This article was published in The Business Times on April 10, 2020 and BRINK on May 11, 2020.
In a matter of three months, COVID-19 rapidly transformed from a local virus outbreak to a global pandemic. While the stress it has put on society at large and on health care systems around the world is unprecedented, it has also nearly 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
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 in response to the COVID-19 crisis.
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 paid significant proportions of their total compensation through performance-linked variable pay awards — both cash and equity. These awards are bound to be dramatically impacted by the slowdown.
To put this in perspective, senior executives in Singapore typically receive between 40%-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%-20% of their total pay in incentives — usually as annual cash bonuses.
Presently, it is 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.
What Can Boards and Remuneration Committees Do?
In Mercer’s discussions with multiple boards and management teams over recent weeks, it has come to light that a number of alternative approaches are being considered with respect to variable compensation for executives.
One approach includes reducing budgets for annual executive and employee cash incentive programs in light 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.
Another route is to revise 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 is still difficult to forecast the duration and scale of such impact as the situation continues to evolve. It is important to bear in mind that reduced expectations have to be balanced with reduced spending to manage affordability of budgets.
If no adjustments are made to either budgets or targets for incentive awards, given the uncertainty, boards and remuneration committees could make discretionary adjustments at year-end. These would be 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 startups 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 mid-way through the grant cycle should the impact be prolonged and deeper than expected. This would be a less-preferred approach by institutional shareholders.
- Given that the share prices for most companies have dropped around 20%-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 to normalize share award grants for FY2020.
- It is also important to note where adjustments are being made to current year share awards; historic awards impacted by the current outbreak must also be adjusted appropriately. Given that 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 unknown, it is 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 pay outs. Another way is to increase the use and proportion of relative performance measures so management is 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.
Responding From the Top
At times such as these, it is important that a company’s leadership team is front-and-center, ensuring they guide their people through the 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.
In addressing the immediate challenges, it is also important that organizations do not overlook long-term priorities of the business, links 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 is 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 foregoing 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.