Compensation in Volatile Times

Observations for the week of May 29, 2020

Recent weeks have seen a sharp decline in the number of new companies disclosing reductions to executive salaries and board cash retainers. COVID-19 has impacted sectors in meaningfully different ways, with some companies continuing to reel from the rapid economic downturn while others have already experienced stock price recoveries. For those harder-hit organizations, we have seen companies grapple with balancing pay for performance with seeking to recognize overall company stewardship in a difficult environment.

Further, this past week, companies have taken the time to consider several potential actions in their pay programs:

  • Despite above-target performance, some non-calendar year companies are opting to apply negative discretion to bonus plans to position payouts at or below target opportunities. The decision to decrease bonus amounts may be part of broader austerity measures enacted at the onset of the COVID-19 pandemic as well as a desire to demonstrate sensitivity in a challenging time. Conversely, there has been little discussion by companies this week on applying positive discretion to FY2020 bonus plans, although such discretion is likely to be applied by many companies later this year.
  • Some companies are contemplating increasing the weight of strategic measures relative to financial measures in existing or go-forward bonus plans. These strategic measures may be intended to recognize efforts toward ensuring resiliency (such as increased market share, among others) by rewarding demonstrated success in navigating challenging macroeconomic conditions and success in placing companies in stronger positions for the future.
  • Companies continue to contemplate approaches to existing long-term plans. One possibility that continues to be discussed is the complete or partial replacement of future performance-based share plans with time-based restricted shares at a meaningful discount on the grant value, despite the possibility that such adjustments could be met with an adverse reaction from investors and proxy advisors.

Observations for the week of May 22, 2020

Salaries:

  • To date we have seen over 560 companies reduce executive salaries and over 350 companies reduce director cash retainers since the onset of the COVID-19 pandemic, most prominently in severely affected industries (e.g., retail, REITs, travel, leisure, etc.).
  • Given that executive salary reductions are voluntary, the total number of companies reducing executive and/or broad-based salaries may be larger than reported. In addition, since many new executive pay actions were disclosed in recent 10-Q filings as opposed to contemporaneous 8-K filings, it remains unclear whether or not the rate of executive pay reductions is steadily increasing, plateauing, or reflective of actions taken in earlier weeks/months.
  • Executive salary reductions have also been viewed by some companies more as an indicator of employee and shareholder/stakeholder solidarity, rather than as a cash preservation tool or effort to preserve employment of the broader employee population given the relatively modest impact executive salaries have on overall company financials.
  • In more severe scenarios, some companies have made salary reductions permanent due to projected long-term contraction in company business.
  • In some instances, we have seen executives donate their salaries to several charities, including COVID-19 relief funds.

Annual Bonuses:

  • Some companies are choosing to delay FY19 bonus payouts to executives as a cash preservation strategy.

Long-Term Incentives:

  • Companies continue to take a cautious approach to assessing any adjustment to existing long-term plans, understanding the tradeoffs between applying discretion and/or redesigning plans with the constraint of contemporaneous disclosure of changes requested by proxy advisors. Further, there is an awareness that adjustments could be met with an adverse reaction from investors and proxy advisors.
  • Some companies are contemplating design changes to future LTIP performance cycles (i.e., FY2021), recognizing that major and significant company milestones tied to existing performance cycles would have been achieved or were nearly achieved immediately prior to the COVID-19 pandemic. These changes would not act as a replacement of existing cycles, but rather provide a potential long-term upside opportunity on a go-forward basis.


Observations for the week of May 15, 2020

To date we have seen over 480 companies reduce executive salaries and over 300 companies reduce director cash retainers since the onset of the COVID-19 pandemic, most commonly in severely affected industries (e.g., retail, REITs, travel, leisure, etc.). However, this week we have seen a decline in the number of new companies disclosing reductions. We do note that disclosure of such actions is often voluntary, so the figures being tracked may actually understate the prevalence of pandemic-related executive and director compensation reductions.

As the second fiscal quarter progresses, companies are taking time to discuss the treatment of existing annual bonus and long-term incentive cycles:

  • While there continues to be limited disclosure and known cases of annual goal resets, boards are increasingly contemplating the use of discretion for determining FY2020 bonus plan payouts, while recognizing the challenging balance between rewarding for performance and ensuring alignment with shareholder/stakeholder interests. To that end, companies are beginning to discuss building frameworks and guiding principles for the application of discretion at year-end. Such principles may be intended to recognize efforts toward ensuring resiliency – both in terms of business and employees – during these times of high market uncertainty.
  • A limited number of severely affected companies are choosing to calibrate equity awards for management and the board at a stock price that is higher than the current value, recognizing that current stock price levels may be overly depressed as result of market uncertainty and may potentially experience a sharp increase in the near future. The decision to increase the grant share price has also been paired with the need to mitigate share usage in existing equity plan reserves.
  • Companies continue to discuss the possibility of granting options in lieu of other existing equity vehicles for their long-term incentive plans. However, this strategy has seen tepid support, as companies recognize the balance between the motivational value from the potential upside opportunity provided by options today and the possibility of being viewed negatively by shareholders/stakeholders as being overly opportunistic.

Observations for the week of May 8, 2020

Salaries:

  • Executive salary cuts and board cash retainers continue to occur most prominently in severely affected industries (e.g., retail, REITs, travel, leisure, etc.), although some companies in less-affected sectors have taken salary actions.
  • Companies have also discussed and tabled salary cuts as a potential future action pending changes in the market or their financial situation.
  • Executive salary reductions have also been viewed by some companies more as an indicator of employee and shareholder/stakeholder solidarity, rather than as a cash preservation tool given the relatively modest impact on overall financials. Severely affected companies that choose to cut salaries specifically as a method of cash preservation have often taken additional austerity measures such as bonus cuts, broader employee salary cuts, suspending 401(k) matches, etc.
  • Conversely, some companies have provided additional benefits to front-line workers, including one-time bonuses, temporary pay increases, and relief funds covering telemedicine, childcare, etc.

Annual Bonuses:

  • While many companies are continuing to take a “wait-and-see approach” toward incentive plan adjustments for the current year, discussions surrounding when and how goals could be reset are beginning to take place, especially as Q3 2020 approaches, but tempered by the requirement for disclosure of such changes by the proxy advisory firms.
  • Disclosure on annual goal resets have been limited, and are have been largely used by only micro-cap or small cap companies at this point.
  • A few companies are discussing splitting their current annual incentive year into two performance cycles, each with a prorated target incentive.

Long-Term Incentives:

  • Companies continue to take a cautious approach to assessing any adjustment to existing long-term plans, understanding the tradeoffs between applying discretion and/or redesigning plans with the constraint of contemporaneous disclosure of changes requested by proxy advisors and shareholder perceptions.
  • Similar to changes in annual bonus performance periods, some companies have discussed splitting existing long-term performance periods into multiple measurement periods and applying performance to prorated target awards.
  • However, there is limited discussion for changes in plan designs that are based on relative metrics, such as relative TSR, given the “self-correcting” nature of such metrics.

Observations for the week of May 1, 2020

We continue to see executive salary reductions (now more than 400 companies) and director cash retainer cuts (more than 225 companies) most commonly in severely affected industries (e.g., retail, REITs, travel, leisure, etc.), although companies in less-affected sectors have also taken salary actions. We also have found strong linkage between companies that have reduced executive salaries and board cash retainers with companies that have announced broad-based employee actions such as furloughs, staff reductions, and broad-based salary reductions. Most of these companies have not indicated a definitive end date to the reductions, but rather intend on reevaluating salaries and retainer reductions when greater clarity and stability emerges in the financial outlook.

Further, this past week, companies have also taken the time to consider several potential actions in their pay programs in response to ongoing macroeconomic uncertainty:

  • Companies are continuing a “wait-and-see approach” toward incentive plan adjustments or goal setting for the current year for both annual and long-term plans.
  • Some companies have also considered the use of a more balanced annual incentive scorecard, including the introduction of company-wide strategic goals to reflect broader organization priorities. Financial goals, however, would still account for the majority of the annual incentive plan scorecard.
  • Boards are increasingly contemplating the use of discretion for determining FY2020 bonus plan payouts, while recognizing the challenging balance between rewarding for performance and alignment with shareholder/stakeholder interests.
  • For long-term incentives, some companies are considering adjusting the mix of 2020 equity grants to decrease the proportion of performance shares in exchange for a higher proportion of time-based equity awards. However, companies may be hesitant about the introduction of absolute stock price leveraged equity vehicles not recently used, such as stock options, given the potential external perceptions of “market-timing” and desire for contemporaneous disclosure from proxy advisors of such significant design changes.

Observations for the week of April 24, 2020

Salaries:

  • Executive salary cuts continue to occur most prominently in severely affected industries (e.g., retail, REITs, travel, leisure, etc.), although some companies in less-affected sectors have taken salary actions.

Annual Bonuses:

  • Most companies are continuing to take a “wait-and-see approach” toward incentive plan adjustments for the current year.
  • Limited discussion among companies thus far for introduction of ESG (environmental, social, and governance) metrics if not already incorporated into existing incentive plans. However, ESG momentum should accelerate once business and operations begin to normalize.

Long-Term Incentives:

  • Companies continue to take a cautious approach to assessing any adjustment to existing long-term plans.
  • Several strategies have been considered for 2020 long-term incentives, including:

             – Delaying goal-setting until summer 2020 or when there is more clarity regarding financial outlook.

             – Replacing PSUs with performance cash with a discount to reflect lower “currency” risk

            – Replacing PSUs with RSUs, with grant values reduced to reflect lower risk of time-based equity.

            – Reducing threshold payout opportunities to ensure downside protection, with some companies leaving maximum opportunities unchanged and others reducing maximum payouts to preserve the symmetry of the plan.

Director Compensation:

  • Cuts in director cash retainers have generally occurred contemporaneously with executive management salary cuts.
  • Many companies are choosing not to make changes in how the calibrate director equity awards, recognizing:

             – Historical differences in prices used for director equity awards versus management equity grants during years of stock price volatility.

Compensation Disclosure Considerations:

  • Proxy advisors have voiced a strong desire for contemporaneous disclosures (i.e. 8-K) of any changes to incentive plans and targets, especially in instances where annual goals are lowered or are shifted towards more strategic/non-financial goals.
  • However, in many instances, companies have chosen not to release compensation changes in the form of 8-Ks, but rather through media press releases.

Observations for the week of April 17, 2020

We continue to see executive salary reductions (more than 350 companies) and director cash retainer cuts (more than 175 companies) most prominently in severely affected industries (e.g., retail, REITs, travel, leisure, etc.), although companies in less-affected sectors have also taken salary actions, often to demonstrate empathy with affected communities, employees, and customers. Further, this past week, companies have taken time to contemplate and evaluate several actions in response to macroeconomic uncertainty:

  • Continuing a “wait-and-see approach” toward incentive plan adjustments or goal setting for the current year for both annual and long-term plans.
  • For companies that have reduced salaries, there appears to be a split practice for determining the basis of annual bonus awards, with companies considering one of three bases: (i) pre-reduction base salaries, (ii) post-reduction base salaries, or (iii) total salaries earned for 2020. Caution should be exercised in using pre-reduction salaries as the basis for bonus awards in order to avoid the problematic pay practice of payouts appearing to be significantly above “target” if performance criteria are even partially achieved. Regardless, governing plan documents need to be reviewed to assess potential stipulations.
  • Exercising board discretion for FY2020 bonus plan payouts to account for the COVID-19 impact, recognizing the challenge that applying positive discretion for executives in this current environment will likely be viewed negatively by shareholders and other stakeholders. Further, companies continue to adopt or contemplate adding pandemics to approved lists of incentive metric adjustments.
  • Remixing 2020 equity grants to decrease the proportion of performance shares in exchange for a higher proportion of time-based equity awards, such as restricted stock units or options. In executing such a shift, companies are evaluating how much of a discount should be applied to adjust for a re-weighting toward “lower risk” vehicles. However, many companies are considering the shift from performance- to time-based equity to be temporary, with performance share usage likely returning to prior levels once there is more clarity in the market.

Observations for the week of April 10, 2020

Salaries:

  • Executive salary cuts continue to occur most prominently in severely affected industries (e.g., retail, REITs, travel, leisure, etc.), although some companies in less-affected sectors have taken salary actions.
  • In order to avoid furloughs and/or employee layoffs, some companies have begun to consider broad-based salary cuts. These cuts may be uniform across all employees or tiered towards higher earners.

Annual Bonuses:

  • Most companies are continuing to take a “wait-and-see approach” toward incentive plan adjustments for the current year.
  • This week, proxy advisors voiced a strong desire for contemporaneous disclosures (i.e. 8-K) of any changes to incentive plans and targets, especially in instances where annual goals are lowered or are shifted towards more strategic/non-financial goals. Proxy advisors will expect any such disclosures to include justification for the changes made.
  • More heavily impacted companies have considered adjusting individual performance goals to focus on business recovery and improvement initiatives, with overall payouts limited to below-target/threshold. Existing financial goals, however, would not be changed (and would likely result in significantly lower/no payouts).

Long-Term Incentives:

  • Companies continue to take a measured approach to assessing any adjustment to existing long-term plans.
  • Proxy advisors have warned against changing LTI plans that are in-process, indicating that re-setting performance goals could be met with severe criticism.
  • While many companies currently use three, 1-year performance periods in their long-term plans, proxy advisors may be critical of companies that truncate future performance periods without a compelling rationale.

Director Compensation:

  • Cuts in director cash retainers continue to in severely impacted industries as well as more broadly as boards seek to show solidarity with management.
  • For calendar-year companies, some boards have discussed calibrating director equity retainers using the same share price used for executive equity grants in the first quarter of the year in order to address sensitivities surrounding the number of shares received during a sudden and rapid stock price decline.

Other Considerations:

  • Companies continue to express caution on retention awards or large increases in pay at this point, understanding that sensitivity to affected shareholders and other stakeholders is critical.

Observations for the week of April 3, 2020

Salaries:

  • Executive salary cuts and director retainer cuts are much more commonplace across all industries. Highest concentration of salary reductions are in the retail, hospitality, airline, equity REIT, and oil & gas related industries that have experienced the greatest impact from the crisis.
  • There are far fewer executive salary and director retainer reductions at less-impacted companies, although some are considering actions to demonstrate empathy with affected stakeholders.

Annual Bonuses:

  • Disclosures on adjustments and plan changes to current year annual incentive plans have been very limited, continuing the general “wait-and-see” approach among most companies (and calendar/fiscal year companies in particular).

Long-Term Incentives:

  • A very limited number of companies are considering or have conducted option repricing; for those that pursue repricing, we expect the designs of any option exchanges to adhere to good compensation governance principles to help ensure shareholder approval.
  • Companies are deferring discussion of changes to existing share-based long-term incentive plans until there is greater visibility to future performance and prospects.

Other Considerations:

  • Some companies are freezing 401(k) matching contributions despite no employee furloughs, highlighting the difficult choices that are facing organizations.
  • We have seen an increase in companies including share requests for 2020 proxies. In many of these cases, companies fast-forwarded the timeline of future share requests to 2020 given generally strong performance in 2019.
  • Although recent literature highlights the increased use of ESG (Environmental, Social, and Governance) metrics for incentive plans, proxy advisors may have a negative perception of any actions that re-weight incentive goals to de-emphasize financial/operational performance in exchange for a higher weighting on ESG.

Observations for the week of March 27, 2020

Salaries:

  • For heavily impacted industries, we have seen an increase in the prevalence of executive salary reductions, along with some instances of reductions in director retainers. "Everything Should Be On The Table".
  • Some non-calendar fiscal year companies are considering salary freezes for senior executives, but continued merit increases for the broader employee population (in less impacted companies).

Annual Bonuses:

  • Most calendar fiscal year companies are taking a “wait-and-see” approach and are not making bonus plan design/goal changes due to uncertainty in the market – for now. Further, there is a desire to avoid multiple plan resets in 2020, and companies want to ensure there is greater visibility to probable performance before re-setting plans or adopting partial-year incentive plans.
  • For companies that haven’t started new plans, we have seen some consideration of adopting plans that have partial-year performance periods. We also expect to see wider-than-typical performance zones that contemplate greater uncertainty.
  • Some companies are considering setting maximum bonus payout levels at target given staffing reductions and COVID-19’s adverse effect on shareholders and key stakeholders, regardless of company performance.

Long-Term Incentives:

  • As of now, it is still too early to determine if there will be any changes to director equity awards that are typically granted in April, May, and June. Based on the share price declines, however, there may be consideration to calibrating grants using a historical average price rather than a spot price.
  • At this point, companies are largely keeping outstanding performance share cycles intact as it may be premature to consider adjusting goals or using discretion (we note that the resetting of long-term performance goals has often been viewed as a highly problematic pay practice by proxy advisors).
  • There have been some initial discussions about the implementation of a total shareholder return “governor” cap at target in companies that have experienced meaningfully negative absolute total shareholder return.

Other Considerations:

  • Companies are expressing caution on consideration of retention awards to senior management at this point.

Observations for the week of March 20, 2020

Salaries:

  • Selected companies (hardest hit industries) are implementing temporary salary cuts to senior executives to signal solidarity with employees.
  • Cuts may last 3 months with potential for reauthorization, or for the rest of the year.

Annual Bonuses:

  • For plans about to be implemented, shifting from annual to two 6-month plan periods, re-evaluating goals in anticipation of lower earnings for the second period.
  • Considering introduction of relative metrics given difficulty of setting goals.
  • Common expectation for the need to exercise discretion at year-end.

Long-Term Incentives:

  • Broadening basis of stock grants to 30-, 60-, or 180- day price averages to determine shares based on value-denominated grants.
  • Balancing consideration of number of shares granted in 2019 and shares calculated at lower price in 2020.
  • Deferring upcoming PSU grants and delay setting goals to lessen uncertainty.
  • Consider capping gains at set percent of target value.
  • Exercise Committee discretion.

Compensation in Volatile Times