At mid-year, with the economy reopening and workers beginning to emerge from work at home arrangements, now is a good time to examine your incentive compensation plans. Both short-term and long-term incentive compensation plans have been impacted by the pandemic. Some impacts have been very clear and significant while other impacts have been minor or less visible.
The first place to begin the review is by examining the business and understanding how the changes in business conditions have impacted the short and long-term performance measures. There are wide ranging impacts on revenue, expenses, equity and debt pricing, government restrictions and financial aid, changed business models and products. The pandemic has had both negative and positive impact on businesses or parts of businesses with similar impact on performance measures. Human resources and finance leaders, working with the Board, need to work collaboratively to understand these impacts and assess what is known year-to-date and determine what reasonable forecasts and estimates can be made for the balance of the year.
Back in March, Willis Towers Watson conducted a survey: “Revisited: COVID-19’s impact on incentive plans, sales compensation;
The majority of firms (85%) participating in the survey anticipated a negative impact on both business results and incentive compensation plans. The majority of firms did not intend to make any changes to the incentive programs; but rather maintain the plan and goals and apply discretion at year end in determining actual compensation awards.
Some organizations took action early on during the pandemic. Many firms that furloughed staff and / or were significantly impacted eliminated salary increases, reduced executive salaries and eligibility for incentives. Other firms with less dramatic business impact chose a status quo approach maintaining existing compensation arrangements. Given the significant uncertainty, this “wait and see” approach was commonly applied across many industries up and down the capitalization structure. And was supported by many compensation consultants.
Institutional advisory firm ISS acknowledged the potential need for modifications to goals and related performance metrics, however, they suggested enhanced communication and disclosure for shareholders describing the Board’s rationale for changes is important. ISS also discouraged making changes to performance goals mid-cycle. https://www.issgovernance.com/file/policy/active/americas/ISS-Policy-Guidance-for-Impacts-of-the-Coronavirus-Pandemic.pdf
Much has happened during the first half of 2020. However, many firms now have much more information than they did back in March. Management teams and compensation committees armed with this experience and enhanced information should step back and assess year to date business results and performance metrics. This insight may enable firms to adjust 2020 performance goals and metrics to provide clear line of sight for participants.
2020 clearly is a unique year and should be treated as such. Short-term incentives are just that; short-term and should therefore focus on top short-term priorities. Using traditional performance metrics or unique goals established for 2020 remains appropriate, however, including additional metrics assessing performance against the pandemic challenges should also be considered. Beyond expected management of the business leaders at all levels needed to respond and act during this pandemic developing new business operating environments, managing remotely located staffs and reacting to the constantly changing dynamics of the pandemic. Performance under these circumstances and navigating the business through this time should be assessed and included in performance-based incentive awards.
It is appropriate to step back and apply discretionary interpretation of the business results and performance metrics given the volatile business environment experienced in 2020 when determining incentive compensation awards.
When examining long-term incentives multiple award years need to be considered; prior years with the term ending in 2020, 2021 and beyond and new 2020 awards with terms ending in 2023 and beyond. The context should remain long-term capturing performance over multiple years with the expectation of volatility and that over time any short-term impact will be overcome.
As noted earlier, ISS and other institutional advisory firms, are against changes to any performance criteria for existing awards. ISS has however acknowledged the unique situation the pandemic has caused and encourages expanded disclosure to explain any changes or discretion that a compensation committee may apply to existing awards. Most companies are following that guidance and will assess the performance at the end of the award term and review what impact the pandemic has had on the actual award amounts.
For awards with terms ending in 2020, the majority of the performance period is over (greater than 80%). Compensation committees should communicate with the management teams their current thinking on how they will assess the pandemic impact on these awards. You do not want incentives to remain in place without any context for management and thereby encourage management decisions that could lead to potentially harmful long-term impact in order to trigger and drive shorter-term payout of these long-term incentives. Obviously other existing long-term awards would also be affected by these decisions so there are some inherent protections against this potential. Communication between the compensation committee and management teams is an essential component of any compensation program and is even more important today.
Making no changes for existing awards with terms ending 2021 and beyond makes a lot of sense with significant time remaining and provides strong incentives for management teams to drive long-term results. Inevitably the pandemic will have some impact on these awards too and should be considered as final award decisions are made.
Some firms deferred and did not make any new awards in the first quarter of 2020 waiting for some general economic stability and better clarity on the what goals or performance terms to apply to these awards. Continuing to provide long-term incentives as part of the overall total compensation strategy is important, perhaps now more than ever. With better insight into the future and understanding how the pandemic has impacted the business firms are able to confidently establish long-term goals. An added benefit may also be the relative stabilization of equity markets and having avoided awarding oversized amounts of equity when prices were depressed and have inadvertently reduced incentive plan capacity.
While much of this guidance is skewed toward a “wait and see” approach, some firms are taking action on both short and long-term compensation programs. There should be additional considerations when setting or adjusting performance targets, accelerating or delaying equity grants, moving from performance to time-base equity awards, creating plans to address stock options or switching to interim equity grants. These considerations including a review of required disclosures, impact on Section 409A and Section 162(m). Additionally, thorough review of any accounting impacts of these changes will need to be examined.
Communicate . . . Communicate.
It is important to communicate to the participants regardless of what is decided regarding incentive compensation for 2020. Communication to participants is always an important mid-year activity and that is especially true this year. Providing clarity to participants on what is expected, what will be measured and how their performance can influence the award goes a long way to driving desired behavior.
It is critical for clear communication to all stakeholders through enhanced disclosure. Firms should be planful in advance of next year’s proxy season to ensure all decisions are clear and can be explained in a rationale and straight forward manner.