The Impact of the Pandemic on Executive Compensation

Joseph E. Bachelder is special counsel at McCarter & English LLP. This post is based on an article by Mr. Bachelder published in the New York Law Journal. Andy Tsang, a senior financial analyst with the firm, assisted in the preparation of the article.

Pandemic Consequences to Executive Pay in 2020

1. Employer actions in response to the pandemic during the first half of 2020.

During the first half of 2020, many companies took actions to reduce executives’ salaries. (For example, as indicated in the Stanford Corporate Governance Research Initiative study noted below, 424 Russell 3000 companies reduced CEO salaries during this period.) Most companies did not take steps to modify their annual and long-term incentive programs, which will generally be adversely impacted by the economic consequences of the pandemic.

A recent study done by the Corporate Governance Research Initiative at the Stanford Graduate School of Business and the Rock Center for Corporate Governance at Stanford University, “Sharing the Pain: How Did Boards Adjust CEO Pay in Response to COVID-19?” (September 1, 2020), by Amit Batish, Andrew Gordon, David F. Larcker, Brian Tayan, Edward M. Watts, Courtney Yu, reports the following regarding 2980 Russell 3000 companies as to executive pay actions taken during the first half of 2020:

  • CEO salary actions. Companies that altered CEO salaries did so in at least one of three ways. The vast majority reduced the salary rate (424 companies). The remainder either deferred salary payments (17 companies) or required/offered an exchange of salary for equity (21 companies).”
  • Annual bonus actions. Changes to annual bonus programs were less frequent, with only 92 companies in the Russell 3000 making adjustments. Among these, 44 companies reduced current- or previous-year bonus payments, and 17 companies deferred the payment of previously earned payments. Ten companies exchanged the payment of bonuses from cash to equity”
  • LTIP actions. Very few companies (33 companies) made changes to their long-term incentive programs (LTIPs). Nine companies reduced the target value of the LTIP. Other changes included reweighting award vehicles such as decreasing the portion of performance units and increasing restricted units (9 companies), changing the metrics to award the LTIP (8 companies), and changing the LTIP to a retention award (7 companies) or discretionary award (1 company—see Exhibit 13).”

2. Stock market swings during the first part of 2020.

The S&P 500 index dropped to 2237.40 points at its lowest level this year thus far on March 23, 2020 (based on trading day closing prices). This represented a 30.75% drop from the level at the end of 2019 of 3230.78. As of August 31, 2020, the S&P 500 rebounded to 3500.31 points. This represented an increase of 8.34% for the year-to-date, as of August 31 (and a recovery of 1262.91 points from the low of 2237.40 on March 23).

Many companies are still negatively impacted by the pandemic. While the S&P 500 index has rebounded, stock prices of many companies in certain sectors (such as the energy, consumer discretionary, financials and real estate sectors) generally have not recovered. Many of these companies continue to suffer losses  or reduced profits as a result of the disruptions caused by the pandemic.

Executives at the companies noted may suffer significant losses through their holdings in their employers’ stocks. A question may be asked whether these losses should be borne by the executive holding the employer stock without some form of mitigation (e.g., supplemental awards at some later point). This in turn raises the question whether executives holding shares of employer stock are really “in the same shoes” as non-employee investors (the latter can invest or sell off  their interests in company stock as and when they see fit). An executive’s interest in the employer stock is in large measure employment-related and not exclusively an investment choice. In a sense the executive is a “captive investor.”

Actions Companies Might Take to Revitalize Their Executive Compensation Programs

Many companies may be at risk of losing executives to other companies (in the same or other sectors) that have better financial prospects. This is especially true if executives at the first group of companies have experienced salary reductions, have outstanding performance-based incentive awards subject to performance targets that have become difficult or impossible to achieve and/or have outstanding stock options that are significantly underwater.

Following are examples of compensation actions that companies might take in order to retain and motivate their executives in the midst the pandemic (subject to compliance with applicable laws including the Coronavirus Aid Relief and Economic Security Act).

  • Award discretionary bonuses to executives who performed well. An annual incentive plan of a company subject to formulaic performance targets may pay out very little, if anything at all, during the pandemic (unless the company has previously adjusted the performance targets). In such a case, the company might consider, at the end of the current fiscal year, awarding special one-time bonuses to those executives who have performed well notwithstanding the challenges imposed by the pandemic. These bonuses might be awarded, in whole or in part, in the form of restricted stock that vests over one or several years to add in their effectiveness in retaining, as well as motivating, such executives.
  • Modify financial performance targets contained in outstanding performance-based long-term incentive awards granted before the pandemic in order to make their attainment more realistic. To the extent outstanding performance-based long-term incentives are subject to financial performance targets that are no longer realistically achievable:
  1. Companies that can determine what are reasonable adjusted financial performance targets taking into account the pandemic should consider adjusting the financial performance targets of such long-term incentives in order to retain the retention and motivation characteristics of these incentives.
  2. Companies that cannot determine what are reasonable adjusted financial performance targets during the pandemic should consider changing the financial performance targets of such long-term incentives to non-financial-based targets (e.g., improving customer relationships and improving the working environment for its employees).
  • Grant time-vesting stock awards rather than performance-based awards. It is generally thought that performance-based awards are superior to time-vesting stock (or stock option) awards because they motivate executives to achieve specified performance targets. In the midst of the pandemic it may be appropriate and worthwhile for companies to consider stock (or stock option) grants that are time- vesting rather than performance-vesting.
  • Provide special retention awards and/or employment agreements for executives who have valuable skills and might move to other companies. Companies that continue to suffer losses or reduced profits as a result of the disruptions caused by the pandemic are especially at risk of losing executives to companies in sectors with better financial prospects. For example, an information technology executive of a consumer discretionary company might consider better opportunities at companies in the information technology sector. That executive’s employer might consider granting the executive a special retention award. If there is not already an existing employment agreement with the executive an employment agreement might be considered, which would include provisions for the special retention award just noted.

Looking Ahead to 2021: Uncertainties as to the Economy and Executive Pay

Compensation committees that will be dealing with executive compensation decisions in the winter/spring 2021 must face the uncertainties of an economy impacted by the pandemic. If the economy continues to improve (as noted above, the S&P 500 index has increased 8.34% year-to-date, as of August 31, 2020), executives who are performing satisfactorily or better will be rewarded with appropriate compensation increases. If, on the other hand, the economy dips again due to the pandemic or other circumstances, tougher stances may be taken by employers as to executive compensation adjustments and awards. In such case, executives also will probably face drop in value of their holdings in their employer’s stock due to market price drops generally. Thus, it is difficult to  predict as of the date of this post what the 2021 executive compensation environment will look like.

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