Pay Pressure Boils Over
Nothing is off the table this year in revamping executive compensation programs.
David McCann - CFO.com | US
January 29, 2009
This undoubtedly will be a pivotal year for finance in all kinds of ways. It is debatable whether one issue, executive compensation, is deserving of so much attention, given the deep seismic shocks across the financial system. Still, market and governmental forces are aligning in the direction of vast change on the pay front.
Companies may break with current practices on underwater stock options, bonus calibration, golden handcuffs, and the mix of long-term and short-term elements of compensation packages, among others. They likely will be pressed to make greater disclosure of executive comp programs, and they may even be required to give shareholders an advisory vote on top managers' pay.
At stake is nothing less than the public perception of their business acumen — a pretty important asset in the current shaky climate. "We're going to see companies either applauded or criticized based on how they respond to these challenges," says Mark Poerio, a compensation and benefits partner at the law firm Paul Hastings.
This year will see more than half of U.S. companies (54 percent) paying smaller bonuses for 2008 performance than for the prior year, according to a survey of 513 companies released today by Towers Perrin. And 4 in 10 expect executive bonuses to be 25 percent or more below last year's levels. Almost three-quarters (73 percent) say the financial crisis has affected their approach to setting 2009 performance targets.
Paul Hastings held a media briefing this week to outline the array of shifts in the executive compensation arena that are already under way or expected to take shape in 2009.
New Options?
The vast majority of stock options — at least 85 percent, according to published reports — are under water and likely to stay there for a long time.
At one time, it was common for companies to simply reprice options during economic downturns in order to hang onto their top talent. But a wave of repricings in the early 1990s led to the Securities and Exchange Commission issuing strict disclosure rules and a surge in shareholder activism on the issue that has not quelled to this day. Right now, sentiment against repricings is so deep that very few companies have taken that route. Others, at most, are weighing the costs and benefits of such a move very conservatively.
There was, though, a recent major exception: Google, which replaced all of its employees' worthless options with new ones at current market value carrying a one-year vesting period. Poerio sees that move as a likely harbinger of a thaw in companies' cold shunning of repricings.
"I think we're going to see companies straightforwardly wrestling with it, and some other leaders like Google will come out, and there will be an escalation of repricings, despite the last 15 years of shame that goes with them," he says. "In this cataclysmic downturn, you might have to rethink your prejudices and acknowledge the value of repricing if you want your people to stay."
In the Towers Perrin survey, 26 percent of responding companies have addressed underwater options or are reviewing the issue, up from just a handful of companies in the firm's fall survey.
Options that are 5 or 10 times lower than their strike price may be worse than worthless. In Poerio's view, they are psychologically debilitating: "It's a thorn in your side — a constant reminder of what the company used to be worth and what it is worth now."
The Long Haul
Even before the current crisis and the new public focus on executive compensation, companies were giving long-term and performance-based awards greater weight in pay portfolios. That shift promises to accelerate markedly now.
But it will raise a significant issue: What happens if there is a three-year cycle for an award, and it is clear at the end of the first year that the goal cannot possibly be achieved — for market reasons, say — regardless of an executive's performance over the next two years? Here too, retention would be jeopardized. Some boards are already saying they may keep the discretion to recalibrate long-term awards every year, or even every six months. Poerio calls such a strategy "quicksand."
It does smack of an attempt to do an end run around shareholders' preference for performance-based awards. Smart boards won't make that mistake. "There will be a real premium on very, very careful design of long-term incentives, working in both performance and adjustments based on the market, as well as peer-group performance," Poerio says. "That complexity is worth it, if you really want to have incentives that work."
Give It Back
Borrowing a page from the Troubled Assets Relief Program for bailed-out financial firms, many companies will be rethinking their clawback provisions. Also expect changes to severance-and-control benefits.
Currently, many companies either have no forfeiture provisions for someone leaving to join a competitor — the traditional meaning of "golden handcuff" — or they have inconsistent ones that evolved individual by individual. That will change in 2009, but the discussion won't end with disloyalty scenarios. More companies will institute clawbacks that will kick in if an executive is guilty of fraud or abuse, if there is a financial restatement, and even if the company miscalculated the award.
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