COVID-19 is creating plenty of challenges for executive compensation programs. Here are two recent memos, one from Semler Brossy and another from PwC, that discuss some of the implications and approaches companies can take to address the effect of COVID-19 on compensation plans.
– Semler Brossy’s memo notes that the right approach to addressing COVID-19 and executive compensation programs will vary across companies depending on where a company is at in terms of business impact from the virus, incentive plan design and its compensation cycle. The memo then discusses four primary approaches companies have followed to address the effect of COVID-19 on executive compensation programs.
– PwC’s memo provides an overview, focused primarily on possible use of discretion in setting performance targets and when determining incentive awards. The memo provides a list of steps for compensation committees to consider in light of the fast-moving COVID-19 developments. The memo also touches on the issue of possible increased scrutiny if discretion is used and satisfaction of executive stock ownership targets in light of falling share prices.
We’ve blogged before about ISS’ new EVA metrics that are being used in this year’s pay-for-performance analysis. Hopefully comp committees are looking at EVA metrics to understand how or if use of the metrics will affect a company’s P4P analysis. And, this Jones Day blog points out that depending on a company’s strategy, EVA may end up hurting its P4P analysis and may reward short-termism.
Perhaps more importantly, are EVA-based metrics really a better measure of a company’s performance? One problematic aspect is that EVA-based measurements can reward CEOs of turnaround companies even if the expected upswings in the companies’ performance have not yet been achieved. The use of EVA can also penalize companies that are investing heavily in the future but not yet realizing the fruits of those investments. Accordingly, the use of EVA to measure performance could incentivize management to pursue projects with quick returns, rather than the multi-year investments that a company may actually need to make in order to realize long-term, sustainable growth.
For this reason, we believe that ISS’s use of EVA may actually promote short-termism, rather than the long-term outlook necessary for sustainable value creation—and for a focus on the sustainability issues that are critical in the current environment.
The memo says companies should review EVA information that was included in ISS’s 2019 proxy voting report and compute similar metrics for 2020. Based on that analysis, a company should consider whether to prepare any disclosure for inclusion in its 2020 proxy statement in anticipation of ISS’s assessment.
Liz blogged last fall about how executive pay was getting more political as bills were introduced in Congress aiming to get companies with high pay ratios to pay higher taxes. Now, news reports say California lawmakers are considering a similar idea – under California SB 37 companies making over $10 million would pay a higher California tax rate with the actual rate determined based on the ratio of CEO pay to average worker pay.
It doesn’t sound like the California bill is expected to get much traction, it’s currently stuck in California’s Senate Rules Committee. It will be interesting to see if other states or cities start putting similar bills up for consideration.
Liz blogged earlier this year about how clawback policies may be turning restatements into a rare species. Recently I came across this memo discussing why, even with a restatement, we don’t seem to read a lot about actual clawbacks when the vast majority of companies in the S&P 500 have adopted clawback policies. Perhaps clawback policies just need more teeth and for a company wanting to strengthen its clawback policy, the memo includes suggestions.
The memo references a study of 242 companies with voluntary clawback policies that later restated earnings and the study found only 3 of the companies disclosed activation of a clawback in their proxy statements. It says one of the reasons is that clawback policies leave a lot of unanswered questions so the question of a clawback is left to the board’s determination. Suggestions for strengthening a clawback policy include:
– List the actual names of the executives covered by the policy in the annual proxy statement
– Identify a specific time period describing how far back in time the company can go to claw back incentive pay from covered executives
– Detail the types of compensation the company can recoup
– Exclude words that give the board of directors discretion to enforce a clawback (for example, don’t use language such as “the board has an option to recoup if an executive is proven to have engaged in misconduct”)
– Specify a meaningful amount (taking the executives’ total compensation into account) that’s subject to clawback
Another factor noted in the memo is that the board should have a deadline to enforce the policy and activate a clawback. The memo includes marked sample clawback policy language to help make a clawback policy stronger.
What was perhaps more eye opening was the memo’s reference to a research paper suggesting companies that voluntarily adopt clawback policies are more likely to issue pessimistic earnings guidance, which leads to lower investment returns for stockholders compared to stockholders of companies without clawback policies.
A recent Harvard Business Review article discusses a new compensation plan design for companies encountering sector or industry disruption – and, it seems like this includes more companies every day. The author, Seymour Burchman of Semler Brossy, says that companies need to look at comp plan design because most “executives are essentially tied to a structure that supports only incremental change versus radical transformation.”
Designing a comp plan to support long-term transformation can be a challenge but the author says it’s not insurmountable.
To do this, the author says you should design your incentive plans around mission, rather than strategy, attaching targets and incentive payouts to those goals in a disciplined way. Your company’s mission offers consistent, yet flexible, guidance for long-term transformation, agile course corrections, and the building, operation, and constant reshaping of stakeholder-rich ecosystems.
It’s up to boards to narrow the focus to two to three mission-based measures that will serve as the basis for a long-term incentive plan, and then to set goals based on those measures. The goals need to be both specific enough to guide actions and measurable enough to show performance improvement. To complement the long-term goals, directors should set annual incentive objectives as intermediate milestones to gauge progress toward long-term outcomes.
With concern about COVID-19, we’ve had questions about what companies are doing when setting performance targets for incentive comp. This blog from Willis Towers Watson discusses implications of COVID-19 for incentive plan goals.
As noted in the blog, many companies have either just set their short-term and long-term incentive goals or they’re trying to figure out how to set the goals in the midst of all the uncertainty. The blog says that as the firm has worked with its clients, some have discussed or decided on the following actions:
– Delaying metric and goal setting until Q2 (this has been the prevailing response so far as it’s viewed as less disruptive to existing incentive plans)
I blogged earlier in the year about how, this year, ESG is one area of focus for comp committees. Depending on your industry and where your company is at with identifying and reporting ESG metrics, the thought of tying ESG to executive comp can seem daunting. That’s why it’s nice to see this Semler Brossy blog discussing “thought starters” for boards when thinking about integrating ESG with executive comp.
The blog discusses approaches for integrating ESG into annual incentive plans as well as long-term incentive plans. As noted in the blog, integrating ESG into a long-term plan can seem most intuitive given the long timeframe of most ESG issues. Given that most companies have several important long-term goals, the blog suggests creating a long-term “scorecard” so that too much value isn’t placed on a single goal. Here’s some of what it had to say about that:
PepsiCo has five 2025 goals related to water use in high-risk water areas; target payout could be tied to achieving all five, with an above-target payout or early vesting if several goals are met early. A long-term “scorecard” could also be devised by setting a different long-term ESG goal each year, eventually focusing executives on achieving two or three material goals at any given point and allowing a natural evolution of long-term goals.
Arrangement for payments upon a change-in-control continue to draw scrutiny from many, including proxy advisors and activist shareholders and if excessive, they often invite public criticism. Here’s a report from Alvarez & Marsal, with commentary from Equilar, that might help boards and comp committees analyze and structure executive change-in-control arrangements to demonstrate accountability.
The report analyzes executive change-in-control arrangements at 200 U.S. publicly-traded companies (top 20 companies based on market cap in 10 different sectors). Among other things, the report provides insight into the prevalence of double-trigger vesting provisions, excise tax gross-ups, change-in-control severance multiples and the breakdown of change-in-control benefit values by industry sector.
With a depressed company stock price, senior officers at AMC Entertainment Holdings recently agreed to a new compensation approach for its executives. The approach involves a reduction in agreed-upon pay in exchange for an equivalent out-of-the-money share grant. AMC’s stock price has been in decline for several years likely at least partially attributable to a decline in movie theater viewership.
AMC’s press release announcing the new executive comp program says cash salaries of senior officers will be reduced by 15% and their target cash bonus opportunity will also be reduced by 15%. Here’s how the reduction will work:
This compensation decrease will be split into thirds and applied evenly as reductions across each of three categories: one-third lowering combined cash salary & cash bonus, one-third lowering at-market restricted share equivalent grant amounts that time vest and one-third lowering at-market performance share equivalent grant amounts that vest based on performance. Importantly, these sacrifices in lowered cash salary and cash bonus, as well as in lowered restricted share equivalent grant and performance share equivalent grant levels, will continue at the new lower totals in each of the coming three years.
To potentially offset the pay reduction, the officers will receive a one-time grant of AMC share equivalents that, with certain exceptions, has a 3-year time vesting provision and requires AMC’s stock price to rise materially in order for vesting to occur. Initial vesting will not occur until AMC’s stock price rises to 102% of the grant date price and future vesting goes up from there. Here’s how the vesting will work:
This share equivalent grant is split into six equal tranches. Initial vesting will not occur until the AMC share price recovers on a 20-day VWAP basis to $12 per share, a 102% premium to yesterday’s market close. The second tranche will vest only when the AMC share price rises to $16, a 170% premium. The third tranche vests at $20, a 237% premium. The subsequent tranches vest at $24, $28 and $32, premiums of 305%, 372%, and 440% respectively.
The press release says certain officers are excepted from the program, such as officers that are expected to retire prior to the 3-year time vesting requirement. All other officers voluntarily signed-on to the program signaling they believe the company’s stock is undervalued.
Will be interesting to see how this plays out. For companies with an undervalued stock price, I can see how some might find the approach enticing presuming risk mitigation is factored in so that compensation-related risks aren’t inadvertently raised.