For some, deciding on a remuneration response to COVID-19 impacts has been like taking an exam where there is a new test format and no one has the benefit of past papers.
But many of us saw the same dilemmas during the global financial crisis. There were some companies that were concerned about retention (but where were the executives going to go?) and others that recognised that incentives were not to be had. The impact on CEO and executive pay was marked. It took ten years after the GFC for executive pay to once more reach the levels of 2007.
COVID-19 has already impacted executive pay. Data to 13 July for the ASX 200 showed that 34 companies had reduced fixed remuneration for their CEOs by a median of 20%, with a 40% reduction at the 75th percentile. Less executives saw reductions than CEOs. Non executive directors (NEDs) were the most frequent casualties of COVID – 41 companies reduced chair and/or NED fees by 20% at the median. Most reductions were short-term, for a quarter or six months at most.
However, these fixed pay reductions are not all – incentives represent a large proportion of executive pay. Of the ASX 200, fourteen companies had announced that their CEO will receive no STI. Three announced that the LTI would not pay out. This is the very tip of the iceberg. Poor last quarter results will mean many more will fail to reach the financial threshold for an annual incentive. Beyond the financial year will be probably a couple of more years of lower profits and dividends. This will wipe out not just one year of long term incentives, but several. Hence CEOs in some of the larger companies may realise pay that is half what they received in 2019 for a couple of years.
Where the first executive pay reduction announcements came as a wave that responded to general fear of the pandemic and ensuing uncertainty, the “second wave” of announcements is likely to be highly individual depending on the circumstances of the company and involve more complexity, including discretion on payment of incentives and introduction of new incentive structures to deal with an environment where no one knows what is happening over the next three months, let alone the next three years.
The following factors will dictate companies’ executive pay actions:
- Are they listed? If not, the variety of actions that can be undertaken is broader, as there will be no proxy adviser and investor guidelines to consider, or AGM votes on remuneration reports.
- What is their cash position? Desperate, constrained or comfortable?
- What happened to the bottom line? The GFC swept across the economy like a broad brush. COVID-19 is highly selective in its misery. Airlines were impacted differently to banks, which were impacted differently to healthcare and biotechnology companies. Even within each sector, specific offerings are differently impacted depending on factors such as geography or target demographic.
- What happened to stakeholders? (shareholders via share price movements, capital raisings, dividends foregone; employees via redundancies; governments via money spent; customers via inability to pay or loss of services; suppliers waiting on late payments and volatile orders)
- How good has their remuneration governance been up to this point?
- How robust is the executive pay framework to cope with uncertainty, results volatility, attraction, retention, and focus on results that matter to stakeholders
Reductions in fixed remuneration are generally about stemming cash outflows and ensuring viability. Caution is, however, advised as reductions touch on contractual obligations. Where it is possible (easy in the listed space, also possible for others depending on liquidity, shareholder and taxation issues) organisations have also swapped fixed remuneration for equity. This may take some getting used to, given that some investor and proxy adviser guidelines cannot accommodate the practice, even though it is in investor interests.
Decisions on incentives, will generally be more limited, except for less cash-constrained companies (unless paid in equity). Incentive payments will be highly differentiated across industries and sectors.
Some companies will decide not to pay incentives due to the impacts on stakeholders. We know many investors will expect this. Some investors and proxy advisers have clearly signalled that incentive payments are not to be considered if companies have sought additional capital from investors, cut dividends and/or received government support.
Other companies want to recognise the incredible efforts of staff and management in handling a pandemic situation without a rule book. Often new health and safety policies needed to be invented overnight and heaven and earth moved to maintain business continuity while safeguarding the health of customers, communities and employees. Or potentially companies want to recognise the ingenuity, thrift and sweat of staff that led to the result being -10% instead of -30%.
For those companies where COVID-19 presented opportunities to launch new products or expand into adjacencies, companies may want to recognise 100 hour weeks racing to beat a competitor with the product and marketing, designing new supply chains or navigating restrictions.
Recognition may come in the form of discretion to pay incentives despite hurdles not being met, or to pay at higher levels than usual, or implementing a special bonus to say thank you to the team. The former path will likely be more frequently trod by listed companies, with the latter a key arrow in the bow of unlisted companies.
Looking forward, the extreme uncertainty and volatility has exposed the flaws of many incentive plans, including the difficulty of setting goals. For short term incentives, “short-term” has in some cases been redefined, and performance “corridors” to be eligible for an incentive broadened. One method of COVID-coping for LTIs is to “go relative” on measures such as Total Shareholder Return (TSR), while the most spoken about alternative is to introduce a long term ownership plan. This replaces performance hurdled equity with a smaller amount of service-based equity that vests over a longer term.
Decisions on payments and new structures will vary widely depending on company circumstance and pay philosophy, but one thing is constant, and that is the need for objectivity. Any decisions should be made within a framework with numeric or concrete qualitative inputs. After all, with no logical basis for decisions, companies may risk becoming one of the case studies for how not to respond to a crisis.