COVID-19 has had a significant impact on corporate performance, and a related impact on executive compensation. In many cases, long-term equity awards that were granted before March 2020 have lost value, and performance goals for annual bonuses have become unrealistic.
Companies still want their compensation programs to motivate and reward executives’ efforts. However, when so many are furloughing employees and reducing dividends, pre-pandemic incentive compensation plans may now seem inappropriate.
Companies turn to discretion
A recent survey of 681 U.S. companies by advisory firm Willis Towers Watson revealed that many had either revised their incentive plans or were considering revisions. The most common proposed change is adding an element of discretion that would enable a compensation committee (or full Board) to adjust awards at the end of the performance period. When discretion is permitted, awards that seem excessive can be reduced, and meager awards can be increased.
Since investors will be wary of companies that exercise discretion—especially when awards are increased—careful disclosure will be critical to retaining their trust.
Formal disclosure requirements
SEC rules for the Compensation Discussion & Analysis section of proxy statements call for companies to disclose “whether discretion can be or has been exercised (either to award compensation absent attainment of the relevant performance goal(s) or to [alter] the size of any award or payout).”
ISS and Glass Lewis both addressed the prospect of pandemic-era discretion in updated guidance. Glass Lewis expects “[e]ffective disclosure and rationales,” and warns that they will look more kindly on companies that had “a good track record on governance, performance and the use of board discretion prior to the pandemic.” ISS’s statement is similar, urging companies to provide “adequate explanation” of the rationale for any changes.
Companies that can or did exercise discretion to adjust executives’ incentive awards should explain their decisions precisely and in plain language. Here are some issues to address.
Rationale. If payouts were increased (or goals decreased), is it still fair to consider the compensation “performance-based”? Perhaps pre-pandemic metrics like sales volume or product launches became less relevant, but did executives outperform by retaining employees and ensuring an uninterrupted supply chain?
Which plan? Proxy advisors (and presumably shareholders) are more inclined to accept changes to the annual incentive plan than to the long-term plan. A company that reprices underwater stock options should expect extra scrutiny. Explain why each specific exercise of discretion was warranted.
Comparability. How are peer companies faring? Are they making similar changes to their incentive plans?
Comprehensive disclosure promotes trust
A recent study by Labrador and BVA Group demonstrated that people prefer plain language disclosure to typical corporate-speak. Plain language is reader-focused—anticipating questions and answering them honestly. Using plain language to disclose discretionary changes to incentive awards may increase the odds that investors will support the actions.