments, reduced confidence in forward goal-setting, volatile stock market performance, and workforce demoralization.

Without being prescriptive, here are some initial considerations that Pay Governance Viewpoints, blog posts, and other communications will address in greater detail in the coming weeks.

1. The Exercise of Discretion. Certainly, any quantification of the global pandemic’s effect should be compared to the financial and non-financial goals established before anyone knew COVID-19 would become the subject of daily headlines. Such an approach will be somewhat more feasible for non-calendar-year companies that found themselves well into their fiscal years before the pandemic occurred. Some compensation committees may wish to consider their management’s 2020 actions to ensure business continuity and long-term sustainability in evaluating performance in a holistic manner. Committees would also be well-advised to consider human resources program changes and any employee actions taken in 2020 when deciding management pay. Acknowledging the effects on employees, customers, and those less fortunate in our communities has rarely been more important.

2. Addressing Mid-Stream Incentive Plans. Tax deductibility rules underlying 162(m) required goals to be set within 90 days of a plan cycle’s inception, but these rules no longer apply. Below are a variety of options for addressing in-process incentive plans, all of which have been used for years by companies in volatile and commodity-based industries:

  • Consider shifting plan weightings away from financial goals and toward non-financial or operational goals that tie to business continuity, sustainability, efficiency, and customer focus.
  • Consider changing individual performance objectives established at the beginning of the year. For companies that already devote a portion of annual incentives to individual objectives, there could be consideration given to amending the original personal performance indicators to include new initiatives and responsibilities that management is undertaking in light of the dramatically changed operating environment.
  • Consider implementing a July – December incentive plan in lieu of, or in addition to, the plan approved at the beginning of the year; resetting current goals may be challenging given the lack of certainty in the current market. In times of crisis, each week may provide greater visibility, so revisiting goals later in the year may be a reasonable approach.

3. Reassessing Equity Grants. Given the current environment, historical equity grant practices may need to be reexamined. What made sense in a bull market may no longer be appropriate today:

  • Consider deciding on a reasonable grant calibration price. When calibrating equity awards, it is sometimes forgotten that stock price is an assumption in any valuation model. For some companies that have not yet made this year’s equity awards, the current stock price may not be feasible for calibrating grants if there are insufficient plan reserves or if the awards would create a higher-than-desirable burn rate. Further, the substantially greater number of shares needed to deliver targeted values today could produce unintended windfalls that may not fully align with the experience of many shareholders. Thus, it could be reasonable to calibrate using an averaging period (10 days, 30 days, 60 days, 90 days, etc.).
  • For companies that traditionally grant equity in the second quarter, consider splitting grants between the second and fourth quarters of 2020. We were all taught about dollar-cost averaging as a prudent method for investing. Granting awards at two different times can help guard against peaks and troughs in a volatile time.
  • Consider whether you are in the rare situation in which it might be viable to move some or all of 2021’s grants into the third or fourth quarter of 2020, with clear communication to participants and in the CD&A that (1) such a strategy was not delivering additional incremental pay over the two-year period and that (2) no LTI awards will be made in the following year. This may be appropriate for companies facing the most serious concerns about employee morale and motivation.

4. Re-think Long-Term Performance Periods. During the Great Recession of 2008, it was difficult for most companies to set viable long-term goals. The concern was as much about overpayment as it was about underpayment based on the goals that would be set three years in advance. Many companies adopted a performance LTI design to change the award basis to the outcomes of three periods in which goals were annually set, measured, and averaged for an initial financial score. In this model, a three-year relative total shareholder return modifier was often used to increase or decrease the averaged financial score within a range, adding a longer-term performance condition to the award. We also saw variations on this theme as some companies adopted two-year performance cycles. As in the last recovery, shorter performance periods may be a temporary solution, with companies reverting to full three-year plans as the environment becomes more predictable.

5. Dealing with Out-of-The-Money Share Awards. While nearly every company has been affected by the crisis, companies in certain industries have lost more than 75% of their value; energy companies have seen a multi-year bear market deteriorate further, and travel and retail companies are experiencing unprecedented challenges. Some potential actions for these organizations include the following:

  • Consider asking executives to surrender stock options that are deeply underwater; this might allow the company to manage dilution levels and provide additional flexibility to make share grants going forward.
  • Consider whether there are LTI award cycles that should be discarded. In these cases, awards could be canceled and new grants made to ensure that the rewards system supports the new objectives that the current environment demands. Given the potential backlash from some shareholders, however, “canceling and replacing” must be approached with care, investor outreach, and balance between employee motivation and the stockholder experience.

                      * * * * * * * * * * * * * * * * * * ** * * * * * * * * * * * * * * * * * * * * * *

Will this be a V-shaped downturn and recovery as it was in 1987, or are we truly experiencing a crisis unforeseen in modern times? No one knows, but all elements of society must do what they can to persevere.

As it relates to executive reward solutions, companies must ensure that compensation committees have the authority to use their business judgment, if they so choose, regarding the global pandemic and its repercussions. For the time being, everything else should be placed on the table — not to be immediately implemented but to be thoughtfully and deliberately considered over the following weeks and months. As solutions are evaluated, companies struggling for business continuity and long-term sustainability must be mindful of the current pain felt by their shareholders, employees, customers, and communities.

Pay Governance will return to these and other potential executive compensation strategies in subsequent Viewpoints, blog posts, and other communications. We will provide weekly updates on our website.


No items found.
No items found.
No items found.

Our Services

We are innovative thinkers with experience in the full range of executive compensation consulting services.

We simplify the complexities of the executive pay process. Our consultants are skilled at helping clients design and administer programs that appeal to reason, hold up under scrutiny, and successfully link executive pay to shareholder value.

View all services