July 27, 2020
ISS Publishes COVID-19 Case Study Focused on Executive Compensation Adjustments
By Greg Gautam and Matthew P. Chiarello
As we previously reported in prior SW Benefits Updates (links below), the challenges presented to management and corporate boards from COVID-19 are significant. Among other considerations, companies might adjust 2020 performance goals, delay compensation decisions or change the mix of equity awards by making more full-value grants. In recent months, proxy advisors Institutional Shareholder Services (“ISS”) and Glass Lewis have published guidance with respect to these and other governance issues (summarized here and here).
To provide further clarity with respect to executive compensation issues, ISS has released the first of four case studies setting forth a framework for the adjustment of annual incentive goals and reductions to CEO annual incentive awards in light of COVID-19. The full case study is available here and we offer a brief summary of the study below. We encourage you to read the case study in its entirety.
Facts: Before the pandemic, a midcap retail company’s compensation committee approved fiscal year 2020 goals and adopted Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”) as the only metric to determine awards under its CEO’s annual incentive program.
Response to COVID-19: The onset of COVID-19 forced the company to close all of its retail locations and rendered the performance goals unattainable. In order to keep its CEO motivated, the compensation committee revised the EBITDA targets by adjusting the projected growth rate downward and the volatility assumptions upward. In addition, the compensation committee reduced the CEO’s award opportunity by 25 percent consistent with pay-for-performance principles and reflective of the reduction in the EBITDA targets.
Benefits: ISS indicates that this response motivates the CEO to obtain full-year operating results by reference to clear metrics, while still aligning performance with shareholder interests. In addition, ISS notes that prospectively adjusting the metrics makes it less likely that the compensation committee will need to exercise year-end discretion to calculate the payout of awards.
Drawbacks: The case study points out the challenges in adjusting the underlying assumptions that result in a lower EBITDA target in light of the uncertainty around COVID-19. Moreover, ISS suggests that this proactive approach may draw shareholder criticism for revising goals to be more easily attainable, especially if the economy stabilizes sooner than forecasted.
ISS makes clear that the above case study is intended to highlight relevant considerations, but does not reflect any specific recommendation from ISS and that compensation committees will almost certainly need to consider a myriad of options to determine the appropriate adjustments, if any, to their respective compensation programs. We will continue to report on these case studies as they become available.