As companies revise their executive compensation practices in 2009 to address the economic downturn, they need to balance good governance and fiscal discipline with the need to keep top talent, compensation experts advise.
Douglas
Corporate America won’t see a complete revolution in executive pay, but many companies are likely to amend at least some parts of their pay programs this year in response to painful drops in revenue, says Mark Poerio, a compensation specialist at the law firm Paul, Hastings Janofsky & Walker. He, along with partners Eric Keller and John Douglas, shared their views on compensation pressures at a Jan. 27 roundtable discussion to offer companies advice on what to expect this year.
Executive compensation has long been a lightning rod for criticism, but the financial crisis has put it under an especially harsh spotlight in the last six months. Washington is abuzz with calls to curb executive pay—especially for companies that take any government bailout money—and shareholders are clamoring for more say over executive pay packages. And for the first time in memory, scores of companies are cutting CEO salaries both to save money and blunt criticism.
Poerio
“It certainly doesn’t play well in the public eye to have highly paid executives amid all the downturn and hardships,” Poerio noted at the roundtable. At the same time, he says companies must remember the basic fact that their executive talent represents the value of the company.
“Making sure your stars stay put is a key factor,” he says. “As much as we want to say, ‘Forego high pay in bad economic times,’ it’s not a motivator and it will generate a flight of talent.”
That aside, he said, companies can also take a few other steps to simplify and clean up their compensation practices, and to retain important employees. For example, he predicts more companies will reprice stock options to offset the effects of huge amounts of underwater stock options.
Repricings were common in the late 1980s and early 1990s, but fell out of favor in recent years as shareholder activism has increased. But now, with a raft of worthless options out there, companies such as Google have recently announced repricing programs, and others are likely to follow suit, Poerio said.
Keller noted that recent changes to accounting rules have made repricings easier. Companies can lock in their incremental expense based on the increase in the value of the option as of the repricing date, and then expense it over the remaining vesting period. “Companies do have an expense for repricing, but the expense exposure is much more limited than it used to be,” he said.
“Compensation committees … are in a much better position to go to executives who have employment agreements that contain out-of-date provisions and say, ‘That’s not market practice today. We want to renegotiate your contract.’”
— Mark Poerio,
Compensation Specialist,
Paul, Hastings Janofsky & Walker
Poerio also expects more companies to shift further away from short-term incentives toward long-term ones.
“I think we’ll see a real premium on very careful design of long-term incentives to work in performance, to make adjustments based on the market, and to take into account for peer group performance,” he said. Companies may also change their ratio of short-term to long-term incentives, for example from 50-50 to 20-80.
Less Forgiving Attitudes
Another likely trend: attaching strings to deferred compensation.
Currently, Poerio said, many companies either have inconsistent provisions or no provisions at all to cap or recoup payouts if an executive jumps ship to a competitor. Now they have a chance to consider clawback provisions for disloyalty, mistakes in calculations, fraud or abuse, and financial restatements.
“The downturn has created a lot of leverage for employers,” he said. “Compensation committees … are in a much better position to go to executives who have employment agreements that contain out-of-date provisions and say, ‘That’s not market practice today. We want to renegotiate your contract.’”
Poerio said some companies have begun designing clawbacks that allow them to hold a portion of an award for a certain amount of time. For example, rather than paying out all of a $100,000 bonus, a company might pay $25,000 in the current year and hold the rest of the award until a year after the executive leaves.
One new idea, which Poerio described as a “tight-fist approach,” allows companies to apply a clawback provision to past awards. For example, as a condition of accepting a stock award for 2009, a company could require an executive to agree to modify the terms of his past awards so a clawback applies both prospectively and retroactively.
Poerio also expects to see many companies disclose changes made to their compensation programs after year-end in the Compensation Discussion & Analysis section of the proxy statements they’ll be filing this spring. Changes made after year-end must be disclosed under Securities and Exchange Commission rules.
Compensation committees are also rethinking severance pay, always a sore point with shareholders. In some cases companies are tying severance pay to performance, and some are abolishing excise tax gross-ups.
Poerio and others expect shareholder advisory votes on pay packages to be a major issue (again) in the 2009 proxy season. Washington is already lining up to make such say-on-pay votes mandatory. So far, only a few companies—most recently Hewlett-Packard and Occidental Petroleum Corp.—have agreed to adopt say-on-pay votes voluntarily, but more now see the writing on the wall and are indicating they will adopt such votes as well.
Keller
Still, Keller says most companies are likely to wait until Congress takes action, to ensure they don’t adopt some reform of their own that could be more far-reaching than what Congress will ultimately require. If that happened, Keller said, companies could scale back to whatever Congress passes, but “it’s going to be perceived as a takeaway.”
Douglas meanwhile, said companies should expect more limits on compensation should they accept government bailout money—and he noted that more and more companies are likely to ask for money from the Troubled Asset Relief Program or other bailout efforts.
“There’s a general dissatisfaction in Congress” that initial limits on compensation applied to TARP recipients weren’t enough, he said. “There will be more … and as the TARP program expands, the compensation restrictions will spread.”
Douglas said one issue to watch is whether Congress will try to apply the far more draconian measures of the Federal Deposit Insurance Corporation Improvement Act of 1991; that law gave the FDIC power to regulate golden parachutes and indemnifications of directors and officers of “troubled” institutions, akin to TARP recipients today. “Congress is using the same words now about golden parachutes, and yet no one has tied those together,” he said.
But all that doesn’t mean there will be a wide reversal of past practices. Absent a company crisis or government intervention, Douglas said, changing the pay structure for an entrenched CEO is a difficult feat.
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