Compensation Season 2021

Jeannemarie O’Brien, Adam J. Shapiro, and David E. Kahan are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell memorandum by Ms. O’Brien, Mr. Shapiro, Mr. Kahan, Andrea K. Wahlquist, Michael J. Schobel, and Erica E. Bonnett. Related research from the Program on Corporate Governance includes the book Pay without Performance: The Unfulfilled Promise of Executive Compensation and Executive Compensation as an Agency Problem, both by Lucian Bebchuk and Jesse Fried.

COVID-19 dominated the compensation landscape in 2020 and will remain a key factor in 2021. The most successful companies have proactively managed compensation programs in response to the pandemic, while maintaining a laser focus on attracting and retaining executive talent. We identify below some of the key factors that will impact the 2021 compensation season.

Assessing 2020 Performance. Director discretion will be as important as ever when it comes to assessing and rewarding 2020 performance. If a company’s preset financial goals for 2020 no longer provide a meaningful measure of company performance due to the impact of the pandemic, directors may need to exercise discretion and rely on subjective judgments regarding individual and company performance. Compensation committees that rely more heavily on discretion to assess 2020 performance should consider establishing a framework of key factors, including, for example, protecting and preserving the workforce and fortifying the company’s long-term liquidity.

Proxy Statement Disclosure. It will be essential for companies to explain 2020 compensation decisions, particularly so for those companies whose directors revise performance goals or exercise significant discretion in determining 2020 incentive compensation payouts. Assuming that companies provide clear, detailed disclosure regarding the rationale for executive pay decisions, we are hopeful that the proxy advisory firms will take into account the exceptional circumstances at work in 2020. For those companies anticipating a challenging say-on-pay vote in 2021, early, proactive shareholder outreach will be as important as ever.

Focus on ESG. There remains a strong interest in environmental, social and governance (“ESG”) issues, including as they relate to compensation and human capital, such as gender pay equity and diversity. We find that company boards are deeply engaged in these issues and expect that there will be an increased focus on these matters through shareholder proposals and requests for disclosure in the coming years. Accordingly, companies should consider including relevant ESG objectives among the mix of incentive compensation performance goals. A balanced approach that includes traditional financial goals, together with ESG-related metrics, is most likely to garner support from the proxy advisory firms.

ISS Policy Updates. ISS announced minor policy updates at the end of 2020. To ensure that shares available under existing plans are not included in the ISS dilution analysis of a new equity incentive plan submitted for shareholder approval, a company (1) must indicate (a) the total number of shares available under any legacy plans, and (b) the number of shares covered by outstanding awards under such plans, and (2) must commit not to make further grants under the legacy plans. ISS increased modestly the threshold passing scores under its equity plan score card (“EPSC”) for S&P and Russell 3000 companies and decreased modestly the high concern threshold for S&P companies under its quantitative pay for performance screen.

ISS guidance regarding the impact of COVID-19, summarized below, will impact 2020 compensation determinations and disclosures for many companies.

  • ISS will consider supporting adjustments to 2020 performance goals if “the justifications and rationale are clearly disclosed, and the resulting outcomes appear reasonable.”
  • ISS may be receptive to “modest” modifications to long-term incentive awards granted in 2020 to reflect pandemic related uncertainty. However, shifts to time-vesting awards or short-term performance periods would be viewed negatively.
  • ISS may support one-time retention awards if a company provides a well-articulated rationale and if the awards are reasonable in magnitude and subject to long-term, “performance-based” vesting conditions.

For a more detailed description of these principles, see our October 26, 2020 client memo.

IRS Issues Final Section 162(m) Regulations. The IRS finalized regulations that eliminated the performance-based exception to the $1 million annual executive compensation deduction limit under §162(m) of the Internal Revenue Code (“§162(m)”). The final regulations confirmed (1) that a “covered employee” of a target public company generally will retain that status following the acquisition of the target company by another public company, even if the target executive is never a named executive officer of the acquiror company, and (2) the elimination of transition relief for private companies that become public. For a more detailed discussion of the proposed regulations, see our December 23, 2020 client memo.

Dodd-Frank Act Regulations. We continue to await final regulations regarding clawbacks and disclosure of pay for performance.

Proactively Manage Talent. Human talent is more vital (and unrestrained by geography) than ever and companies should be prepared to act quickly if a key contributor is at risk of exiting. Over the last year, many companies have acted decisively to enter into long-term arrangements with key executives who have proven track records. Succession planning is equally vital. It is essential for boards to periodically assess the leadership pipeline and prepare for unexpected succession events.

Review Change-in-Control Protections. With so much focus on the pandemic, it is easy to overlook fundamental matters that may seem remote. The threats of shareholder activism and/or unwanted takeover attempts are as real as ever. It is essential to review, understand and strengthen, if necessary, compensation-related arrangements that maintain stability in the face of an activist challenge or a change in control.

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