The Advisors' Blog

A new Pay Governance memo (posted with other resources in our “Covid-19” Practice Area) indicates that several compensation practices that were adopted two years ago in response to COVID-19 uncertainty were carried into the 2021 compensation year – and may linger even longer. Here’s an excerpt:

Wider performance curves. Many companies widened their performance curves to minimize the chance of a zero or maximum payout given the uncertainty in setting performance targets. This uncertainty persisted at the beginning of 2021, and a widening of the performance curve allowed companies to retain the basic structure of existing plans but with far less pay/performance leverage.

Semi-annual short-term incentive performance periods. Companies in industries facing the greatest level of uncertainty continued or adopted a “1 st half/2 nd half” short-term incentive plan whereby 6-month goals are set at the beginning and the middle of the performance year to allow for a “resetting” of targets at mid-year based on a more current financial outlook.

Inclusion of qualitative metrics. After unprecedented levels of discretionary adjustments were applied in 2020, some companies added or increased the weighting of qualitative metrics to allow the Compensation Committee to exercise discretion within predefined guardrails (e.g., +/- 20%).

Above target annual incentive plan payouts. Given the limited visibility at the beginning of 2021 amid the continued impact of COVID-19 (e.g., supply chain pressures, “The Great Resignation,” etc.) and 2020 annual incentive plan payouts, the majority of which were below target or zero, many companies may have established relatively conservative financial targets for their 2021 annual incentive plans. Early indications are that above target (or maximum) annual incentive payouts are being reported by companies that were more resilient than forecasted and capitalized on better-than-expected market opportunities in 2021.

So far this season, 80% of Russell 3000 companies are paying annual incentives above target (average of 160% of target), while the remaining 20% of companies have average payouts of 67% of target. Based on year-over-year comparisons for a subset of companies paying 2021 annual incentives above target, 2020 annual incentives were paid out at an average of about 90% of target.

Inclusion of relative total shareholder return (TSR) as a metric in performance share (PSU) plans. Many companies struggled to set annual financial targets, let alone multi-year goals for PSUs. To address this uncertainty, more companies may have added relative TSR to their PSU scorecards, thereby eliminating the need to establish absolute goals at the beginning of the performance cycle.

Replace multi-year goals with multiple annual goals in PSU plans. Another approach companies carried over or adopted is the use of annual goals within PSU programs, with performance measured each year and earned shares distributed on, for a 3-year plan, the third anniversary of the grant. This approach allows companies to maintain a performance-oriented plan while minimizing the risk with 20-20 hindsight of setting overly aggressive or conservative performance targets.

The Pay Governance team goes on to note several pandemic-era practices that don’t appear to be continuing: Base salary reductions, exercise of upward discretion, and modifications of in-flight LTI awards.

– Liz Dunshee