Long-term incentives in a COVID-impacted world
Although the severe downturn in global equity markets has largely reversed itself, there are numerous factors with important implications for outstanding and future long-term incentive (LTI) equity compensation awards:
Many analysts perceive that rebounding equity values are divorced from economic fundamentals, and therefore are likely subject to significant future volatility
Uncertainty regarding the future direction and cadence of COVID-19 make it almost impossible for management teams to reliably project future financial performance expectations related to the P&L
Uncertainty also weighs on the future of the company’s balance sheet as revenues and profitability are depressed, impacting future strategies for growth
In this environment, companies have many questions regarding the design and administration of their LTI / equity platforms. Many considerations will influence how these questions should be addressed, including:
Q: Can (or should) we change the performance objectives in our LTI awards?
A: How do projected results align with original range of performance expectations? What clarity do you have today regarding future events and financial projections? Does your eligible workforce rely on regular internal communications around performance objectives and progress towards same? Are employees comfortable with how the Board has exercised judgment/discretion in the past?
Q: Should we delay making normal awards that have financial performance requirements?
A: Are you able to set reasonably predictable goals at this time? How soon can you project the ability to set reasonable goals? Are relative goals (in comparison to peers or an Index) a reasonable substitute for internal goals?
Q: Should we reconsider our mix of LTI vehicles to move away from goal-based awards towards those that reward retention and/or simply stock price gains?
A: Are employees optimistic about a stock price rebound? What level of imbedded gains and retention value is already held by the eligible population? What are internal perceptions of the stock price as a performance indicator? What have investors communicated to the company regarding the performance orientation of past awards?
Q: How should we calibrate the value of our awards in light of stock price declines?
A: How much has the stock price declined and was the decline sudden or gradual? How many shares are available in your share pool? When did you last seek shareholder approval for more shares? Have you historically solved for the value or number of shares in making equity awards?
In these situations, it is important to understand that there is no one-size-fits-all solution, as the foregoing factors do not impact all companies or industries equally. On one end of the spectrum, transportation, leisure, hospitality, and retail companies have been hit hardest by mandatory business closures and the obvious decline in consumer spending; these stocks continue to trade at levels as much as 75% below pre-COVID levels. The span of potential changes these organizations may need will vary significantly.
In steep contrast, shares in technology and fin-tech sector companies have been more resilient and in some cases have rebounded to levels that far exceed pre-COVID levels. These organizations are unlikely to require any meaningful modifications to their LTI platforms.
Responses to questions regarding LTI / equity awards must be tailored to each situation. We find that companies often confront situations like these with short-term tactical solutions that may have poor (or at least disjointed) long-term implications.
As such, we encourage companies to revert to their foundational pay philosophy and consider a few complementary principles by which to judge potential solutions:
Preserve (or improve) alignment with the investor experience
Adopt sustainable programs to avoid a need for serial changes
Make allowance for the use of discretion – sound judgment informed by 20/20 hindsight is always appropriate
Balance financial and non-financial objectives in moving towards the new normal