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29 April, 2020

 

As Remuneration Committees meet to discuss executive pay in 2020, Covid-19 is expected to have a profound impact on pay packages.

 

Many companies with December year ends, both listed and unlisted, are currently reviewing pay and incentive rewards for their senior executives.  Even those with alternative year ends will be dealing with these issues in the not too distant future.

 

Many companies are looking at their packages with a critical eye. If a business is furloughing employees or taking any other form of government support, it needs to consider very carefully whether it’s appropriate to award pay rises and bonuses in 2020. Many such businesses will be considering pay reductions for executives in order to support their employees.

 

Even if it’s not receiving government support, it should also consider its stakeholders and how they will view increases. Obviously, shareholders are key stakeholders, as dividends may have been reduced or withdrawn, but it should also consider employees and how they’re faring – especially any with zero-hour contracts – as well as how suppliers are being treated.

 

 

Fixed pay and bonuses

 

Reductions in fixed pay for executives is not an uncommon response to this crisis. A smaller proportion of businesses are also delaying or cancelling bonus payments. However, many feel that where the bonus relates to performance in 2019, it’s unfair to penalise recipients for events in 2020 – especially since pay may be impacted this year.

 

The challenge for management teams is that people will need to make a huge contribution to the business during the crisis, and use innovation and ingenuity to navigate their companies through difficult times.

 

As a result, setting targets for annual bonuses in 2020 will be tricky, and the level of economic uncertainty means it might be difficult to set financial targets. The best response may be to set a range of performance targets based on the latest assessment of the impact of Covid-19 on the organisation. The other alternative is to wait a bit and set them later in the year.

 

 

Long term incentive rewards

 

Another approach is to exercise discretion when assessing pay at end of year, taking into account changes in the company’s circumstances and the strategies that were used to deal with them. This is particularly significant in dealing with long term incentives as well as short term incentives.

 

For existing rewards, performance targets may not be met. But it is controversial even now to change rewards that have not yet vested. Instead, it is preferable to wait until vesting and for the Remuneration Committee to exercise its discretion according to the organisation’s response to the pandemic.   It should be borne in mind that the exercise of discretion to limit vesting is always more popular with investors than using discretion to allow additional vesting!  A strong rationale and good communication are important tools for the Remuneration Committee in this situation.

 

When it comes to new awards, there is scope to reduce the number of shares awarded.  However, don’t be in hurry to do so.  Investors have indicated that they do not expect such a reduction if the drop in share price is attributable only to COVID 19.  If the fall is due to the poor performance of the company compared to its peers, then a reduction in the award equal to 50% of the share price fall, would be typical practice.

 

The use of discretion by the Remuneration Committee when it comes to the vesting of bonuses or long-term incentives could leave the committee open to criticism. But it’s probably an unavoidable part of responding to these difficult times. Scenario planning and modelling outcomes could be a good way of dealing with any potential fallout.

 

The Remuneration Committee has a difficult task on its hands - its decision needs to be appropriate to the context of the organisation and incentivise strong performance going forward in these challenging conditions. The answers are likely to look very different to previous years’ packages. 

 

Guidance and updates on executive pay are coming out from investors on a regular basis. If you would like to talk to someone about any of these issues, contact Amanda Flint on amanda.flint@mercer.com

 


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