Impact of COVID on executive compensation
Tuesday, March 02, 2021 @ 8:42 AM | By Trevor Zeyl, Nader Hasan and Brandon Schupp
On one hand, shareholders may be frustrated if executive compensation goes unchanged while shareholders are asked to remain patient in the face of poor financial performance. On the other hand, boards of directors and compensation committees will want to ensure that management teams are incentivized and that their interests are aligned with those of shareholders. Failing to balance these concerns appropriately may attract scrutiny from activist shareholders, who may focus on executive compensation decisions made during the pandemic as a wedge issue in the 2021 proxy season.
Two options that companies may consider in attempting to balance these concerns are cuts to executives’ base compensation and adjustments to performance-based compensation.
Executive pay cuts
It has been reported that at least some companies in Canada, including a number of TSX listed companies, have announced executive pay cuts as the financial impact of the pandemic has become more clear. Reducing executives’ base compensation may, among other things, contribute to a perception of solidarity at a time when shareholders and employees have been financially impacted by the pandemic. In the same vein, boards and compensation committees may consider the perspective of shareholders and employees before awarding large bonuses and other discretionary compensation to executives.
Potential drawbacks of reducing executives’ base compensation are that doing so may disincentivize executives and create retention challenges for some businesses. Accordingly, before implementing any pay cuts, boards may wish to consider how comparable businesses have introduced reductions to executive compensation.
Where a straightforward reduction to executives’ base compensation may create undue retention risk or raise concerns that executives may be disincentivized, it may be possible to partially offset such reductions by adjusting thresholds for performance-based compensation.
Reassessing performance-based measures
Given the challenges faced by many companies during the pandemic, performance measures established prior to the pandemic may be simply unachievable in the current environment. As such, executives may feel that their compensation shouldn’t be reduced on the basis of performance targets established prior to the pandemic, particularly given that many executives have had to shift their focus from performance targets to employee safety and other pandemic-driven concerns. Accordingly, some adjustment of performance measures may be warranted to reflect that the poor performance of many companies is not attributable to the performance of their executive teams.
However, simply eliminating performance thresholds may provoke the ire of shareholders and attract scrutiny from proxy advisers. Instead of eliminating performance thresholds altogether, boards of directors and compensation committees may consider adjusting performance measures to tailor executive compensation based on the company’s performance relative to its competitors. In assessing relative performance, companies may wish to consider not just financial performance but also health and safety, employee retention and other measures that may have been impacted by the pandemic. In this way, executive compensation may remain meaningfully linked to the performance of the company, defined broadly, but executives are not held accountable for financial challenges that may have impacted the entire industry. Such adjustments to performance thresholds may have the effect of partially offsetting reductions to base compensation for executives who have performed well during the pandemic, resulting in a more principled approach to compensation as compared to leaving base compensation untouched and performance thresholds out of reach.
Adjustments to executive compensation may be necessary for some businesses given the financial impact of COVID-19. While simply reducing base compensation may disincentivize executives and create retention risk for a company, it may be possible to offset these challenges by adjusting performance thresholds for executive compensation such that they remain attainable despite the financial impact of the pandemic. By appropriately balancing these forms of compensation, it may be possible to adopt a principled approach to executive compensation that balances the company’s need to preserve cash with the importance of rewarding executives who have performed well during a particularly challenging year.
Trevor Zeyl practises corporate and securities law, with particular emphasis on public and private mergers and acquisitions, financings and corporate governance. He is a member of Norton Rose Fulbright’s special situations team, which encompasses Canada’s leading hostile M&A, shareholder activism and complex reorganization transactions. Nader Hasan is an associate in the M&A and securities group and a member of the Canadian special situations team at the firm. Brandon Schupp is an associate with a focus on securities, M&A, corporate governance and shareholder activism.
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