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10/1/21, 3:36 PM 5 Executive Pay Issues for 2021

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5 Executive Pay Issues for 2021 Pandemic-related challenges take a toll on executive compensation

By John A. Morrison and Alexandra Orsini Barone © Ogeltree Deakins

November 20, 2020

he 2021 executive compensation season will be more challenging than usual for most companies due to the �nancial and economic

consequences of the COVID-19 pandemic. To meet these challenges, companies should be aware of several key issues as they

design their 2021 executive compensation programs.

1. Revisiting Clawbacks and 'Cause' De�nitions

Expanding clawbacks and "cause" de�nitions to cover misconduct beyond �nancial matters may help ensure that a company will be able to

recoup executive compensation in the event of reputational harm to the company or adverse publicity.

Recently, the U.S. Securities and Exchange Commission (SEC) announced (https://www.reginfo.gov/public/do/eAgendaMain?

operation=OPERATION_GET_AGENCY_RULE_LIST&currentPub=true&agencyCode=&showStage=active&agencyCd=3235&csrf_token=739

86BB1C8D8833E7C234D63D2431A704BEFB764D7F40398DEE4CDAA0AE09B71BAFC48906485A4984A5D914BEF28D9B88936) that it

will issue revised rules to implement the clawback provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2021.

The existing proposed SEC clawback rules (https://ogletree.com/insights/faqs-on-the-secs-proposed-clawback-rule/) generally require a

public company to adopt a clawback policy to recover excess incentive compensation paid to current or former executive o�cers during

the three �scal years prior to the date the company is required to �le a �nancial restatement due to a material error, regardless of whether

the restatement is caused by an executive's misconduct.

Although the SEC's clawback rules apply to public companies, private companies are viewing clawback policies as good corporate

governance and are adopting similar practices. In anticipation of this new guidance, companies may want to review their clawback policies

to con�rm they comply with current SEC guidance.

Companies might also consider implementing clawback policies that extend beyond �nancial restatements (e.g., requiring employees to

return incentive compensation awards if grounds exist for a "for cause" termination), as well as revisiting the "cause" de�nitions in executive

compensation arrangements to con�rm that they adequately protect the company.

2. Change in Control and Severance Agreements

Due to �nancial challenges, a number of companies are facing di�cult restructuring decisions. In addition, many �nancial buyers and

competitors have not abandoned their strategic business plans and may initiate acquisitions of companies that are temporarily undervalued

in the COVID-19–disrupted economic environment. Accordingly, companies may want to review existing change in control or severance

arrangements or implement new arrangements.

With respect to severance arrangements, it is important to consider whether they are subject to the Employee Retirement Income Security

Act (ERISA) and Internal Revenue Code Section 409A, and, depending on how post-termination health bene�ts are provided, determine

any continuing health bene�ts compliance issues under COBRA. Companies should consider reviewing change in control arrangements to

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ensure leadership continues to be focused on the company's business and is protected in the event of an unexpected or unwanted

transaction.

3. Temporary Salary Reductions

In light of the ongoing COVID-19 pandemic, many companies have changed a number of their internal compensation policies or practices in

2020. For example, companies may have implemented temporary salary reductions with promises to repay forgone salaries either later in

2020 or in a future year. It may be a good time to revisit such arrangements and ensure that any repayment is completed prior to March 15,

2021 to avoid potential Code Section 409A concerns.

In addition, companies may want to be aware of any state wage and hour laws implicated by these salary reductions. Publicly traded

companies may want to con�rm whether repayments are required to be disclosed under SEC rules.

Companies that implemented salary reductions may be at risk of losing key executives to competitors and should consider whether

restoring compensation (or, alternatively, o�ering discretionary bonuses or retention awards) would assist in e�orts to retain and motivate

key executives.

[SHRM members-only toolkit: Designing Executive Compensation Plans (www.shrm.org/resourcesandtools/tools-and-

samples/toolkits/pages/executivecompensationplans.aspx)]

4. 2020 Performance Awards

The pandemic has a�ected the ability of many companies to e�ectively set performance goals and determine payouts for long-term and

annual incentive compensation programs. In determining 2020 incentive award payments, companies that have been signi�cantly

impacted by the pandemic may choose to exercise compensation committee or board discretion to adjust performance metrics set earlier

this year.

In making these determinations, companies may want to con�rm that incentive compensation plan documents provide the compensation

committee or board with discretion to make adjustments. Companies should also consider establishing a framework that takes into account

how discretion will be applied this year and in future years.

Publicly traded companies planning to adjust performance goals should be aware of guidance from proxy advisory �rms, such as

Institutional Shareholder Services and Glass Lewis.

5. 2021 Incentive Compensation

Because the e�ects of the pandemic on the economy in 2021 and beyond remain unclear, it may be helpful to con�rm that incentive

compensation programs explicitly provide the compensation committee and board with the discretion to adjust performance metrics and

determine payouts.

In designing 2021 incentive compensation programs, companies may want to consider the current economic climate while keeping in mind

that incentive programs serve the important purpose of e�ectively motivating and retaining key executives. For instance, some companies

may change �nancial performance metrics to strategic metrics (such as satisfying diversity, equality, and inclusion objectives) to address the

economic uncertainty or may delay setting performance goals until later in 2021 when there is more clarity regarding a company's business

outlook and macroeconomic trends.

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Other companies may include a lower maximum payout but also lower the eligibility threshold for receiving a performance award. To

address the uncertainty of incentive compensation payouts, it might also be useful to provide retention bonus opportunities to key

executives to maintain and motivate current business leadership.

Each of these key issues is important to discuss with outside counsel and compensation consultants when making decisions about

executive compensation this year and when considering 2021 changes.

John A. Morrison (https://ogletree.com/people/john-a-morrison) is the team leader of the executive compensation practice at law �rm

Ogletree Deakins, in the �rm's Atlanta and New York City o�ces. Alexandra Orsini Barone is an associate in the �rm's Washington, D.C.,

o�ce. © 2020 Ogletree, Deakins, Nash, Smoak & Stewart, P.C. All rights reserved. Republished with permission.

Related SHRM Articles:

Fewer Workers Will Get Pay Raises in 2021; Bonuses Gain Ground (www.shrm.org/ResourcesAndTools/hr-

topics/compensation/Pages/fewer-workers-will-get-pay-raises-in-2021-as-bonuses-gain-ground.aspx), SHRM Online, November 2020

Executive Pay Measures Shift Toward Fairness, Social Responsibility (www.shrm.org/ResourcesAndTools/hr-

topics/compensation/pages/executive-pay-measures-shift-toward-fairness-and-social-responsibility.aspx), SHRM Online, September 2020

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News, trends and analysis, as well as breaking news alerts, to help HR professionals do their jobs better each business day.

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COVID-19 — Managing executive pay and incentives in uncertain times

COVID-19 — Managing executive pay and incentives in uncertain times 2

In a matter of three months, COVID-19 has rapidly transformed from a local virus outbreak to a global pandemic. While the stress it has put on society at large and healthcare systems around the world is unprecedented, it has also almost brought the global economy to a grinding halt.

This slowdown is likely to be prolonged, and given the scale and severity, businesses need to adapt quickly. In the short term, organizations will need to adopt some cost- containment measures, and rethink their cash flows and working capital requirements.

An important piece of the jigsaw for organizations from this perspective is remuneration. Often constituting one of the largest “controllable” costs, organizations need to undertake careful planning to retain, reward and motivate employees through this crisis.

Extraordinary times demand extraordinary measures

In response to the COVID-19 crisis, several companies in Singapore, and around the globe, are already implementing executive pay reductions in the form of salary freezes and voluntary pay cuts or reduction and deferral of bonuses. These include Marriott, Lyft, BT, Santader, Singtel, SATS, SP Group, Singapore Airlines and Temasek Holdings, among others.

While the overall financial impact of executive pay cuts on the company’s bottom line is likely to be limited, such cuts are critical from a leadership, perception and messaging perspective. At a time when share prices are plunging and as companies may need to consider headcount reductions, executives cannot be seen as financially insulated.

From a remuneration standpoint, however, most senior executives are paid significant proportions of their total compensation through performance-linked variable pay awards — both cash and equity. These awards are bound to be dramatically affected by the slowdown.

To put this in perspective, senior executives in Singapore typically receive between 40% and 70% of their total pay in performance-linked incentives, up to half of which could be in long-term, equity-based vehicles. In comparison, most other employees only receive between 10% and 20% of their total pay in incentives — usually as annual cash bonuses.

It ’s now become critical for organizations to effectively navigate and manage variable pay components by trying to balance the affordability aspects with fairness to ensure that motivation and productivity levels do not drop — which can arguably have a major enduring impact on business performance.

COVID-19 — Managing executive pay and incentives in uncertain times 3

What can boards and remuneration committees do?

In Mercer’s discussions with multiple boards and management teams over the past few weeks, we’ve seen that a number of alternative approaches are being considered with respect to variable compensation for executives:

• Reducing budgets for annual executive and employee cash incentive programs in view of lowered performance expectations and the need to better manage immediate cash flow and expenses. Organizations need to be mindful to do it in conjunction with reduced performance goals, or management will be doubly penalized with reduced budgets and below par performance, resulting almost certainly in low or no payouts.

• Revising targets for incentive awards for FY2020 and beyond — especially where they were set prior to the COVID-19 outbreak taking hold. While in some sectors in particular this is necessary, given the immediate nature of the impact, it ’s still difficult to forecast the duration and scale of such impact as the situation continues to evolve. It ’s important to bear in mind that reduced expectations have to be balanced with reduced spending to manage affordability of budgets.

• No adjustments made to either budgets or targets for incentive awards, given the uncertainty. Boards and remuneration committees would make discretionary adjustments at year-end based on actual outcomes and business response, considering talent risk, pay competitiveness and affordability.

• For equity-based, long-term incentive awards there are multiple implications and considerations:

– Equity-based compensation can serve as a useful reward and retention tool, especially when cash spend on salaries and incentives is being reduced. Many start-ups are adopting this approach to reduce cash-burn rate.

– Setting long-term targets for future grants as per business expectations, but allowing for either the exclusion of the period for COVID-19 in performance calculations or “retesting” targets midway through the grant cycle should the impact be prolonged and deeper than expected (a less preferred approach by institutional shareholders).

– Given the share prices for most companies have dropped around 20% to 30% on average in the last few weeks, any grants made right now would inevitably result in a higher number of shares being awarded, resulting in higher dilution/depletion of share reserves. Boards are considering either delaying the grants to later in the year when share prices normalize, or awarding the same number of shares as last year, using a three-month average share price or capping the dilution impact, in order to normalize share award grants for FY2020.

– It ’s also important to note that where adjustments are being made to current year share awards, historic awards impacted by the current outbreak must also be adjusted appropriately. Given most awards are based on aggregated performance over two to four years, companies should exclude the COVID-19 impact period from performance calculations to maintain consistency in approach.

– As the full impact and duration of COVID-19 remains an unknown, it ’s difficult to set meaningful and accurate long-term targets for performance-based awards. One way to provide for that inaccuracy is by expanding the range between threshold and superior levels of performance expectations, hedging against significant deviations and avoiding major volatility in payouts. Another way is to increase the usage and proportion of relative performance measures, so managers are rewarded for how they performed against their peers rather than against absolute targets.

– Boards are also considering replacing a proportion of the performance-linked share awards with time- vested restricted share awards. This hedges against any unfair and undesirable volatility in executive earnings, overcoming accurate long-term target- setting limitations and providing a retention tool to secure talent when the business emerges from the crisis. This should inevitably be clubbed with reduced award sizes, longer vesting periods or higher shareholding requirements for executives to ensure they are held accountable for a positive and sustained post-crisis recovery.

In all of this, companies must take a long-term approach to variable pay, ensuring that executives’ behaviors are aligned with the long-term success of the company.

COVID-19 — Managing executive pay and incentives in uncertain times 4

Responding from the top

At times such as these, it ’s important that a company ’s leaders are front and center, ensuring they guide their people through this difficult period by maintaining a sense of fairness, commitment and optimism. To do so, they must ensure that they are not seen as protecting self-interest over the interests of employees, shareholders and the broader community.

Company boards across industries are responding by reducing their own fee levels to express solidarity with senior management and shareholders.

But in addressing the immediate challenges, it is also important that organizations do not overlook long-term business priorities and linkages to compensation structures, and the need to effectively communicate these with senior management and employees. Companies need to acknowledge that talent is a scarce commodity, and therefore they must do enough to retain their best, especially as they emerge from this outbreak.

It ’s heartening to see companies respond to the downturn in humane ways. Some are setting up funds to address hardships faced by their employees while several company executives are forgoing their paychecks to contribute toward humanitarian efforts to support communities.

This is as much a test of leadership as it is of businesses. Those who lead from the front and row the boat to safety — while ensuring no one falls over — will emerge in the best shape to thrive when this crisis abates.

Author

Nishant Mahajan Head of Executive Remuneration, ASEAN E: [email protected] T: +65 8163 8451

Nishant leads the Executive Remuneration Advisor y business for Mercer across the ASEAN market. He currently advises remuneration committees and boards of some of the leading listed and privately owned companies across multiple industr y sectors, investor profiles and strategic challenges. He also suppor ts the Singapore Institute of Directors professional development programs and is par t of the guest faculty with the INSEAD MBA module on incentives and per formance.

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