Fifteen months into the pandemic, vagueness and uncertainties around executive compensation loom large for many companies and industries globally. It’s no wonder that adjustments to executive pay plans and conducting fair and honest messaging on those changes come with their fair share of challenges.
As remuneration committees reflect on the past year, there are many lessons to be learned from the pandemic, including incorporating environmental, social, and governance (ESG) metrics and taking stakeholder concerns about executive remuneration into account.
What Changes Did Companies Make to Compensation During the Pandemic?
In a report published last year by CGLytics and Diligent on the compensation practices of the Russell 3000, we saw the financial and non-financial impact of COVID-19 become clearer, with some 246 companies issuing adjustments to their incentive plans to reflect an unusual performance year. The data suggested that 10 types of adjustments were made to short-term incentive (STI) plans and nine types of adjustments made to long-term incentive (LTI) plans. We saw modified performance periods, reduced targets and maximum payout opportunities, delayed goalsetting, payout suspension adjustments, cancellations, and suspensions in both plans.
Other adjustments made to STI plans included adding new metrics, the added discretion in the payout of STI plans, reset goals, switches to equity from cash, and grants of a one-time special bonus. Other adjustments made to LTI plans included granting special awards, changes in performance share unit metrics, increased weight of time-based vehicles and modified outstanding awards.
What KPI Metrics are Companies Using to Determine Compensation?
Our CGLytics data suggests that profitability measures, followed by revenue and sales, remain the most used metric by companies with disclosed plans around compensation. Returns measures, such as return on capital employed, return on invested capital, and return on equity, are also prevalent key performance indicators (KPI). Though these financial metrics are easily quantifiable and show the business’s profitability, they fall short of the metrics employed in determining payouts. Remuneration committees can do more by incorporating more holistic measures of success, such as KPIs around stakeholder interest and ESG.
One of the most common changes to incentive plans by issuers has been to add new metrics; commonly added metrics have been cash flow, earnings before interest, taxes, depreciation, amortization, revenue, or strategic KPIs. We also found that a significant number of companies have reduced target or maximum payout opportunities. Some issuers have reset performance goals based on updated forecasts, while others have also delayed goal-setting.
How Should Boards Be Thinking About Executive Remuneration Plans?
Approaches to changing and redesigning executive compensation will undoubtedly vary across industries and regions. With revised financial plans subject to many unknowns, boards will need to apply discretion to determine executive emoluments and assess whether compensation is tied to performance over which the executive has control. Isolating the effect of the pandemic on executive pay from financials and then reassessing results to determine payouts may be possible where pandemic-related impacts are discrete and measurable. Still, in most cases, the loss of revenue dominates these costs. In addition to these challenges, the effects of the pandemic and the social and climate crises that have shaken the world in equal measure last year have also brought discussions of tying ESG and diversity, equity, and inclusion (DEI) metrics to executive compensation.
Incorporating KPIs around some of the following measures may be useful for remuneration committees:
One measure we recommend is issuers incorporating relative performance to their closest peers in their executive compensation designs. Pre-COVID-19, peer benchmarking was prevalent in long-term incentive plans and may be helpful when applied to annual incentive plans as well. Our CGLytics database shows that across its universe, only about nine companies had peer benchmarking in their annual incentives for the 2019 financial year.
Measures to Safeguard Investor Interest
Perhaps one of the methods necessary on the road to recovery is to incorporate stock price performance relative to pre-crisis levels. Another KPI that may be useful and appealing to shareholders is to measure how soon issuers can bounce back to dividend payments and share buybacks, which is centered around cash back to investors and signifies strong liquidity.
Emphasis on Display of Crisis Management in Leadership
For all other stakeholders, such as employees, it will be helpful to see how executives applied more agility in decision making, saved jobs for employees, or restored broad-based reductions. These metrics provide measures of profitability of the business and how well leaders were able to manage the crisis and safeguard the interests and well-being of other stakeholders, particularly employees.
Tying ESG and DEI Metrics to Executive Compensation
In a recent Diligent Institute and Corporate Board Member report, 25 percent of surveyed board members indicated their companies were already tying compensation to ESG issues or were planning on doing so. This number was 40 percent for DEI issues. Though these numbers are much lower than they need to be, they show clear progress toward a more holistic executive compensation structure in the future.
The Importance of Messaging Around Executive Compensation
Above all else, it is important that companies communicate changes to the structure and purpose behind their executive remuneration policy. For example, many companies issued statements that indicated their executives would be taking extensive salary cuts due to the pandemic. Despite these much-touted pay cuts, our CGLytics pay-for-performance data tool suggests that the average CEO realized pay in the S&P 500 actually grew by 16 percent from 2019 to 2020. Most of the pay cuts were done on base salary, which usually forms only about five percent of the average CEO realized pay. Long-term incentives usually form the highest component of average CEO realized compensation (more than 70 percent). Within the same period, long-term incentives released also grew by 25 percent in the S&P 500.
It has become necessary that remuneration committees consider all stakeholder interests in designing executive compensation. Ideally, executive compensation should be structured to incentivize executives to lead pandemic recovery plans that safeguard all stakeholders (investors, employees, and government) while incorporating the relevant and proper ESG metrics to ensure long-term business sustainability. Not to mention, remuneration committees should effectively and strategically communicate these structures to shareholders in such a way that intentions and outcomes are transparent and easily understood by the shareholder and stakeholder community. A tall order indeed, but one long overdue.
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