The Advisors' Blog

Due to the Covid-19 pandemic, some compensation committees had to use their discretion with incentive plans to retain and motivate executives. While investors and proxy advisors seemed to give more leeway to discretionary changes in year one of the pandemic, there’s growing expectation that executive compensation designs should swing back towards pre-pandemic practices – we’ve seen this reflected most recently in ISS’s updated FAQ for pandemic-related pay adjustments. Semler Brossy offers some suggestions for building more resilient compensation programs that can both withstand uncertainty and motivate executives:

– Extended runways for short- and long-term incentives: Semler Brossy suggests that for annual bonuses, compensation committees can consider setting up “longer runways for earning awards by widening the range of outcomes that trigger payouts. This approach allows for greater performance volatility with the opportunity for some payout at lower levels of performance, and a higher bar for maximum payouts.” Compensation committees can also “shift down the payout curve” so executives can still meet their targets and get their bonus during difficult times, but “not receive windfalls if a crisis creates tailwinds.”  For long-term incentives, companies can consider using additional metrics that reflect the company’s long-term strategy, including ESG metrics. In addition, “boards may also include metrics with different time frames, such as four-year terms.”

– Qualitative scorecards for annual bonuses: Companies can increase the impact of non-financial metrics in their executive compensation designs, and scorecards can help objectively frame these non-financial results. These qualitative scorecard metrics “can be strategic (such as boosting market share growth in targeted channels or setting up new businesses), operational (cost management or productivity), ESG-related (especially environmental and social), or some combination of all of these.” Boards will still have to exercise some discretion, but a properly constructed scorecard may be able to clearly connect the dots between executive performance and fair pay.

– Relative metrics in long-term incentives: Semler Brossy notes that “relative metrics, such as market share, total shareholder return, EPS, or ROIC against a defined peer group, can also overcome the problem of external factors” but notes that relative metrics have some drawbacks – including not having a truly comparable peer group.  Committees can also consider “reducing the plan’s weighting of its performance component” as an alternative to using relative metrics, as long as 50%+ of the awards are tied to performance and not tenure.

For compensation committees looking to get a quick refresh on where peers have landed in 2021 with executive compensation designs and practices, here’s also Farient’s handy Covid tracker – it tracks executive and director compensation for the Russell 3000 (currently as of July 31, 2021).

– Emily Sacks-Wilner