2021: the changing landscape of executive compensation
As we enter into the second month of 2021 still faced with uncertainty, no one could have predicted that this time last year a pandemic was going to encompass the world grinding most organisations to a halt.
With companies searching for ways to survive and thrive in the ‘new normal’, Business Chief APAC explores how organisations have been managing their executive compensation plans – both in the short term and the medium to long term – and what the future will look like for executive compensation for the rest of 2021 and beyond.
Executive compensation: short term management
When the pandemic hit in March 2020, the crisis required immediate and decisive action from management teams with a focus on the wellbeing of the business, employees and supply chain partners. In an article titled ‘Managing executive compensation during COVID-19’ by Yong Fei Tan Director, Executive Compensation, South Asia, and Shai Ganu, Managing Director and Global Practice Leader at Willis Towers Watson the two explained the importance of channeling management’s efforts on crisis management in order to get past the survival phase of any crisis.
“This may lead to some non-conventional approaches in the short term. For example, linking management’s KPIs to the percentage of the workforce who are protected from the COVID-19 infection, or to healthcare and recuperation spending, or preventing job losses, or encouraging social distancing and working from home protocols. Once the business operations stabilise and companies have better understanding of market conditions, then they can resume normal performance measures and targets,” says Tan and Ganu.
In addition to non-conventional approaches to the virus, some boards took a voluntary fee reduction ranging from five to 20 per cent. Showing solidarity, some top executives from high impacted industries also volunteered to take up to 100 per cent cuts in their fixed salary while maintaining some form of target variable incentive. Meanwhile, in less impacted industries, salary increments for top executives were frozen.
“These actions can be seen as a gesture to preserve cash. More importantly, they can make a positive impact if the funds are set aside for COVID-19/CSR/Environmental, Social and Governance (ESG) efforts,” comments Tan and Ganu.
Aside from the previous two response methods to COVID-19, many organisations have taken a ‘wait and see’ approach, which Tan and Ganu have deemed as perhaps the only time that an approach like this could be reasonable and appropriate. “Rather than spending time and energy reviewing incentive plans, forecasting financial outcomes and setting performance goals, boards and management should focus their attention on human capital management.”
Executive compensation: medium to long term management
Whilst the above is suitable in the short term, organisations in the medium to long term should focus on the below for long term stability and returning to work, even if it is in a ‘new normal’ scenario.
Both Tan and Ganu highlight that employees should focus on their wellbeing including physical, mental, social and financial, while boards should consider ways to conserve cash, particularly if they are seeking government assistance, and/or are deploying cash flow and cost containment initiatives.
It is also important to maintain an enhanced and clear line of communication between investors and stakeholders. “Customers and the media are more likely to scrutinise pay decisions made,” comments Tan and Ganu. “Proactive and effective communication, and engagement with shareholders, employees and the public to manage optics is paramount given the significant changes. We expect ongoing communication and implementation of human capital management metrics into incentive plans and/or governance oversight to progress.” The two also emphasise the importance of documenting and analysing the outcomes of the pandemic, adjusting long term executive compensation strategies to build resilience.
In addition, Tan and Ganu identify two other important long term focuses for organisations, these include talent retention and restructuring. “In times of crisis, business opportunities and talent pool becomes available, and at times, at a bargain. Development and/or enhancement of existing talent retention program therefore becomes crucial,” comments Tan and Ganu, who add that “While long standing compensation principles (align, attract, retain, incentivise, and hold accountable) still apply, this may be a great opportunity for boards to consider shifting the focus of its executive compensation plans to take a more balanced perspective, such as the increased focus on ESG measures and on all stakeholders.”
Executive compensation: 2021 and beyond
With the potential for the post COVID-19 world to provide “an opportunity for companies to thoroughly review their executive compensation plans and make changes that otherwise would have been difficult to implement before the pandemic crisis” Willis Towers Watson, in an article titled Asia Pacific incentive plans will look a bit different in 2021 by Don Delves Managing Director, Practice Leader, Executive Compensation, North America, and Trey Davis Executive Compensation Leader, the two highlight that “the timing and speed of an economic recovery is debatable, but one thing we know for certain is that we are living with much greater uncertainty and risk today than before the pandemic [...] The economy going into 2021 will be weaker than it was going into 2020.” With this in mind, Delves and Davis have outlined seven executive compensation initiatives that companies should consider in 2021 and beyond.
- De-risk the incentives – In a high risk business environment with increased uncertainty, Delves and Davis explain the benefits of reducing the risk and leveraging embedded incentives. “This means less upside and less downside, and less incremental payout per unit of incremental performance.”
- Set lower performance goals – With the likelihood that the economy in 2021 will not be as well performing as expected prior to COVID-19, Delves and Davis also highlight that companies will be looking to lower their performance goals for 2021. “If companies reduce goals, they should consider the total cost of the incentive plan relative to the lower profit or other performance goal to make sure appropriate sharing ratios are maintained within a reasonable range.”
- Changing the performance measure mix – Depending on the opportunities and challenges that present themselves in the rest of 2021, the two identify that it could make sense for organisations to place a higher weight on cash flow or EBITDA and a lower weight on revenue.
- Strategic measures and/or objectives – With the pandemic highlighting the need for organisation to rethink their operation models in order to maintain employee engagement and business operations, Delves and Davis note that “this may be the time to make key strategic moves like making an acquisition, exiting a business, repositioning assets, accelerating new technologies, shifting costs and investments between businesses, or taking advantage of market inefficiencies and dislocations.”
- Relative performance measures – “In uncertain times, performance relative to peers is a good way to gauge how well a company is performing and avoids the difficult challenge of setting goals,” comments Delves and Davis. While making direct financial performance comparisons to other companies can be challenging, the two further explain that relative performance is the best way to maintain relatively simple metrics.
- Transitioning to long term incentive (LTI) mix – whilst many companies in Asia have begun to move to an LTI mix, Delves and Davis cautions that 2021 may be the appropriate time for companies to ensure that they are not relying too much on performance vesting shares – a common executive compensation initiative for Aisan companies compared to Western markets.
- Annual goals for long term performance plans – with the continued economic uncertainty as a result of the pandemic, it is nearly impossible for companies to set realistic three-year goals. Instead Delves and Davis state that organisations should consider developing three one-year goals. “Rather than setting three-year cumulative goals, consider average performance over three years, or simply focus on performance in the third year of the plan (for example, achieve a certain level of revenue or profit by year three).”
While we remain in a period of great uncertainty that is likely to continue beyond 2021, organisations should expect that some aspects of the pandemic’s effects will be temporary, but “others will be more permanent and reflect fundamental shifts in the economy and how business gets done. As a result, as companies adapt their 2021 incentive plans to the current reality, they should consider whether the changes are temporary to reflect these unusual times or are more reflective of longer-term changes in the business landscape and strategy,” concludes Delves and Davis.