Steve Pakela AND Brian Schiering of Pay Governance ask understatedly, “Is a Replacement for Your Short-Term Incentive Plan Right for You?”
Let us be very clear about this: That is not the right question. The question is, “Is any adjustment of the incentive compensation right for shareholders?” The purpose of incentive compensation is to align the interests of executives with investors. Unless Pay Governance has some plan to replace their losses, the answer is no. Shareholders should be very skeptical about efforts along these lines and should at a minimum insist that any gains be indexed so that there are no windfall profits from overall market rebounds.
An excerpt from their statement:
When it comes to 2020 incentive arrangements for calendar-year-end companies, COVID-19’s arrival in the United States could not have come at a worse time. The vast majority of these incentive plans were approved by compensation committees in February, prior to many businesses being thrust into financial and public-market turmoil. When these plans were approved, it was generally business as usual for most companies, and shareholders were enjoying stock price peaks. Performance goals were based on company budgets established during the fourth quarter of 2019, back when the prospects for 2020 were much different than they are today. Within short-term incentive arrangements, performance metrics, and individual performance objectives reflected the desire to pursue business strategies that would bring the success of the past several years to new heights. Now, at the beginning of April, so much has changed in so many ways that “everything should be put on the table” concerning executive compensation design and practice.
Today, many annual incentive arrangements are “stranded” with performance goals that are no longer achievable and performance metrics that are no longer aligned with short-term objectives. We believe that providing responsible incentives during this time will be critically important for motivating and focusing employees through the crisis and uncertainty that we anticipate over the remainder of the calendar year. This Viewpoint provides discussion points and ideas for addressing short-term incentive arrangements that are no longer achievable or appropriately aligned. Future Viewpoints will address long-term incentive arrangements and other practices.
When considering bonus plans for 2020, the good news is that The Tax Cuts and Jobs Act approved in late 2017 essentially eliminated the performance-based exemption of IRC 162(m). The elimination of 162(m) provides compensation committees much more flexibility to make changes as appropriate beyond the first 90 days of the plan year, allowing companies to consider changing performance goals, metrics, or target opportunities without adverse tax consequences. While flexibility to make changes exists, compensation committees should continue to consider the various constituents who have a powerful voice in Say on Pay and a significant stake in the company’s well-being: shareholders, proxy advisors, employees, customers, and communities.
The first question to be asked is, “Are the current performance metrics and individual objectives appropriate to support the company for the remainder of the year?”