The Advisors' Blog

– Liz Dunshee

I blogged earlier this week that COVID-related pay decisions will dominate the upcoming proxy season. Unfortunately, the business environment remains uncertain and companies must examine whether previously-adopted metrics remain appropriate. In our “Covid-19″ Practice Area, we’ve posted this chart from Winston & Strawn that catalogues companies that have disclosed changes to annual or long-term incentives due to the pandemic and resulting economic uncertainty. This 9-page Aon memo outlines a framework for deciding whether – and how – to change pay programs. Here’s an excerpt:

Now that we are almost six months into dealing with the pandemic, it’s becoming clear that compensation committees will need to use far more discretion than they have in the past. Given scrutiny over executive compensation is far greater in the era of say-on-pay voting than it was a decade ago, compensation committees will want to review performance objectively and rely more on measured judgement than pure discretion to make compensation decisions.

Relevant internal stakeholders — including compensation committees, executives, HR and rewards leaders — should begin the process by thinking through these types of questions:

▪ How, and how much, should executives and employees be rewarded for results delivered during an unprecedented crisis?
▪ How do we measure performance when performance measures or goals established early in the year don’t translate to the long-term health of the company given the current environment?
▪ How do we help compensation committees move from formulaic to measured judgement?
▪ What should we expect in terms of shareholders’ and proxy advisory firms’ reactions?

To ensure companies are prepared in the coming months to make compensation decisions with measured judgement that withstands intense scrutiny, now is the time to start establishing a process with a solid framework.

Keep in mind that while mid-year adjustments and discretionary awards might be necessary to motivate executives during a challenging time, they also contribute to skepticism of incentive pay programs. This Economist article discusses the growing contingent who are questioning whether “pay-for-performance” is working (a phenomenon I’ve blogged about a few times over the last couple of years). Here’s an excerpt:

In 2017 MSCI, a research firm, published its analysis of realised chief-executive pay between 2007 and 2016 at more than 400 big public American firms. At more than three-fifths of the firms, it showed no correlation with ten-year total returns. Some firms overpaid lousy bosses; others underpaid successful ones. Pay-for-performance “may be broken”, MSCI concluded. A recent paper co-authored by Lucas Davis of the Haas School of Business finds “strong evidence” that bosses of energy firms see clear pay gains when stock valuations rise as a result of an oil-price spike which they have no way to influence.

A fresh analysis by Equilar, commissioned by CalPERS, a big Californian public pension fund, identifies similar trends. It looked at the past five years of realised CEO pay for most firms in the Russell 3000 and compared this with the companies’ total returns. The bosses in the top pay quartile made twelve times what those in the bottom quartile did, but produced financial returns only twice as good. The bosses in the second-lowest pay quartile made nearly three times as much as those in the bottom quartile, even though their firms’ total returns were actually worse. “There is no evidence that boards can tell in advance who is a talented CEO,” sums up Simiso Nzima of CalPERS.