The Guerdon Associates and CGI Glass Lewis Forum addressed executive pay and board discretion
09/04/2020
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It was prescient that, prior to COVID-19, the Guerdon Associates and CGI Glass Lewis 14th annual Governance and Remuneration Forum program addressed whether or not, and to what extent, boards should use discretion to adjust executive pay.

This article summarises this panel discussion.

The Forum panel and discussion were held on 12 March, just prior to social distancing regulation taking effect.

Many companies will not meet targets and budgets, and executives are facing a zero payment, not because of any lack of effort, but due to circumstances beyond their control.

The panel considered how shareholders want to see executives paid for performance – and the effects of the pandemic have nothing to do with performance. It was recognised that some market participants hold the view that if TSR is negative, no incentives should be paid (see HERE) though others may find this too simplistic .

It was broadly recognised there is no definitive answer to the question of whether or not discretion will be accepted. However, it was agreed that many executives need to be put on notice that incentive payments for the 2020 year are unlikely if their business suffers.

Investors will be working through the ramifications of COVID-19 for quite some time. The only thing that was certain was that, with any exercise of discretion (positive or negative), messaging will be critical. If an adjustment is being made to the incentive outcome – what is the adjustment, and why is it being made?

Once the metrics have been tested and the scorecard outcome assessed, the board would need to stand back and consider:

  • the executives’ performance prior to the start of the pandemic and for the whole year;
  • whether this result reflects expected or better than expected outcomes;
  • how shareholders would react to an executive receiving an incentive payment in the circumstances;
  • any other extenuating circumstances, and make a decision.

The exercise of discretion, either way, would be based on process and procedure to result in fair outcomes and in the best interests of the company.

Companies will be expected to clearly explain and justify the discretionary adjustment and describe the factors considered by the board and its rationale for the adjustment. Presenting the details of the incentive outcome before the adjustment and the adjusted outcome will be expected. This will particularly be helpful if the discretion is a positive adjustment – what the executives received above the baseline outcome. This focus being a result of a trust deficiency whereby investors suspect boards are too lenient on management.

The discussion drew out the often-overlooked point that incentive pay is variable, and is, in fact, at-risk pay. Incentive pay should be expected to move between zero outcomes and maximum outcomes over time.

Investors and proxy advisors can be expected to evaluate on a case by case basis considering factors such as:

1 . What is the specific purpose and structure of the short-term incentives in the company?

The remuneration framework and pay mix is not the same for all companies. A company with a low fixed remuneration may pay incentives for more modest levels of performance to recognise this.

2. How much worse could the company’s performance have been?

There may be grounds for a positive adjustment if target numbers have not been met, but the company has outperformed its peers in difficult circumstances (see HERE) .

3 . What is the company’s particular situation?

There will likely be little support for positive adjustments to incentive outcomes if the company is raising capital and retrenching workers or cutting their pay. Glass Lewis’ recent policy release by Senior Vice President Research and Engagement Aaron Bertinetti (see HERE) noted that “responsible” companies hardest hit by the crisis were taking action to roll back planned salary increases or cancel above target incentives.

Mr Bertinetti went on to say “Even those companies who project a “business as usual” approach to executive pay will face opposition if employees and shareholders see their own “paychecks” cut. Companies would be wise to avoid this.”

A balance needs to be struck between alignment with shareholders and rewarding executives for their performance.

The key message, however, from the panel discussion was for boards to:

1. Sit tight and see what the rest of the year brings before firming decisions, given that many investors’ outlook will depend on the further trajectory of the crisis and many investors are still formulating their views on executive pay.

2 . Manage executive expectations .

3 . When the year has closed, ensure a considered approach to discretion with detailed justification considering the company and social context.

In the words of Glass Lewis’ Aaron Bertinetti:

“The stark reality is that for many workers, including executives, they should not expect to be worth as much as they were before the crisis, because their free market value as human capital has now changed. There is a heavy burden of proof for boards and executives to justify their compensation levels in a drastically different market for talent.”

© Guerdon Associates 2021
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