The Advisors' Blog

As compensation committees consider company performance and payout amounts under incentive compensation plans, the question of whether unplanned, discretionary adjustments should be made to address unusual or one-time occurrences will arise for some. Institutional investors often take issue with these adjustments when they result in greater payouts to executives, particularly if the company fails to articulate a strong rationale in its proxy materials.

This Semler Brossy insight reviews recent adjustment practices by Fortune 100 companies specifically focused on the type of discretionary adjustments met with skepticism from institutional investors — those made outside of a pre-defined metric (for example, further adjustments beyond those in the definition of an Adjusted EBITDA metric). Looking at the 2023 proxy statements of 92 Fortune 100 companies, Semler Brossy found that very few made discretionary, upward adjustments:

We found that 22 companies (approximately 24 percent) adjusted incentive payouts or targets. Of those companies, 10 made changes only to Annual Incentive Plans (AIP), 10 adjusted only Long-Term Incentive (LTI) plans, and 2 made changes to both AIP and LTI plans. Of these, the majority (14) were downward adjustments, which tend to receive minimal scrutiny from investors.

Of the eight companies (approximately 9 percent) that made upward adjustments to incentives (six of 12 LTI adjustments, two of 12 AIP adjustments), all displayed a positive total shareholder return (TSR) in the year of adjustment. This is an important distinction: upward adjustments are received more positively when they align with the shareholder experience (e.g., positive TSR) and business outcomes. Additionally, upward adjustments typically were made due to factors outside management’s control such as macroeconomic factors (COVID-19, Ukraine conflict) or tax and accounting regulatory changes. Commentary from ISS on these upward adjustments was generally minimal in most cases (none received “Against” recommendations).

The main factors driving adjustments were “macroeconomic factors, M&A activity, pay vs. performance misalignment, changes to company long-term strategy, and tax-related regulatory changes,” while adjustments were not made for “changes in market supply and demand or competitive landscape, non-tax and accounting regulatory changes, or changes in interest rates.” The insight notes other circumstances that commonly result in adjustment, including “restructuring costs, renegotiation of contract terms, foreign currency fluctuations, asset impairments or write-offs, litigation costs, accelerated items, and impacts from natural disasters.”

In terms of navigating and communicating adjustments to lessen or manage potential criticism, the insight notes the importance of considering upfront whether the adjustments are aligned with the shareholder experience and business outcomes, considering whether the adjustments relate to factors outside management’s control, and, in all cases, clearly articulating a strong rationale. Preferably, companies would set a framework for adjustments before a performance cycle begins and then “have consistent and symmetrical application of the pre-defined guidelines” so that the adjustments occur in both directions and don’t inherently favor management.

– Meredith Ervine