The Advisors' Blog

– Eric Marquardt, Towers Perrin

A new Towers Perrin survey shows that the vast majority of U.S. companies are making multiple adjustments in their pay programs for executives and other employees in response to the deepening economic crisis. Overall, the modifications will mean lower – or no – 2009 salary increases and bonuses for 2008 performance for many U.S. employees, along with reductions in the value of 2009 equity grants for many executives.

The survey was conducted online from January 6th-14th and targeted U.S.-based midsize and large companies. A total of 513 companies participated in the survey. Nearly 65% of the participants had experienced stock price declines of 30% or more in 2008, with 28% down 50% or more.

This survey found that most companies are holding the line on salaries by cutting their 2009 merit increase budgets, freezing salaries or cutting base pay. Merit budgets for the overall survey group averaged 2.4% for most levels, and were lower at 1.9% for executives. When companies that froze or cut salaries were removed from the sample, the budgets grew to nearly 3.0% on average.

Compensation committees are struggling to set incentive plan performance targets in light of 2009 budgeted/planned results that are significantly below 2008 levels, coupled with considerable uncertainly about how quickly the economy will rebound. Almost three-quarters (73%) of the survey respondents say the financial crisis has had an impact on their approach to setting 2009 performance targets under annual incentive plans. The most common considerations among companies reporting changes in their approach to goal-setting are greater use of discretion or judgment in determining awards, setting lower threshold performance levels and greater use of relative performance measures instead of absolute measures (e.g., setting a revenue growth target at 10% above median performance for the industry, rather than a fixed growth rate).

The survey also shows that many companies are rethinking their approach to determining the size of their 2009 long-term incentive grants. Three key elements of a long-term equity award, number of shares, price per share and total grant value are all being examined, both individually and in combination, for potential change. Regardless of methodology, the research indicates these total long-term incentive grant values will decline between 15% and 20% on average. Our recent consulting experiences indicate the decline may be even greater.

A growing number of companies are also wrestling with questions about how to deal with underwater stock options and whether or not to reset performance goals on outstanding awards under long-term performance plans. The survey responses suggest that relatively few companies have fully addressed these issues thus far, although more are beginning to focus on the issue. To date, just over a quarter (26%) of the companies either have addressed underwater options or are currently reviewing the issue. If the market downturn is prolonged, we would expect to see more companies consider the issue of underwater options.

Even fewer of the companies surveyed appear to be moving toward adjusting the performance goals for outstanding cycles under their long-term performance plans to reflect the current business climate. Only a few companies (2%) have recalibrated performance goals or plan to thus far, although 11% of the respondents are now considering such steps. Once again, the longer the market downturn lasts, the more we would expect companies to consider actions like option exchanges to help retain and motivate key talent and recognize some value from the expense associated with past grants.

A strong concern of a majority of companies in the survey was the potential for losing their best performers and those in pivotal roles during this market downturn. The data indicate the more limited dollars available for compensation awards, or adjustments, will go to these individuals through retention awards, bonus payments and individual salary increases, increasing the differential between the best performers and the remainder of the staff.