Executive Compensation Considerations at 2020 Year End

Listen to "Executive Compensation Considerations at 2020 Year End"

Alyssa Abbott My name is Alyssa Abbott, and I am the Interim Director of the Gupta Governance Institute at Drexel University’s LeBow College of Business. Welcome back to BoardSpeak, our thought leadership series. I’m delighted to be joined today by Diane Thompson, of counsel at Cozen O’Connor. She has been a partner at national law firms, a senior executive of HR at public companies, and a partner at Ernst & Young. I asked Diane to join me today for a brief high-level conversation about COVID-19’s impact on executive compensation and the potential legal ramifications as a result of modifying exec comp programs.

Diane, the current focus, or perhaps, preoccupation of compensation committee discussions right now is what to do about 2020 performance metrics and goals in light of the pandemic. We have seen reductions in executive pay across sectors and industries in order for companies with pinched cashflow to remain financially viable, but also to reinforce a sense of solidarity with employees outside of the C-Suite. From your perspective, what should boards and compensation committees be aware of when reducing executive pay?

Diane Thompson One of the key things, from a purely legal perspective, is to be sure to take a look at any contractual provisions, either in employment agreements or other binding contracts with executives. Perhaps look at the programs and plan documents, the incentive arrangements, and/or equity arrangements, to be sure that there are no provisions in there that would require any bilateral type of an agreement for reduction of compensation or expose the company to any potential future litigation.

Obviously, it is their fiduciary responsibility and their role to look at what’s appropriate for all of the stakeholders and protect the interests of the shareholders. But, by saying “across the board we are going to reduce pay”, you may end up with the opposite impact on retention of those key people when you need them the most. Reducing compensation might be a conceptual aspect of taking a look at how you can reconfigure executive pay and reward the individuals who are pulling the company back up and out of the current situation of COVID, which wasn’t accounted for in the formulation of the performance metrics at the beginning of the year. Where we are now, comp committees are meeting and struggling with these issues. They may be taking a look at ways of delaying or readjusting some of the compensation to take those performance metrics into account and to blend them with the performance requirements from the beginning of the year.

In most of these types of plans and programs, there are provisions for extraordinary situations, and the ability of the comp committee to adjust in extraordinary situations. I would be perfectly comfortable giving a comp committee guidance to say, you need to have a really solid foundation of factual disclosure, a good story to tell, and you need to get that story out to show you are responding to the key issues in the company at the moment. This approach, rather than just chopping compensation, would be well-received.

Abbott I like your comment around an extraordinary situation, and I agree that a global pandemic is certainly extraordinary. To your point, objectives, and incentive programs for 2020 were set early in the year before COVID hit. These targets might not be applicable anymore, but boards and compensation committees may feel that they need to retain and incentivize the top talent. What are the potential legal ramifications of adjusting bonuses or incentive programs?

Thompson You have to look at whether or not you have contractual obligations and would be reducing something that someone’s contractually entitled to. When we look at these programs, there’s two prongs of bonuses, right? The annual bonus and the long-term bonuses or incentive arrangements or equity arrangements, depending on how they are presented in a particular company. Adjusting annual bonuses may be a little less difficult if you had the relative type of performance metrics in place, assuming that you’re in an industry that’s been impacted across the board in the same way, either very negatively or very successfully. It’s key to understand that, although there may be companies who are facing the rather dismal situation of reducing bonuses and taking into account the financial situation of the company even though the individuals may have performed well, there are also companies who are looking at the potential that the stretch goals that they set are being significantly surpassed. Do you reward for situations or do you reward for performance in the context of adjusting for those situations, but not adjusting for people to have a windfall?

Look initially at what your requirements are legally, and at any documentation that needs to be addressed and bilaterally agreed to. Then look at what your abilities are to make adjustments and what would be appropriate. Can you adjust your annual bonuses, but look at the averaging component of a three-year long-term type of an arrangement and adjust or shift the balance there? This way you’re looking at more of the longer-term impacts and the recovery potential for some of these companies on a longer period of time while still retaining them and incentivizing them to get there. When you look at executive compensation, we oftentimes focus on the very top level, the key people and CEOs whose compensation is disclosed. But, it is just as important, or maybe even more important, to drop down to that next level of individuals who are actually at the operational level, who are driving the company, and keeping them focused on how they best do their jobs.

Abbott Great point about the next level down, certainly something to keep in mind. I do want to talk about the September issuance by the SEC Division of Corporate Finance, the new C&DI under Reg S-K related to COVID-19. What should boards and compensation committees know about this new issuing?

Thompson In my reading of it, I focused more on the human capital management component of it and the disclosure requirements on the part of the SEC to get a better sense of how companies are approaching the general principles that the SEC is trying to focus in on. Certainly, we’ve, seen over the last several years this continual focus, not only on disclosure, but transparency, and really getting down to a more granular look at how companies are achieving these types of objectives. It’s easier, then, for the shareholders, and others, to really get a sense of whether the trajectory of effort is in the direction that’s going to achieve the goals.

When it comes to human capital management, I think there’s a couple of key components, particularly right now. One being the safety aspect of the workforce and making sure that there’s employment stability, that the stability of essential workers is assured by appropriate safety measures, and looking at rewarding those individuals for what they’re doing under very trying circumstances. I think that really begs for detail and assurance level disclosure and transparency to address that component of human capital management.

Second, with respect to the focus going forward, I think there’s a continual need that will certainly be a focus of the Biden administration on diversity and inclusion as a key aspect of human capital management. We’re going to need to see more disclosure, and more detail on how companies are moving towards those goals and what steps they’re taking to ensure that those individuals that have been hired, and who bring more diversity and more inclusive perspectives, are on a path towards success and ultimately rising to management and to leadership roles in companies.

The third component would be looking at what is going to be the shift in terms of the shareholder investor guidance organizations like ISS and Glass Lewis, and how they are going to view this guidance in terms of their guidance and their annual perspective on where executive compensation disclosure will go.

Abbott Before we wrap up, are there any other considerations that you personally believe boards and compensation committees should be aware of as we are approaching year end and looking into next year?

Thompson Number one, it’s really important to look ahead and preserve and document the efforts that the board and the comp committee are taking when they’re making either adjustments to compensation, or adjustments to any kinds of performance metrics. It is important to have the ability to be transparent and to disclose and document your thought process. Particularly, because oftentimes they will ask, “why did they do that?”. It is important to be really clear about why the decisions that are being made are made. Looking into the future, there is obviously a focus on what the regulatory agencies will do under a democratic administration. The focus of the regulatory world has been a reduction of regulatory requirements and whether or not the regulatory world will shift their focus now and become more in line with what we had before the Trump administration.

Abbott Diane, I want to thank you for joining us today and sharing your insights with the Gupta Governance Institute stakeholders and thank you to our audience for listening. We hope you enjoyed today’s discussion. I ask that you fill out the response form in the email you received to provide feedback on what topics you’d like to hear in our subsequent discussions. On behalf of the Raj and Kamla Gupta Governance Institute at Drexel university, thank you and take care.