Executive compensation: 2021 and beyond (US)
COVID-19 is causing “unprecedented, negative economic impacts in an accelerated fashion,” comments Alvarez & Marsal.
“Many experts, furthermore, believe that the coronavirus crisis is just getting started, and that the countermeasures that are causing such negative economic impacts may last not for weeks, but for months or longer. Whether engaged in the airline, hotel, restaurant, physical fitness, cruise line, retail, oil and gas, or any other industry, significant impacts will flow through all sectors, with few, if any, insulated from the downturn.”
With this in mind, Business Chief North America takes a look at insights from Joseph E. Bachelder, Special Counsel at McCarter & English LLP, the Corporate Governance Research Initiative at the Stanford Graduate School of business, and the Rock Center for Corporate Governance at Stanford University, on the impact of COVID-19 for executive compensation in 2020, as well as actions that could be taken in response going forward.
COVID-19’s impact in 2020
In a study conducted by the Corporate Governance Research Initiative at the Stanford Graduate School of business and the Rock Center for Corporate Governance at Stanford University, titled ‘Sharing the Pain: How Did Boards Adjust CEO Pay in Response to COVID-19?’ the report identified three actions taken by 2,980 Russell 3,000 companies in response to the impact of COVID-19:
- Altered CEO salaries: among those that altered CEO salaries, 424 companies reduced their salary rate, while 17 deferred the payments, and 21 exchanged salary for equity.
- Changes to annual bonus: less frequent than altered salaries, 92 companies made changes to annual bonuses. Of those 92, 44 companies reduced the current or previous years payments, 17 deferred the payments, and 10 exchanged cash for equity.
- Amended long term incentive programs (LTIPs): few of the Russell 3,000 companies (33) made changes to their LTIPs. Of those 33, nine reduced the target value, nine adjusted award vehicles, eight changed the metrics to award LTIPs, seven changed LTIPs to a retention award, and one changed LTIPs to a discretionary award.
Suffering one of its largest negative closing milestones, the S&P 500 index recorded a 30.75% decrease on the levels at the end of 2019, totalling 2237.40 points following the outbreak of COVID-19 in March.
Whilst the S&P 500 index has begun to recover - currently sitting at 3,733.24 points - many organisations continue to be impacted by the pandemic, with stock price in many sectors including energy, consumer discretionary, finance and real estate struggling to recover and suffering losses or reduced profits.
With this in mind, Bachelder reflects on executive compensation in the form of company stocks. “A question may be asked whether these losses should be borne by the executive holding the employer stock without some form of mitigation [...] 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’.”
Forward-looking response to the impact of COVID-19
- Annual incentive plans When it comes to executive compensation programs, Alvarez & Marsal explains the importance of taking into account the impact of the COVID-19 crisis going forward. With the virus continuing to have significant impact around the world for organisations and economies, “the scope and extent of the current crisis is unknown.” While organisations will have set targets for 2021, the continued evolution of the virus may result in the need for revisions. If so, Alvarez & Marsal adds that “companies may wish to adopt a ‘wait and see’ approach as opposed to taking swift action to adjust performance metrics too quickly and avoid the need for multiple revisions to the performance criteria, which would undoubtedly be viewed negatively by shareholders and shareholder advisory firms alike.”
- Equity compensation Similar to annual incentive plans, equity compensation - in particular stock - have experienced negative outcomes as a result of COVID-19, due to the outbreak causing significant value decreases for company stocks. “Companies will need to consider measures to create value for executives, and to realign their interests with those of shareholders generally,” comments Alvarez & Marsal, which identifies three approaches going forward:
- Resetting awards based on the lower current stock value
- Issue new awards based on current share prices
- Issue additional awards to maintain a view that the intended long-term incentive (“LTI”) value will be achieved
However, Alvarez & Marsal does note that whether a company decides to reset existing awards or issue additional awards, each approach comes with its own potential challenges that shouldn’t be overlooked.
Look at the year ahead and beyond
While the end of 2020 brought about approved vaccines and rapid distribution at scale, it has also brought new variants and increasing cases. As a result, expectations for the year ahead for executive compensation - like many other functions - are continuing to look uncertain.
Should the S&P 500 index continue to improve despite fluctuations caused by ongoing events? Bachelder expects that “executives who are performing satisfactorily or better will be rewarded with appropriate compensation increases.” However should “the economy dip again due to the pandemic or other circumstances, tougher stances may need to be taken by employers to adjust executive compensation and awards.”
While it may be hard to definitely predict one way or another what 2021 will look like when it comes to executive compensation, there are clear approaches that organisations can make in response to economic changes to mitigate the impact. As a result, understanding them and being agile to adopt new methods will be vital to the success of any organisation.
How innovation is transforming government
According to Washington Technology’s Top 100 list, Leidos is the largest IT provider to the government. But as Lieutenant General William J. Bender explains, “that barely scratches the surface” of the company’s portfolio and drive for innovation.
Bender, who spent three and a half decades in the military, including a stint as the U.S. Air Force’s Chief Information Officer (CIO), has seen action in the field and in technology during that time, and it runs in the family. Bender’s son is an F-16 instructor pilot. So it stands to reason Bender Senior intends to ensure a thriving technological base for the U.S. Air Force. “What we’re really doing here is transforming the federal government from the industrial age into the information age and doing it hand-in-hand with industry,” he says.
The significant changes that have taken place in the wider technology world are precisely the capabilities Leidos is trying to pilot the U.S. Air Force through. It boils down to developing cyberspace as a new domain of battle, globally connected and constantly challenged by the threat of cybersecurity attacks.
“We recognize the importance of the U.S. Air Force’s missions,” says Bender, “and making sure they achieve those missions. We sit side-by-side with the air combat command, intelligence surveillance, and reconnaissance infrastructure across the Air Force. There are multiple large programs where the Air Force is partnering with Leidos to ensure their mission is successfully accomplished 24/7/365. In this company, we’re all in on making sure there’s no drop in capability.”
That partnership relies on a shared understanding of delivering successful national security outcomes, really understanding the mission at hand, and Leidos’ long-standing relationship of over 50 years with the federal government.
To look at where technology is going, Bender thinks it is important to look back at the last 10 to 15 years. “What we’ve seen is a complete shift in how technology gets developed,” he says. “It used to be that the government invested aggressively in research and development, and some of those technologies, once they were launched in a military context, would find their way into the commercial space. That has shifted almost a hundred percent now, where the bulk of the research and development dollars and the development of tech-explicit technologies takes place in the commercial sector.”
“There’s a long-standing desire to adopt commercial technology into defense applications, but it’s had a hard time crossing the ‘valley of death’ [government slang for commercial technologies and partnerships that fail to effectively transition into government missions]. Increasingly we’re able to do that. We need to look at open architectures and open systems for a true plug-and-play capability. Instead of buying it now and trying to guess what it’s going to be used for 12 years from now, it should be evolving iteratively.”