- Finding the right balance. The resurgent economy has led to a significant uptick in initial public offerings (IPOs), special purpose acquisition companies (SPACs), and merger & acquisition (M&A) activity.
- Making key decisions. It’s critical to determine appropriate levels of compensation for an employee as well as the ideal compensation vehicle, given an organization’s specific industry and circumstances.
- Raising stockholder awareness. Companies preparing for an IPO or De-SPAC transaction should consider a pay philosophy that is compatible with a publicly traded status.
- Explore new opportunities and deals. Change in control (CIC) arrangements have become an effective way to attract qualified candidates and to reward top performers for their success.
- Navigating challenges. Companies in financial distress should identify key employees, consider the use of retention awards, and, in the event of a bankruptcy filing, amend current compensation plans to withstand potential scrutiny from bankruptcy courts and other stakeholders.
Over the past couple of years, the rapidly changing economic environment has forced companies to quickly pivot between compensation strategies to effectively attract, retain and incentivize employees. The sharp economic downturn at the onset of the global pandemic presented a challenge from a human capital management standpoint.
Companies had to navigate through the turbulence by striking a balance between laying off some employees and retaining others. When the economy initially rebounded quicker than anticipated, companies once again had to pivot their compensation strategies to keep pace with the red-hot job market amid the “Great Resignation.”
The resurgent economy also led to a significant uptick in initial public offerings (IPOs), special purpose acquisition companies (SPACs), and merger & acquisition (M&A) activity. Now that the dust is settling from the surge in economic activity, some companies expect that they may soon be faced with a recessionary environment if high inflation and geopolitical issues persist.
The swift nature of these economic transitions makes it imperative that companies smoothly pivot between compensation strategies to appropriately incentivize and retain employees.
Attracting and Retaining Talent in a Hot Job Market
Today’s hot job market has compelled employers to turn to creative and even aggressive compensation strategies to attract and retain top talent. One of the key drivers of attracting and retaining talented employees is a competitive pay package, in terms of both amount and design.
Employers should be armed with robust data that provides the most up-to-date market levels of competitive compensation. It’s critical to determine appropriate levels of compensation for an employee as well as the ideal compensation vehicle, given an organization’s specific industry and circumstances.
When making these key decisions, it is best to take a holistic approach that balances market factors, a company’s strategic initiatives and existing internal pay equity and structure. The amount of total compensation under any program should be meaningful and aligned with market levels for the participant’s role.
Appropriately designed incentive programs help motivate employees to achieve a company’s short-term and long-term goals. Short-term incentive plans, which are typically earned over a one-year period and paid in cash, keep employees laser focused on the near-term goals of the company. Long-term incentive plans, which are typically earned over a three- to five-year period and equity-based, are commonly tailored to a select group of employees who are responsible for the long-term growth of the company.
Determining the most appropriate incentive metrics is an important consideration in plan design. It is critical to ensure that incentive goals are achievable, but not so easy as to guarantee a payout. Otherwise, employees could be demotivated by overly aggressive goals, or not truly incentivized by goals that require too little effort.
Clear and comprehensive communication of the compensation framework is essential to a successful program. This involves clearly communicating the terms of the plan at the outset, and ongoing communication regarding goal achievement, payouts and vesting events.
Shifting from Private to Public
The rapid economic rebound saw a surge of IPO and SPAC activity. Public listings are typically a catalyst for rapid growth and change within an organization, which leads to increases in hiring volume and pressures on internal pay equity. Additionally, once a company enters the public market, it will not have as much flexibility as a private entity, therefore determining the go-forward compensation framework in advance of going public is critical.
Developing a public company roadmap ensures compensation programs are competitive, equitable and flexible enough to meet future needs, compliant with governance requirements, and aligned with stakeholder interests.
Companies preparing for an IPO or De-SPAC transaction should consider a pay philosophy that is compatible with a publicly traded status. Items to consider include adjusting compensation arrangements to be market competitive, preparing for detailed disclosure requirements around executive and board pay (e.g., CD&A disclosure, CEO pay ratio, etc.), forming a compensation committee charter, and complying with other governance policies (e.g., stock ownership guidelines, hedging, etc.).
Finally, it is critical to build key stakeholder awareness, ownership and buy-in throughout the process of transitioning to a new compensation philosophy. Having compensation discussions with relevant stakeholders will help make the pivot from private to public a more cohesive process.
Turning to Opportunistic Deal Making
The recent economic turnaround encouraged many companies to explore opportunistic deal making. Companies preparing for M&A activity should consider which key talent is critical to retain, the change in control (“CIC”) arrangements currently in place and the tax impact of the golden parachute rules. As part of the diligence process, acquirers should consider the potential cash outlay related to the target’s existing executive compensation arrangements and any related tax consequences.
CIC arrangements have become an effective way to attract qualified candidates and to reward top performers for their success. CIC arrangements are commonly put in place to ensure that executives evaluate every opportunity (including a merger or acquisition) with an eye toward maximizing shareholder value, without worrying about how such an event will affect their personal circumstances.
CIC arrangements are typically found in short-term incentive plans, long-term incentive plans, employment agreements, and CIC/severance plans. In addition to CIC arrangements, deal bonuses or retention awards may be needed to avoid attrition prior to or shortly after a deal closes.
When a CIC does occur, the CIC arrangements will trigger payments, which could subject both the corporation and key executives to significant adverse tax consequences under the golden parachute rules. If golden parachutes exceed a “safe harbor” limit, the company will lose the corporate tax deduction and the employee will owe a 20% excise tax on “excess parachute payments.”
Depending on the circumstances and the number of employees affected, the cost to the corporation and the employees could be substantial. Accordingly, it is extremely important to consider excise tax mitigation alternatives such as a reasonable compensation analysis, base amount planning, or pursuing a shareholder vote to approve the payments (for private companies only). It is also prudent to ensure that an employee’s CIC arrangement is designed for success.
Many pitfalls can be avoided through plan design that considers tax implications, regulatory hurdles, and shareholder concerns. As soon as it is determined that a CIC may be on the horizon, the company should take steps to understand the impact of the golden parachute rules to both the company and the employees.
Struggling in a Competitive Marketplace
The pandemic did not treat all industries equally. Sectors, such as technology, were positively impacted and experienced significant growth, while sectors, such as travel and hospitality, faced immense challenges.
This dynamic creates an imbalance between struggling employers seeking to retain their critical employees and other employers that try to lure those high-performing employees away. When a company becomes distressed, it can be very difficult to incentivize and retain key employees. Key employees are still needed to guide the company through uncertain times, but they are often the ones at risk of being lured away to more stable job opportunities.
Companies in financial distress should identify key employees, consider the use of retention awards, and, in the event of a bankruptcy filing, amend current compensation plans to withstand potential scrutiny from bankruptcy courts and other stakeholders.
Since employee retention is critical to a successful restructuring, companies typically implement retention awards as soon as possible to lock down key employees. Retention awards are usually designed to last at least through the anticipated period of the restructuring. Retention payments can be made in installments or in a lump sum at the end of the retention period. Retention amounts are sometimes even paid upfront subject to a clawback.
With respect to a company’s annual incentive program, existing performance metrics should be evaluated to ensure they are still appropriate and consider modifying payment timing from annually to quarterly (as quarterly programs tend to keep employees more focused in the restructuring context). Since a company’s equity is typically wiped out in a restructuring, the long-term incentive program can be converted to a cash-based program with shorter performance periods (sometimes the long-term incentive program is even combined with the annual incentive program).
Once a company has entered bankruptcy, all compensation programs must receive court approval. Employees who are deemed “insiders” for all intents and purposes cannot receive pure retention awards during a bankruptcy. Accordingly, insider compensation plans approved during the bankruptcy process must be incentive-based and be reasonable in amount and design, including the use of challenging performance metrics.
Companies have more flexibility with respect to non-insider compensation plans during a bankruptcy. Bankruptcy courts will oftentimes approve retention plans for non-insiders and allow the continuation of pre-petition bonus plans, if appropriate.
When a company emerges from bankruptcy, compensation programs are generally adjusted to reflect changes to the go-forward business. A new equity plan is typically implemented, and new employment agreements are negotiated. These new compensation arrangements serve as incentive and retention tools and will help align the employees’ interests with the new owners.
Navigating the Pivots
Boards of directors and compensation committees need to remain attentive to changing market trends and be ready to respond when challenges arise regarding the benefits provided to employees. Proactive compensation planning helps companies smoothly navigate the pivots of a volatile economy.