In the second half of 2021, the market for talent at almost all levels of the organization was red hot, with increased levels of turnover and challenges in attracting new staff. Companies across most industries have been faced with significant employee retention challenges, putting upward pressure on compensation levels. Another new factor in 2021 was the reemergence of inflation as an economic concern, with annualized rates of inflation of 6.2% in October and 6.8% in December. If this level of inflation continues into 2022, companies may be under additional pressure to increase pay. As we look forward to 2022, we expect that compensation committees will have to advise management on how to respond to these labor market concerns. To further complicate the work of compensation committees, we expect that they will be faced with a more active regulatory regime, with the SEC and other regulators showing some more aggressive signs.Finally, we expect that ESG concerns will continue to be a primary focus for shareholders and that expectations in terms of disclosure will only heighten in 2022.
War for Talent
2021 was the year that the ‘Great Resignation’ entered the lexicon. Companies are now faced with unprecedented levels of turnover and a tight market for new talent. This means compensation committees should be supporting their management teams as they try to creatively keep current employees and bring in new talent. Management teams are balancing flexibility in how jobs are structured and where employees work to address employees’ lifestyle and career concerns. At the executive level, we have seen companies across a broad range of industries make special retention awards to keep key executives, in some cases with eye-popping values (see, for example, JP Morgan and KKR). For key talent deeper in the organization, we have seen companies make off-cycle base salary increases and more liberal grants of time-vesting equity or cash retention awards. Some sectors are granting equity to a broader group than ever before. Beyond throwing cash at the problem, 2022 is a good time to examine all elements of the employee value proposition, including learning opportunities, career pathing and company culture.
In the fourth quarter of 2021, inflation was running at an annualized rate of more than 6%. We have not seen these levels of inflation for decades. The biggest concern from a compensation standpoint is that the purchasing power of employees will be diminished and ultimately put further upward pressure on wages, which are already under significant pressure due to the tight market for talent. Many companies have found themselves raising their annual salary increase budgets from the recent 2%-3% to 4% or more for 2022. We expect that many companies will be coming to the comp committee asking for additional compensation dollars in 2022 for ad hoc increases, particularly if inflation continues at more than 6% well into 2022. One potential mitigating factor is that many businesses had a strong performance year in 2021 and above target incentive payouts may help offset the impact of inflation, at least for bonus-eligible employees. Many companies are planning for the need for additional salary dollars by building a buffer into the business plan.
Regulation and Legislation
In 2021, Congress and the Biden Administration passed the Infrastructure Investment and Jobs Act, which had no real impact on executive compensation. In 2022, if they move forward with Build Back Better, there could be increases in corporate tax rates or a corporate minimum income tax rate, an increased tax rate on people earning more than $10 million, and a surcharge on corporate stock buybacks. Even without new legislation, we expect that regulators will be active in 2022. The SEC has on its agenda addressing outstanding items under Dodd-Frank, including rules on mandatory clawbacks and the enhanced disclosure of pay and performance, as well as proposed refinements of the rules for 10b5-1 trading plans. The SEC will also review the human capital disclosure rules which were only first issued in August 2020, with the potential for these disclosures to become more prescriptive.
In 2021, ESG was already a priority for compensation committees, since it was and remains high on the agenda of institutional shareholders as well as other key stakeholders. The SEC has expressed interest in this area, and at some point regulators may step in to mandate certain ESG disclosures. For now, the primary drivers of change are the institutional shareholders and agencies that provide ESG ratings for institutional investors (ISS, MSCI, Sustainalytics). From the perspective of the compensation committee, we have seen the greatest focus on the topics of pay equity and diversity and inclusion. In 2020 and 2021, there was also a push to incorporate more elements of ESG into incentive plan designs, either through a discretionary assessment or through pre-defined metrics with explicit weightings in the incentive calculation. Ultimately, the inclusion of ESG metrics should be driven by the business strategy and companies should consider carefully whether inclusion makes sense.
The Changing Role of the Compensation Committee
Social issues and the pandemic have expanded the areas that may fall under the purview of the compensation committee. In particular, diversity, pay equity and inclusion touch on many areas that historically were under the compensation committee or, at least, committee “adjacent.” If you have not done so already, 2022 is a good time to take a fresh look at the compensation committee charter and calendar to make sure they align with the areas of focus of the committee. It is also of value to work with the management team to make sure that the committee is receiving the right data and analytics to understand how the company is performing against objectives for these new areas of emphasis.
We expect 2022 to be an active year for compensation committees with some new issues that committees have not had to focus on in recent years. We are hopeful that the COVID-19 pandemic will have less of an impact on executive compensation in 2022; however, the last two years have shown that the course of the pandemic has been hard to predict.