July 29, 2020
July 29, 2020
The social and public health crises that have defined the first half of the year have changed the rules of business and expectations of corporate leadership. Consequently, how compensation committees are now approaching their work and rethinking executive pay practices was the focus of NACD’s first virtual Leading Minds of Compensation peer exchange. Christopher Y. Clark, senior director of partner relations and publisher of NACD Directorship magazine, and Lindsey Baker, associate director of partner relations, moderated the event, which featured the following panelists: Robin Ferracone, founder and CEO of Farient Advisors and director of Trupanion; John Fletcher, director of Repro Med Systems, Axcelis Technologies, ClearPoint Neuro, and Metabolon; Brian Lane, partner at Pay Governance; Wendy Lane, director of Al-Dabbagh Group, Lane Holdings, and Willis Towers Watson; and Steve Van Putten, senior managing director of Pearl Meyer. Highlights of that discussion follow.
What are the key issues underpinning modifications to compensation plans in the current business environment? What are the impacts of those decisions?
John Fletcher: Some crises are a one-time occurrence or of limited duration. The coronavirus pandemic is a different kind of challenge. In the current environment, corporate board members must deal with a high level of ongoing risk, an unknown duration, and an uncertain outcome. In that context, we have compensation committees who will be considering the following issues:
Executive base pay. Should compensation committees insist on executive base pay reductions? If the company is doing furloughs or layoffs, should executives be paid back and under what conditions? When compensation is an element of variable pay, and is less likely to be earned at this time, should that base pay percentage be increased?
Executive incentive. Should compensation committees adjust performance-based pay to align with an adjusted financial outlook? Virtually every company has adjusted its outlook for 2020. Should companies revise their performance goals now, rather than performing a retrospective? If so, should new goals solely reflect quantitative metrics, or are there relative or qualitative measures?
Performance metrics. Are there alternatives to modifying performance metrics and ensuring employees are motivated? Should companies move to quarterly goals? So far, the biggest impact has been in Q2, with some impact in Q3. We don’t know what will happen in Q4.
Perception of compensation changes. If performance measurements and metrics are changed, how will shareholders, employees, and proxy advisors perceive those changes? Did the compensation committee take into account the interests of all constituents when making what were thought to be sound decisions?
What do you expect the impact of these business challenges will be on CEO pay practices?
Robin Ferracone: On the salary piece, I’m anticipating the question of when pay will be restored. A lot of companies are waiting to see if they’re in the clear to bring pay back to what it was. I expect this year we’ll see little increase in compensation—and possibly a general decrease in compensation. The talent market has been destabilized and there’s more supply than demand.
I do want to point out that we have a black swan event and there’s a lot one can learn. I’ve got one client that has a call center. They find there are fewer calls because there is less demand for services; however, because of that, they’re finding that they’re able to respond to calls more quickly and that is improving customer retention. Even companies with durable models can learn something, and that can impact both the measures and the goals in the incentive plan. For those companies that are not so fortunate to have durable business models, there is soul searching to do.
This will have an impact on the measures and what the goals are. I’m expecting to see more qualitative measures to refocus people on the values and ESG concerns that organizations have right now. Secondly, think about the goal ranges and make sure they’re wide enough, durable enough. And use discretion in plans appropriately. One of the things we will see more of is a questioning of long-term incentives. Should we put in more restricted stock as opposed to performance shares? Finally, I think disclosures are going to be case-by-case this year. I think we’ll see better disclosures with a lot of disclosure on the human capital component.
What should compensation committees be considering, beyond the next one or two years?
Steve Van Putten: At the moment, everyone is focused on the near-term impact of this very unusual year. We still need to make hard decisions about temporary pay reductions, if and how to use discretion for 2020 bonuses, and what to do about multi-year incentive goals set in 2020 that are no longer attainable.
Looking to 2021 and beyond, it’s likely we will still be experiencing significantly reduced visibility and increased volatility. When I think about the key areas of attention for compensation committee members beyond the immediate concerns, one that may not be top of mind is whether you have a loss of retention or motivational value in the program. Even if, as we saw with the stock market, prices recovered fairly quickly, it’s likely that the goals you set in early 2020 were either materially impacted or are no longer attainable. And keep in mind that while it may be slow, executive turnover is still happening.
From a director standpoint, what should you do about that? First, don’t overreact. I would start by understanding the magnitude of how your potential and realizable value have been impacted. Also, be certain that those multi-year goals really aren’t attainable because it may be that you have time to catch up and reach those goals. In that regard, proxy advisors are likely to scrutinize any modifications to your long-term rewards.
Given all of that complication, how do you move forward? One thought is to increase the use or weight of restricted stock in future awards. The rule of thumb is that performance-based rewards should represent at least 50 percent of LTI [long-term incentives]. The second [thought] is to address the heightened uncertainty and volatility head-on by allowing yourself more time to set performance goals, but be prepared to consider the use of discretion again.
For companies with a depressed stock price, is it time for a stock option exchange?
Brian Lane: It needs to be considered holistically. For those industries that are still option-heavy—like biotech companies and private companies—a depressed stock price can have significant complications for outstanding equity that is predominantly stock options—and you lose the retentive and motivational value associated with outstanding equity.
There are many things for the compensation committee to consider when evaluating whether a stock option exchange makes sense, namely the fact that you would be repricing management equity awards at a time when your other stakeholders don’t have the opportunity to do the same (e.g., shareholders can’t just as easily reprice their investments).
There are two key implications of that connection between the shareholder experience and the executive experience. First is the need to disclose the business rationale for why an option exchange is being considered, and to that end, understanding whether your institutional investors have released policies or guidelines on option exchanges can be helpful. Second is that the proxy advisors tend to take a pretty hard line on option exchanges, particularly ISS, which has a prescriptive list of features they want to see in order to view an option exchange favorably. Weighing the ISS provisions against what makes sense for the company is really important, as is considering the benefits of an option exchange [for management] in comparison to the experience of shareholders and other company stakeholders.
How do you see the connection between the compensation committee, talent, and the intensified focus on civil rights and workplace equity?
Wendy Lane: Companies are making more explicit recruitment commitments. Think about it: If you have a bias at the beginning, it just gets worse down the line. [Private-equity investment firm] Blackstone Group historically recruited from other Wall Street companies, but is now saying it’s only going to do that as a last resort and instead recruit from historically black colleges and universities.
There’s a really interesting retention program that Intel is doing called WarmLine, which is a way to get a sense of which employees are thinking about leaving and what their disgruntlements are and this has enabled the company to better retain minorities than they had historically. And many companies have more explicit diversity goals when it comes to hiring. Intel set a goal in 2015 that by 2020 they were going to have full representation in their leadership and technology ranks. They achieved that in three years, and in part it was probably because executive pay was tied to a diversity metric, and in part because they made that public declaration. Now, we’re seeing lots of companies making explicit commitments online and they’re backing those up with executive pay practices. My understanding is that CEOs now have about 10 percent of their compensation based on diversity and inclusion metrics and I’m sure this is going to multiple that.
NACD: Tools and resources to help guide you in unpredictable times.