Responsible Executive Compensation During Times of Crisis

Bonus Feature

BY SHAI GANU, DON DELVES AND RYAN RESCH

gainst rising concerns of mortality, livelihood and recessions driven by COVID-19, “How much should executives get paid?” is, understandably, not the A most pressing question to be answered. This pandemic is, first and foremost, a human-capital crisis. The prominence of people in the economic equation has been made apparent, effectively revealing the importance of people versus physical and financial capital. With a direct impact on people’s lives, there is a great deal of uncertainty in terms of basic human needs — food, shelter, health — and concerns regarding the long-term economic impact and the relative pace of the recovery. All of this makes the coronavirus-driven downturn different. Given this, boards should be looking at executive compensation plans as an important tool to focus management’s efforts on surviving the crisis while March 2020 March 2020 March | |

1 2 Responsible Executive Compensation During Times of Crisis UNDERSTANDING PURPOSE

Purpose captures why the organization exists, what its mission is with its various constituents, and its strategy and objectives. Management’s focus during the COVID-19 crisis: • Mission: Staying true to the company’s purpose and strategy over the long term, while adjusting in the short term • Well-being: Health and safety of employees and partners, social distancing protocols • Survival: Ensuring the company continues to exist and provide value to stakeholders

at the same time ensuring the health and well-being times, companies are encouraged to focus on all affected or in a booming industry. The economic • Crisis management: Business continuity plans, deliberate and calm decision making. of all stakeholders: Employees, customers, supply- stakeholders equally. order is shifting, and how we measure and pay for chain partners, communities and shareholders. BlackRock’s Global Head of Investment Stewardship, success will shift too. Michelle Edkins, has similarly stated that: A Critical Role for Executive Compensation Guiding Principle 2: Alignment Experience from past downturns is fueling concerns The concept of long-term sustainability would Executive compensation has always (or at least UNDERSTANDING ALIGNMENT that large corporations — and their executives suggest that companies that come through this since the 1980s) served to align the interests — will unfairly benefit from the current situation. crisis and do well would be exactly the kind of of management with those of owners. It will be This principle ensures management is aligned with, and acting in, best interests of shareholders and all stakeholders. Companies are often seen as having an asymmetric companies you would look to as role models critically important to continue demonstrating risk-reward relationship: They are encouraged to … Companies can still demonstrate that they this alignment and sharing the pain (and gain) Management’s focus during the COVID-19 crisis: assume a lot of risk in upturns (e.g., debt, growth have effective leadership. In times of crisis, that with shareholders. • Employees: If a company is experiencing furloughs and focus, M&As), but protected by government bailouts becomes more apparent, not less apparent. At this critical time, there also is a profound employee pay cuts, then executives should take a bigger pay cut. in times of crisis. While this is more perception than need to make sure that executive compensation • Supply chain partners: Credit facilities reality, companies and their boards will need to be This is where executive compensation programs is aligned, to some demonstrable degree, with • Customers: Discounts and payments terms more sensitive than in prior downturns to how they can play a critical role. Boards and management can the interests of employees, and other stake- • Shareholders: Policy on share buy-backs or dividends; are viewed by investors and other constituents. use them to channel energies during the crisis by: holders. Shared pain during the downturn, and process for LTI award number of shares in event of depressed Companies are under immense pressure from all • Creating alignment evidence that all are in this together during the stock prices stakeholders and constituents — including insti- • Clarifying objectives recovery is important. • Regulators: Availing of assistance programs and satisfying tutional investors who are calling for exemplary • Setting strategy Also, consideration should be given to incentive associated requirements leadership. The various public pronouncements on • Establishing priorities performance measures that incorporate the degree • Proxy advisers: Monitor COVID-19 specific guidance how companies are reacting to the crisis, including • Defining accountabilities to which employees are hurt by the downturn and • Governance: Principle-based decision making with stronger the number of executive pay cuts taken at the • Motivating performance benefit from the recovery. board discretion. same time as employee layoffs are announced, are • Reflecting the company’s purpose and emphasizing the connections between financial what it values. Guiding Principle 3: Accountability decisions (including share buybacks and divi- Now more than ever, it is important for companies Executive compensation and incentives are a primary dend policies), employee actions and executive to take a principles-based approach to executive vehicle through which the board holds manage- compensation. compensation. Amid all the uncertainties, a core set ment accountable for performance — and through UNDERSTANDING ACCOUNTABILITY Recent communication to boards of directors from of principles can serve as guideposts for companies which senior managers hold others accountable to Accountability describes the relationship between pay elements, Sacha Sadan, director of corporate governance at to govern their executive compensation programs. achieving key goals and objectives. This link is key to performance, individual actions and governance systems. Legal & General Investment Management (LGIM), the effective operation of any enterprise. Management’s focus during the COVID-19 crisis: one of the United Kingdomf’s largest institutional Guiding Principle 1: Purpose While it may be necessary in certain cases to investors, captures the sentiment well: Every company exists to fulfill some need in society. re-set goals, extend performance ranges, introduce • KPI focus: Agreeing on strategic priorities, but dynamically target-setting given uncertainties We are living through an unprecedented economic shorter performance periods, change performance Whilst in the normal operating times you ably upheaval that will change the core nature of measures, exercise discretion and implement new • Financial goals: Cash flow, capital management, cost containment balance managing your shareholders and all many businesses. incentives, all of this must be done in ways that other stakeholders, during these challenging Have the fundamentals of your business changed hold managers accountable for their actions and • Cash preservation initiatives: Cash deferrals or base salary times we encourage you to focus on all of in meaningful ways? Have your mix of products, results. Discretionary adjustments to plans that are reductions as appropriate your stakeholders. services, customers, pricing, margins, suppliers, not tied to performance and achievement of chal- • Stock options: Considerations for underwater stock options, as competition, strategy and objectives changed? Have lenging goals should be avoided. appropriate

March 2020 March Sadan’s advisement conveys a subtle, yet your priorities or timelines changed? Has the risk • Share ownership: Promote management purchasing shares with 2020 March long-term holding locks | important, nuance: In normal times, companies level of your business changed and in what ways? Guiding Principle 4: Engagement | balance shareholders on one side of the equation For many companies, the answer to at least Executive compensation must help motivate the • Retention: Special programs for critical talent, across all levels of and all other stakeholders are another group on some of these questions will be “yes,” regardless whole management team and drive performance the organization. the other side of the equation. However, in trying of whether your company is badly hurt, modestly and results. That said, executives and managers are 3 4 Responsible Executive Compensation During Times of Crisis

Now more than ever, tending to corporate financial health will be key, but demonstrating leadership, commitment and alignment with employees, customers and supply-chain partners will be equally important.

we may also see an evolution of executive compensation plans to reflect: UNDERSTANDING ENGAGEMENT • Longer-term orientation with larger proportion of LTI, deferrals and share ownership requirements Engagement encapsulates human behaviors, motivation, retention, and engagement. • The risk-reward asymmetry, deleveraging of plans with lower upsides and downsides Management’s focus during the COVID-19 crisis: • Accelerated adoption of Environmental Social • Leadership: Instill confidence, deliberate calm, bounded optimism Governance (ESG) metrics — with greater focus on • Communication: Proactive and transparent engagement with human capital governance shareholders, employees and the public • Boards holding management accountable for • Resilience: Document learnings from outcomes of pandemic to both financial performance improvements, and longer-term executive compensation strategies. maintaining a healthy, high performing, optimally capable, sustainable workforce.

motivated by many other things, including career Crises force commonality of purpose. Hopefully, success, moving up in the organization and being an companies will see through this crisis with an effective leader — especially in challenging times. enhanced appreciation of how much the value Incentives need to be adapted to new economic of human capital has increased, and the critical realities and mission-critical goals and objectives. importance of better management and governance Performance measures, goals, ranges and payout of people and risk. curves will need to be re-examined. Key value Now more than ever, tending to corporate drivers will need to be re-assessed. The mix of pay financial health will be key, but demonstrating elements and vehicles may need to be adjusted. leadership, commitment and alignment with And new measures incorporating human capital and employees, customers and supply-chain partners other stakeholders may be introduced or expanded. will be equally important. Well-designed executive compensation plans should focus management’s Additional Considerations efforts in achieving healthy balance sheets, moti- The crisis might also necessitate some unconven- vated employees, satisfied customers and thriving tional short-term approaches; for example, linking communities on a sustainable long-term basis. executive compensation to management’s actions Companies will do well to be patient and see how to mitigate the spread and impact of COVID-19, things unfold in the coming weeks and months. We ensuring employee well-being, developing work- are all in this together, and we will emerge out of force resilience, effectively leading through the this together, as people. crisis (e.g., business continuity plans, working from

March 2020 March home, social distancing, health protocols). Shai Ganu is a managing director and global practice leader, executive compensation, at Willis Towers Watson. Don Delves is a | Over the longer term, the crisis will likely change managing director and executive compensation practice leader, the nature of work, role of organizations in society North America, at Willis Towers Watson and Ryan Resch is a and expectations from leadership. Correspondingly, managing director at Willis Towers Watson.