8 Principles to manage executive compensation during COVID-19 crisis
Experience from past downturns, such as the global financial crisis, have fueled concerns that large corporations would end up benefiting from the situation. Very often, many of the senior executives assume lots of risk in bull markets but are protected by government bailouts in bearish conditions. On the contrary, the COVID-19 crisis this time is a different type of downturn, one that unfolds very rapidly, disrupting most industries, economies, and directly impacting everyone’s lives.
One would have never thought that an unknown virus could become the Black Swan of 2020 affecting how we work, play, and interact with one another. Notably, COVID-19 has become a human capital crisis, completely changing the way organizations manage their human capital within a short period of time.
In this context, corporate boards should look at executive compensation plans as an important tool to focus management’s efforts on surviving the crisis, and protecting the health and wellbeing of all its stakeholders, including employees, customers, supply-chain partners, and shareholders.
What can companies do in the short, medium, and longer-term during this downturn?
The following outlines some of the immediate actions corporate boards and management teams have adopted in refining their executive compensation programs to respond to the crisis:
- Year of two halves: The crisis has necessitated immediate and decisive action by management teams as they focus on the well-being of the business, employees, and supply chain partners. To help companies get past the survival phase, it is important to channel management’s efforts on crisis management. This may lead to some non-conventional approaches in the short term. For example, linking management’s KPIs to the percentage of workforce who are protected from the COVID-19 infection, or to healthcare and recuperation spending, or preventing job losses, or encouraging social distancing and working from home protocols. Once the business operations stabilize and companies have a better understanding of market conditions, then they can resume normal performance measures and targets.
- Show solidarity: This should apply to all businesses regardless of the significance of the impact. Some Board of Directors have voluntarily taken a fee reduction in the range of 5 to 20 percent. For highly impacted industries, top executives have volunteered to take up to 100 percent cuts in their fixed salary while maintaining some form of target variable incentive. This could still be motivating to executives especially if the right amount of equity is granted at low prices. For less impacted industries, salary increments of top executives have largely been frozen. These actions can be seen as a gesture to preserve cash. More importantly, they can make a positive impact if the funds are set aside for COVID-19 / CSR / ESG efforts. Leaders of leading organizations have shown to take the lead on this and we applaud them.
- Wait and see: This might be the only time that a “wait and see” approach is deemed reasonable and appropriate. Rather than spending time and energy reviewing incentive plans, forecasting financial outcomes and setting performance goals, Boards and management should focus their attention on human capital management. For example:
- Review severance provisions to understand cost implications of potential headcount reduction proposals.
- Ensure the company is protected against potential takeover actions.
- Review change-in-control provisions to motivate executives to seek out and collaborate on potential M&A transactions that are in the best interests of shareholders.
- Trust the Board: As a result of the above, the 2020 financial year’s short and long-term incentive plans are likely to be in a state of limbo. With annual increments delayed, the short-term incentive (STI) and long-term incentive (LTI) targets based on budgets approved before COVID-19 would not make sense now. However, what should remain clear is the articulation of the plan’s principles as well as key metrics underlying those principles. As for the actual targets, it is best to revisit them at a later stage, the earliest possibly in July or for some companies even after FY2020 has ended. We foresee many Boards exercising, in unprecedented ways, their right to absolute discretion. Needless to say, the level of trust between Board and management is crucial during this time.
In the medium to longer-term, companies could focus on these actions to restore stability and return their business back to the ‘new normal’:
- Focus on a few key things: Employees, especially their wellbeing including physical, mental, social and financial, should be the focus. It is critical to understand managements’ actions taken for the broader workforce and assess alignment. Boards should remain briefed on broader workforce actions, for example:
- Continuing pay and benefits for workers impacted by store or factory shut-downs
- Providing paid time off for hourly associates diagnosed with coronavirus or being quarantined
- Paying hourly workers who cannot work due to office closures or remote work policies
- Providing stipends to support work-from-home arrangements for impacted staff
- Providing additional pay (hourly increases, special bonuses) for essential/front-line workers.
In addition, the board should consider ways to conserve cash, particularly for those seeking government assistance, and/or those deploying cash flow and cost containment initiatives. These could be reduced dividends, furloughs, and/or employee pay reductions.
- On-going enhanced communication: During this period, investors, along with other stakeholder groups such as customers and the media, are more likely to scrutinize pay decisions made in 2020. Proactive and effective communication, and engagement with shareholders, employees and the public to manage optics is paramount given the significant changes. We expect on-going communication and implementation of human capital management metrics into incentive plans and/or governance oversight to progress. It is important to document and analyze the learnings from the outcomes of the pandemic and adjust the longer-term executive compensation strategies for companies to build resilience.
- Retention: In times of crisis, business opportunities and talent pool becomes available, and at times, at a bargain. Development and/or enhancement of the existing talent retention programme, therefore, becomes crucial. A simple gesture of annual pay increment for selected few in a potentially zero percent market increment environment could go a long way. On the other hand, Boards could consider more sophisticated longer-term retention plans as well. Furthermore, increasing share ownership requirements for CXOs could signal greater alignment of interest with shareholders. From a talent attraction perspective, a well-thought-out and well-tenured incentive plan can be modified to include change-in-control provisions to facilitate potential M&A activities.
Crises force commonality of purpose. The post COVID-19 world may provide an opportunity for companies to thoroughly review their executive compensation plans and make changes that otherwise would have been difficult to implement before the pandemic crisis.
- Restructuring priorities: While longstanding compensation principles (align, attract, retain, incent, and hold accountable) still apply, this may be a great opportunity for Boards to consider shifting the focus of its executive compensation plans to take a more balanced perspective, such as the increased focus on ESG measures and on all stakeholders.
The COVID-19 crisis presents many important human-capital lessons for companies to reflect – the investment in employees, engagement with multiple stakeholders and adoption of purpose-driven management systems, including its executive compensation plans. Rather than trying to find a balance between a shareholder group on one side of the equation and the rest on the other side, companies should focus on all stakeholders equally. Such a balanced model will lead to the long term betterment of employees, consumers, companies and society.