In their initial reactions to the COVID-19 pandemic, organizations have focused on human capital, primarily in the areas of employee well-being and the safe continuation of operations to meet customer demand. As a result, many organizations have yet to address incentive pay issues.
Some organizations made incentive awards before the onset of COVID-19, while others proceeded on a business-as-usual basis with an eye to adjusting when more information was available. Regardless of the approach taken, upcoming compensation committee meetings promise to tackle complex and potentially controversial topics.
Research from Willis Towers Watson revealed that most (74%) organizations are proceeding with an annual incentive plan that is consistent with last year’s, while 12% indicated they have made more substantive changes. A small number of companies (5%) indicated that, as a result of COVID-19, they suspended their plan for the year.
Among those respondents with incentive plans, one in six reported that they have taken action, and over half are planning or considering changes. The most common responses include planning for discretion at year-end, adjusting previously approved goals, changing performance metrics, delaying goal setting, widening ranges and moving to a purely discretionary plan. Most of these are actions being considered and are likely to be topics of discussion at upcoming compensation committee meetings.
“The most common response has remained consistent since we started surveying incentive plan actions: Plan for discretion. This is an important discussion to have ahead of time to ensure the appropriate accruals are happening throughout the year,” according to the Willis Towers Watson blog. “Many companies either approved their annual incentive plans prior to the full global onset of COVID-19 or decided to proceed on a business-as-usual basis recognizing the near impossibility of goal setting in the current environment. As a result, many plans are tracking below threshold, which may not reflect the efforts being taken by participants, including but not limited to executives. Despite this, we are still not seeing many companies adjusting previously approved goals reflecting the continuing uncertainty.”
Where more proactive action is happening, Willis Towers Watson found the following:
- When goal setting has been delayed, most companies anticipate finalizing goals during Q2.
- When target bonus award values have been or could be reduced, it is typically by less than 50%, although around 15% of those making/planning reductions might make larger reductions.
- When performance periods are being modified, practice is mixed with a slight bias toward using two six-month periods for the 2020 performance year.
Change of Focus
For many organizations, another significant reason either to consider discretion in the annual incentive plan or to move to a purely discretionary plan is the diminished relevance of the performance metrics established at the start of the performance period. While in a “typical” year the organizational focus may be on top-line sales, if customers are not buying, that focus is pivoting to areas more within participants’ control, such as margin, cost management, cash flow and liquidity, Willis Towers Watson said.
A minority of companies (26%) indicated that they have made changes to performance metrics or are planning or considering changes. Profit, top-line and earnings metrics were the most commonly observed to have a reduction in goal level. Where companies added new metrics, the most common included human capital metrics, nonfinancial metrics such as milestones or environment- or employee-related goals — the “E” and the “S” in ESG (environment, social and governance) — individual performance, cash and efficiency metrics.
“We expect that the use of human capital metrics may increase more rapidly following this pandemic, as boards and investors become more acutely aware of the importance of effective human capital management,” according to the blog. “This is perhaps an early sign of bigger things to come.”
Long-term incentives represent a significant investment for organizations — a way to deliver meaningful value while aligning recipients’ interests with those of shareholders and focusing on key performance priorities.
The survey found that around a quarter of organizations indicate that they are considering the use of supplemental awards — either for select individuals (28%) or broader populations (19%) — likely reflecting concerns around retention with projected low levels of vesting and depressed award values in the current environment.
As it relates to performance-based, long-term incentive plans, one in five organizations has already taken action. However, almost 60% of organizations are considering action in at least one area, most commonly intending to consider discretion on vesting, changing performance metrics, adjusting previously approved goals or delaying goal setting altogether.
Willis Towers Watson notes that any actions that impact the named executive officers will require disclosure in the compensation discussion and analysis (CD&A) at year-end, so organizations should consider how to disclose the merits of potential actions to shareholders.
“Proxy advisors have acknowledged they will likely have to use more judgement than in prior years; therefore, transparent and compelling disclosure will be critical,” according to Willis Towers Watson. “Contextualizing potential actions through an external lens may help inform discussions and decision making.”