Compensation Advisory Partners’ (CAP’s) analysis of 300 S&P Composite 1500 companies with fiscal year ends (FYEs) near December 31 found that the most frequent recent executive pay action taken in response to COVID-19 continues to be annual incentive modification. The CAP analysis – which is part of our ongoing efforts to track executive compensation and human capital actions related to COVID-19 – shows that 50 percent, or 150 companies made COVID-related changes to their executive incentive plans. Of the companies that made incentive changes, 60 percent made annual incentive changes, 9 percent made long-term incentive changes, and 31 percent changed both incentive plans. The S&P 400 (Mid Cap) and S&P 600 (Small Cap) companies were more likely to exercise discretion to adjust final annual incentive payouts than the S&P 500 (Large Cap) companies.

Key Findings

• 50 percent of S&P Composite 1500 companies with fiscal year ends (FYEs) near December 31 modified their incentive plans due to COVID-19, up from 42 percent of September FYE companies.
• Of companies that disclosed incentive plan changes, they were typically for the most recently completed or outstanding performance period(s) vs. prospective changes.
• Consistent with September FYE companies, modifications were more likely to be to the annual incentive plan among December FYE companies.
• Most September and December FYE companies that adjusted annual incentive payouts for the impact of COVID-19 relied on compensation committee discretion – either positive or negative. CAP’s analysis of the December FYE companies shows that Mid Cap and Small Cap companies were more likely to exercise discretion than their larger S&P 500 peers.
• The most prevalent annual incentive actions were 1) exercising or adding discretion to the plan, 2) adding or changing the performance measures, and 3) revising the payout scale.
• The most prevalent long-term incentive actions were 1) adding or changing the performance measures, 2) modifying the performance period, and 3) changing the long-term incentive vehicle mix.

Study Sample

CAP has been tracking COVID-related executive compensation and human capital actions taken by S&P Composite 1500 companies since the beginning of the pandemic. The S&P 1500 index includes three indices: S&P 500 (Large Cap), S&P 400 (Mid Cap) and S&P 600 (Small Cap). This analysis focuses on 300 S&P 1500 companies – the first 100 to file proxies from each of the three indices. In past studies, CAP analyzed S&P 1500 companies with June FYEs (65 companies) and September FYEs (101 companies).

Findings

Among the 300 December FYE companies, 50 percent made changes to their outstanding and/or go-forward incentive plans. This represents an increase from CAP’s finding that 42 percent of September FYE companies and 43 percent of June FYE companies modified their incentive plans.

Incentive Changes

The types of incentive actions taken have varied based on the company’s FYE and how much of the company’s fiscal year overlapped with the pandemic.

In CAP’s earlier research, the most common action among June FYE companies was to exclude one quarter of COVID-19 from their performance periods and calculations. In contrast, September and December FYE companies had to address the impact of two or three quarters of the pandemic during their fiscal years. September and December FYE companies viewed the pandemic as a long-term event. These companies had a chance to engage with investors and hear guidance from proxy advisors, who discouraged changes to long-term incentives. As a result, September and December FYE companies made fewer changes overall, and changes were more likely to be made to annual incentive plans.

Annual Incentive Changes

Of the 150 December FYE companies that made incentive changes, 136 made changes to their outstanding and/or go-forward annual incentive plans. Larger companies in the S&P 500 most commonly changed annual incentive metrics, goals, and payout scales, and also excluded the impact of COVID-19 from financial results. S&P 500 companies applied discretion to annual incentive payouts, but not to the extent of smaller S&P 400 and S&P 600 companies.

The three most prevalent annual incentive changes among the December FYE companies that made such changes are:

Exercised Discretion to Adjust Final Payout: Forty-five December FYE companies (33%) in the S&P 1500 exercised or added discretion to their outstanding annual incentive plans. Among these companies, approximately 75 percent exercised positive discretion. Most companies that exercised positive discretion increased the payout to between 50 percent and 100 percent of target. The remaining 25 percent of companies exercised negative discretion and typically reduced the payout to be equal to, or less than, target. Companies in the S&P MidCap 400 and S&P SmallCap 600 indices were more likely to exercise discretion to adjust annual incentive payouts vs. those in the S&P 500 (Large Cap) – 41 percent and 33 percent vs. 24 percent, respectively.

Added or Changed Metric(s): The most common structural annual incentive plan change has been to add or change metrics: 29 percent of December FYE companies (39 companies) made this adjustment. Commonly added metrics focused on operating income or liquidity, or strategic measures in the context of the pandemic.

Revised Payout Scale: Twenty-one percent of December FYE companies (29 companies) revised their annual incentive payout scales. Among these companies, approximately 80 percent revised the maximum payout down, most commonly capping the payout at 100 percent of target. Companies that reduced target payouts did so by 25 percent to 50 percent. Companies that reduced threshold payouts most commonly lowered their thresholds from 50 percent to 25 percent of target. One company increased the maximum payout for its 2021 plan to compensate named executive officers (NEOs) for the reduced payout in 2020 due to COVID-19.

Long-term Incentive Changes

Of the 150 companies that made incentive changes, 60 adjusted their outstanding and/or go-forward long-term incentive plans. Forty-six of those 60 companies also adjusted their annual incentive plans. The intent of awards covering performance over multiple years is to control for performance volatility over the short-term, so December FYE companies have been less likely to adjust their long-term incentive plans throughout the pandemic. The following chart shows the long-term incentive actions taken by December FYE companies in order of prevalence.

The three most prevalent long-term incentive changes among the December FYE companies that made such changes are:

Added or Changed Metric(s): As in annual incentive plans, the most common long-term incentive plan change was to add or change metrics (25% of December FYE companies, or 15 companies). The most common change has been to add, or increase the weighting of, relative performance measures, primarily total shareholder return. Other commonly added metrics focused on operating income and liquidity.

Changed the LTI Vehicle Mix: Most companies that changed their LTI vehicle mix (17%, or 10 companies) shifted away from performance-based vehicles that require goal-setting and toward retention vehicles with time-based vesting. Most of these long-term incentive plans, however, continue to be predominantly performance-based, which aligns with the long-standing expectations of proxy advisors and major investors. Select companies excluded the chief executive officer from the shift to time-based equity.

Revised Payout Scale: Nine companies revised their long-term incentive payout scales. Similar to companies that revised their annual incentive payout scales, it was most common for companies to revise the maximum payout down, capping payouts at 100 percent of target.

Looking Ahead

While the vaccination process is well under way in the United States, the economy continues to have significant uncertainty, with businesses unsure which COVID-related shifts are long-term and which will phase out as a new normal emerges. This uncertainty makes goal-setting difficult for annual and long-term incentive plans. To mitigate some of the goal-setting challenges, companies facing continued uncertainty are considering or have implemented changes to 2021 incentive designs including:

Annual Incentive Plans

• New or increased weighting of a non-financial component in the annual incentive plan, including operational, strategic, and individual performance metrics. These may be incorporated as environmental, social and governance (ESG) metrics, which provide a more holistic view of business performance and consider different stakeholders.
• Bifurcation of annual incentive performance periods (i.e., first half/second half).
• Use of wider performance scales around target goals, which may lead to less volatility in payouts.
• Delay of goal-setting to improve accuracy.

Long-Term Incentive Plans

• Use of, or increased weighting on, relative performance measures, primarily total shareholder return.
• Use of wider performance scales around target goals, which may lead to less volatility in payouts.
• Use of shorter periods for performance-based long-term incentives by companies that continue to have challenges with long-term goal-setting. (A common approach is to replace a three-year performance period with three one-year performance periods.)
• Increased use of time-based restricted stock/units for retention. CAP still expects at least 50 percent of long-term incentives to be performance-based, given the long-standing expectations of proxy advisors and major investors.

CAP anticipates that many of these incentive design changes are temporary in nature and expects companies to revert to more traditional incentive designs in 2022 as goal-setting becomes less challenging. However, CAP believes that the pandemic has accelerated certain trends that were already in progress, such as the shift to ESG measures.

Additional COVID-19 Resources – Compensation Advisory Partners

• COVID-19 Resource Center. CAP’s COVID-19 Resource Center includes a searchable database of business actions related to COVID-19 that can be filtered on company, revenue, company type, industry, and action. CAP’s COVID-19 Resource Center can be accessed here.
• Recent Proxies Highlight COVID-Related Incentive Actions for September FYE Companies. CAP summarizes incentive actions taken by September FYE S&P 1500 companies in response to the COVID-19 pandemic. The report can be accessed here.
• Recent Proxies Provide In-Depth Look at COVID-19 Pay Actions. CAP summarizes incentive actions taken by June FYE S&P 1500 companies in response to the COVID-19 pandemic. The report can be accessed here.
• Early Filers: COVID-19 Impact on 2020 Incentive Plan Payouts. CAP summarizes incentive actions taken by 50 companies with fiscal years ending between August and October 2020. The report can be accessed here.
• Early Read on ISS’ View on COVID-Related Compensation Changes. CAP reviewed select broad market COVID-19 executive compensation actions and the corresponding ISS report commentary. The report can be accessed here.
• Compensation and Human Capital Corporate Actions in Response to COVID-19. CAP is regularly updating a report containing the findings of CAP’s corporate action tracker and additional interactive visualizations of key trends across industry groups and action types. The report can be accessed here.

Theo Allen, Courtney Halle, Louisa Heywood, Zaina Jabri, Kyle White, and Han Wen Zhang provided research assistance for this report.

Compensation Advisory Partners (CAP) is monitoring corporate public announcements for the S&P 500 (large cap), S&P MidCap 400 and S&P SmallCap 600 to compile a database of pay actions taken in response to the COVID 19 pandemic:

• Annual and long-term incentive design changes
• Compensation actions for chief executive officers (CEOs), executives, boards of directors and employees
• Workforce reductions and expansions
• Changes in dividend policy and share buybacks (not covered in depth in this document)

These indices were selected because 1) they allow for size comparisons and 2) they compose the S&P Composite 1500 index, which covers approximately 90 percent of the market capitalization of U.S. public companies.

As of February 28, 2021, CAP had identified actions taken by 879 companies in these indices, with many companies taking multiple actions in response to COVID-19. (Company details, including over 650 additional U.S. and non-U.S. companies, are available on our COVID-19 Resource Center)

Key takeaways of actions to date include:

• Nearly 60 percent S&P 1500 companies have announced compensation and human capital actions in response to COVID-19
• All auto companies have taken COVID-related human capital actions. The retailing and consumer services industries also are nearing 100 percent prevalence of COVID-19 actions
• Initial actions focused on conserving cash through executive salary cuts. Over the summer, pay actions began to focus on annual and long-term incentives
• Most companies that reported COVID 19-related pay actions adjusted their annual incentive plan or both their annual and long-term incentive plans
  • o CAP’s reports on incentive actions by June and September fiscal-year-end companies provide an early look at pay decisions being made by compensation committees across corporate
    America.
• CEO and executive pay cuts were made by one in four firms, while board pay cuts were made by about one in five. Large- and mid-cap companies have been less likely to cut board pay
  • The median salary cut for CEOs is 50% in the S&P 500 (large cap) and S&P MidCap 400, and 30% in the S&P SmallCap 600. Other executive salary cuts are made on a graduated scale, with typical cuts at 20% to 25%
  • S&P 500 (large cap) and S&P MidCap 400 companies cut director cash retainers by a median of 50%. S&P SmallCap 600 firms applied a lower 30% cut to retainers. The duration of cuts is typically not defined
• The prevalence of adverse broad-based employment actions spans the three indices, with furloughs being most common
• Positive broad-based employment actions are more likely to be taken by large firms

Users can view additional visualizations of key trends across industry groups and action types below.

Data effective: February 19, 2021

Instructions to use this tool:
Company Type, Index, and Industry Group Filters

• Select the desired company type, S&P index, and industry group scope using the menus
• Charts below will reflect data only for companies in the selected scopes
• Select multiple options by holding down the CTRL key
• Scroll down in the Industry Group menu to see all available options

Charts

• First chart shows the number of cumulative company actions over time, broken down by sector
• Second chart shows the number of company actions per day, broken down by action type
• Click on an action type in the legend on the left to see data only for the selected action types
• Select multiple action types by holding down the CTRL key
• Click the area below the legend to reset to all action types

Louisa Heywood and Zaina Jabri provided research assistance for this report.

For more information about our services, please contact us.

CAP reviewed COVID-19 actions taken by 50 companies with fiscal years ending between August through October 2020 (defined as the Early Filers). Revenues for these companies ranged from $2 billion – $275 billion (median revenues of $8 billion); median fiscal year end market capitalization was $10 billion.

This report focuses on annual and long-term incentive plan actions taken by companies to address the impact of COVID-19 on incentive payouts for 2020. We will address the impact of COVID-19 on 2020 executive pay levels for the Early Filers in a future CAPintel report.

Key Findings

• Approximately 55% of Early Filers made changes to their incentive plan programs due to COVID-19; changes were more likely to be in the annual incentive plan design
• Of companies that disclosed changes, they were typically for the most recently completed performance period vs. prospective changes to the incentive plan design
• Companies were most likely to adjust the final payout for the 2020 annual incentive plan by exercising discretion
• Companies generally made adjustments that increased the final payout, with limited instances of adjustments resulting in a reduction in payment
• Among companies that exercised positive discretion, the payout as a percentage of target, on average, increased from 45% of target to 85% of target

Findings

Among the 50 Early Filers companies, approximately half (27 companies) made retroactive and/or prospective changes to their incentive plan programs due to COVID-19.

Of the companies that made changes to their incentive plans, it was more common to make changes to the annual incentive plan (93%) vs. the long-term incentive plan (33%). Overall, companies did not disclose making wholesale changes to their incentive plan design on a prospective basis; companies that did disclose changes to their ongoing incentive plan design were more likely to make changes to the long-term plan.

For companies that took actions impacting incentive plan payouts for 2020 performance, applying discretion to the final annual incentive payout was most common; four companies adjusted underlying financial performance to remove the impact of COVID-19 when determining annual incentive payouts.

Only six companies disclosed changes to long-term performance plan payouts in 2020 suggesting that companies were more reluctant to make adjustments for longer term performance awards, given the limited timeframe COVID could impact final results (i.e., six months out of a 36-month performance period).

Incentive Plan Adjustments

Overall, 74% of companies in our study either exercised discretion (positive or negative) or adjusted the underlying financial results.

Exercising Discretion

Among the companies that exercised discretion, most applied a positive adjustment which resulted in an increased final payout. Among companies in our study that exercised positive discretion, the payout as a percentage of target, on average, increased from 45% of target to 85% of target. In very limited circumstances did companies exercise discretion that increased the final annual incentive payout from below target to above target. Most notably, Air Products increased the bonus payout from 58% of target to 152% of target. The company highlighted the impact of COVID on the business, its focus on employee well-being, shareholder value creation during the pandemic, continued company growth, strategic actions taken by the company and making no other changes to the executive compensation program. ISS and Glass Lewis both recommended “For” executive compensation say on pay, showcasing that robust disclosure can be key in effectively communicating company decisions to shareholders.

Only two companies noted the use of negative discretion to reduce the final annual incentive payout for all NEOs.

Adjusting Underlying Financial Performance

Only a handful of companies disclosed adjusting underlying financial performance. Companies most commonly adjusted profit-based metrics to add back costs related to COVID-19 (such as enhanced cleaning procedures, setting up remote work, etc.) that were unforeseen and outside of management’s control. No companies in our sample disclosed adjusting revenue performance due to COVID-19’s impact on sales; however, companies were more likely to cite COVID’s impact on revenue as a rationale for use of positive discretion on the overall final payout.

One company, Tyson Foods, adjusted operating income for the broad-based annual incentive plan payout but did not provide an annual payout to the named executive officers (NEOs). Instead, the company granted a restricted stock unit award to the NEOs to reflect the extraordinary effort taken during the fiscal year thus bifurcating the company’s approach to rewarding its employees.

For the long-term incentive plan, only two companies disclosed removing the impact of COVID-19 from the incentive plan payout calculation. Adjustments were made to profit-based metrics in both cases and were due to unexpected expenses related to COVID-19. One of these companies, Jabil, noted that payout went from below target (90% of target) to above target (108% of target) as a result.

Conclusion

Disclosure from the Early Filers provides insights into how companies are incorporating the impact of COVID-19 into incentive plan payouts. Compensation committees are taking a holistic approach to reviewing overall company performance and removing a portion of the impact of COVID-19 on incentive plan performance. Regardless of if a company made changes to is incentive plan payments, most companies addressed the impact of COVID-19 on the business in their disclosure (including actions taken by the company to address ensuring employee safety or how the organization helped the communities in which they operate).

We would expect to see similar trends in company actions when companies with December 31st fiscal year ends begin to file their proxy statements in the coming weeks. For companies that are planning to exercise positive discretion on final incentive plan payout, having robust and clear disclosure in the proxy statement will be important to communicate with key stakeholders the rationale for company actions.

Whitney Cook and Zaina Jabri provided research assistance for this report

With the 2021 proxy season already underway, our understanding of ISS’ tolerance for COVID-related compensation changes is becoming clearer, as ISS has begun to release their proxy research reports ahead of the annual meetings for companies with fall fiscal year-ends. For calendar year-end filers, these reports will serve as weathervanes for ISS’ reaction to incentive plan changes made in response to the pandemic.

To provide insight into the proxy advisor’s disposition this year, CAP reviewed select broad market COVID-19 executive compensation actions and the corresponding ISS report commentary. Our analysis highlights six companies that made various changes to their annual and long-term incentive plans and awarded one-time special grants.

CAP’s preliminary findings indicate that if a company made COVID-related compensation changes and received an elevated level of concern on the ISS pay for performance evaluation, the proxy advisor will likely recommend Against the Say on Pay proposal, thereby significantly impacting the Say on Pay vote. To date, we have observed four companies that experienced sharp declines in their Say on Pay results, with two failing to receive majority support.

Impact of ISS’ Quantitative Pay for Performance Evaluation on Say on Pay Recommendations

Based on our early read, it appears that ISS’ assessment of pay decisions related to COVID-19 is highly correlated to the concern level on their quantitative CEO pay for performance screens, which inform Say on Pay recommendations. When there is a low concern level, a company’s COVID-related changes seem to be more palatable for ISS; however, when there is an elevated level of concern, ISS seems likely to delve more deeply into a compensation program and view any COVID-related changes more critically.

True to the sentiments expressed in their October 2020 Frequently Asked Questions (FAQs), ISS seems highly skeptical of one-time special awards and discretionary upward adjustments to annual and long-term incentive payouts (especially if payouts were tracking well below target). Four of the companies we analyzed were chided for making discretionary incentive plan changes, such as altering performance periods to exclude the months most heavily affected by the pandemic and trigger payouts despite COVID impacts. ISS also found special grants problematic, particularly when used to replace underperforming performance-based awards.

Conversely, two companies made COVID-related compensation changes that seemed more acceptable from ISS’ perspective and in-line with their FAQs. These changes included adjustments to the threshold and target performance goals for in-flight long-term incentives, bifurcated performance periods with payouts well below target for annual incentive awards, and modest special one-time grants.

Supplemental Filings

Supplemental filings from two companies, Aramark and Becton, Dickinson, indicate their frustration with the proxy advisor’s inflexibility considering the unprecedented events of the past year. One company urged that its actions be viewed within the “broader context of executive compensation,” while the other went so far as to suggest that ISS did not have the “resources or business experience to understand” the complexities of its business.

Summary of Executive Compensation Actions and Say on Pay Results

The table below summarizes the actions of six companies that made changes to their incentive plans and provides results from their votes on Say on Pay. Thus far, four companies passed and two failed to receive majority support on their Say on Pay votes.

As calendar year-end companies confirm 2020 payouts, design 2021 incentive plans, and finalize their Compensation Discussion and Analysis (CD&A) in the proxy statement, beware that ISS is highly critical of special one-time awards, upward (discretionary) adjustments to payouts, front loading annual equity awards, and reductions in performance-based long-term incentives. It will be imperative that companies have compelling rationales as to why these decisions were made and how they are aligned with long-term shareholder value creation. As proxies continue to be filed and companies disclose more COVID-related changes, we should have a better sense of proxy advisory firms’ receptiveness to such alterations.

If an early read is any indication, numerous COVID-related compensation changes and negative one-year TSR can affect a company’s Say on Pay vote. As evidenced by the adjustments at Aramark, Becton, Dickinson, PTC and Walgreens Boots Alliance, there was a significant drop in their Say on Pay votes in 2021, with shareholders objecting to compensation changes. Since Say on Pay went into effect in 2011, median support was 95 percent plus, but 10 years later, we may expect to see that median level of support decrease.

This article highlights ISS’ commentary on broad market COVID-19 executive compensation actions. For more detail regarding companies’ COVID-related changes, please visit our COVID-19 Resource Center.

Annual incentive changes are the most prevalent recent actions taken recently by public companies impacted by COVID-19, according to a Compensation Advisory Partners analysis of proxy filings of 101 S&P Composite 1500 companies with fiscal year ends (FYEs) near September 30. The CAP analysis – which is part of our ongoing efforts to track executive compensation and human capital actions related to COVID-19 – shows that 42 percent – or 42 companies – made COVID-19-related changes to their executive incentive plans. Of the 42 companies:

• 60 percent made annual incentive changes,
• 14 percent made long-term incentive changes, and
• 26 percent changed both types of plans.

In our earlier research, most June FYE companies modified both their annual and long-term incentive plans, and the most common action was to exclude the three months of COVID-19 from their performance periods and calculations. In contrast, the September 30 FYE companies had to address the impact of COVID-19 during half of their fiscal years. Six months into the pandemic, companies knew that COVID-19 was a long-term disruption, and they may have had time to engage with investors and incorporate guidance from proxy advisors, who indicated that changes to long-term incentives would be scrutinized. As a result, changes to annual incentive actions are far more common for the September FYE companies.

Of the 42 September FYE companies, 22 took only one incentive action, while 20 companies took two or more actions.

The September FYE companies show significant representation from the Capital Goods (23%), Materials (9%), and Health Care (9%) sectors. While not a completely representative sample, this group provides an interesting look at executive compensation responses to COVID-19.

Annual Incentives

Of the 42 companies, 36 made changes to their outstanding and/or go-forward annual incentive plans. Now that companies have more information about the economic impact and disruption caused by the pandemic, they are exercising or adding discretion to the plan, adding, or changing performance metrics, and adjusting the performance period. Other actions taken include resetting performance goals, excluding COVID from the performance results, and switching from cash to equity.

Long-Term Incentives

Of the 42 companies, 17 made changes to their outstanding and/or go-forward long-term incentive plans. Eleven of the 17 companies also adjusted annual incentive plans. The most common adjustments were changing metrics for performance awards, changing the long-term incentive vehicle mix, and modifying the performance period.

Special Awards

Some September FYE companies have provided special awards to NEOs in addition to other incentives because of the impact of COVID-19. The special awards are designed to achieve different goals: retain top talent, reward leadership through a difficult period, and incentivize future performance.

CAP will continue to track and publish additional analyses of companies disclosing incentive adjustments in its COVID-19 Resource Center, which also includes a searchable database of business actions related to COVID-19.

Additional COVID-19 Resources – Compensation Advisory Partners

• Recent Proxies Provide In-Depth Look at COVID-19 Pay Actions. CAP summarizes incentive actions taken by June fiscal year end S&P 1500 companies in response to the COVID-19 pandemic. The report can be accessed here.
• COVID-19 Resource Center. CAP’s COVID-19 Resource Center includes a searchable database of business actions related to COVID-19 that can be filtered on company, revenue, company type, industry, and action. CAP’s COVID-19 Resource Center can be accessed here.
• As the Pandemic Continues, so do Executive Pay Actions. CAP summarizes executive compensation, employment and shareholder actions announced by S&P 1500 companies in response to the COVID-19 pandemic between March and July 2020. The report can be accessed here.
• Compensation and Human Capital Corporate Actions in Response to COVID-19. CAP is regularly updating a report containing the findings of CAP’s corporate action tracker and additional interactive visualizations of key trends across industry groups and action types. The report can be accessed here.

Zaina Jabri provided research assistance for this report.

In late January, proxy advisor Glass Lewis published guidance on its approach to executive compensation given the ongoing COVID-19 pandemic. Acknowledging the significant market-wide disruptions caused by the global pandemic in 2020, Glass Lewis remains committed to compensation plans with strong linkages between pay and performance. Glass Lewis has made no changes to the mechanics of its pay-for-performance model and continues to use three-year weighted averages to measure pay and performance, even in 2020.

While not changing its pay-for-performance model or long-term focus, Glass Lewis acknowledges that qualitative assessments of companies and their pay programs will be important in such an unprecedented year. Though its main concern overall is whether pay is aligned with performance, Glass Lewis will consider many additional factors during the disrupted year, including:

• Overall executive pay levels – When a pay-for-performance disconnect is identified, low pay levels can mitigate Glass Lewis’s concern, while high pay levels can amplify the concern.
• Company performance – Strong company performance despite macroeconomic challenges can potentially mitigate Glass Lewis concerns about high pay levels.
• Company performance momentum – A disconnect between past pay and performance can possibly be mitigated if the company’s performance has improved in recent months relative to peers.

Companies should carefully read Glass Lewis’s “Approach to Executive Compensation in the Context of the COVID-19 Pandemic” when drafting their compensation discussion and analysis (CD&A) reports to ensure that investor concerns are addressed.

Comparing Glass Lewis and ISS COVID-Related Guidance

A summary of the Glass Lewis guidance and how key points compare to Institutional Shareholder Services’ “U.S. Compensation Policies and the COVID-19 Pandemic: Frequently Asked Questions” follows.

Base Salary Adjustments: The most common COVID-related pay adjustment is a temporary reduction in named executive officer (NEO) base salary, an action taken by more than half of companies within Glass Lewis’ coverage that have disclosed at least one COVID-related pay modification. Glass Lewis views salary reduction as a minor symbolic change given that base salaries are generally small relative to total compensation.

Alignment with ISS Voting Guidelines: ISS views temporary salary reductions as mitigating if they meaningfully reduce total compensation and will view such reductions more favorably if annual incentives are calculated with the lower base salary.

Annual Incentives: Glass Lewis cautions that it will view increases to short-term pay levels or above-target payouts with scrutiny. Companies that have removed caps or made significant adjustments to performance measures or calculations need to disclose their rationales clearly. In addition, companies that exercise upward discretion or measure performance based on qualitative or nonfinancial measures need to carefully disclose their rationales and ensure that overall payouts are reasonable relative to performance and past payouts.

Alignment with ISS Voting Guidelines: ISS views changes to annual incentive programs as reasonable in light of the COVID-19 pandemic as long as companies provide clear and compelling rationale, and the outcome is reasonable.

Long-Term Incentives: Glass Lewis will closely scrutinize amended performance-based awards, particularly mid-cycle adjustments to performance periods, metrics, and vesting conditions. It will apply additional consideration to program changes that have the potential to result in windfall benefits due to exogenous improvements in market conditions, such as if performance-based awards are replaced with time-based awards. Glass Lewis will look less favorably at companies that change metrics or performance periods for awards near the middle or end of their performance cycles. Concern may be mitigated if modifications, such as switching to solely time-based equity, are confined to a specific time period and if companies have a history of good governance and pay vs. performance alignment prior to the COVID-19 pandemic.

Alignment with ISS Voting Guidelines: ISS will generally view changes to in-process awards negatively given the intent of awards covering performance over multiple years is to control for performance volatility over the short-term.

Other Glass Lewis Guidance

One-Off Awards: Glass Lewis cautions against one-off awards granted to offset base salary reductions or below-target incentive payouts. Any one-time awards should be sized reasonably with internal alignment to past company practice and external alignment to peer pay levels. Concern may be mitigated if supplemental awards are subject to additional performance or vesting criteria, and if companies are not relying on one-time awards year after year.

Increases to Quantum and Forwards vs. Backwards: On a total compensation basis, Glass Lewis will look unfavorably on increases in total compensation unless companies have achieved strong performance on both a relative and absolute basis. Higher total compensation because of COVID-related adjustments will face extreme scrutiny. When upward discretion is applied to performance or payouts, Glass Lewis will look for meaningful rationale. Glass Lewis continues to prefer year-over-year increases to target compensation rather than high payouts for backward-looking performance.

Major Structural Changes: Glass Lewis cautions against short-sighted decision-making. It urges boards to think critically about implementing sweeping, long-term changes given ongoing market uncertainties, and will view concessions made in early 2020 negatively when the company has recovered meaningfully but the executive’s windfall has not been counterbalanced.

Potential Windfalls: Glass Lewis will evaluate pay program changes, especially to equity programs, for the potential for windfalls. Examples of actions that can result in windfalls and merit additional consideration include deviation from past equity granting practices, equity grants made at stock price lows, removal of performance-based equity awards from incentive programs, and replacement of performance-based awards with time-based awards. Longer time-based vesting can be used as a potential guard against such windfalls.

Equity Plan Proposals

Glass Lewis published revised guidance on equity plan proposals, option repricing and golden parachutes for 2020.

Equity Plan Proposals: As share prices have dropped, Glass Lewis expects higher dilution and larger share requests in equity plan proposals. Glass Lewis will require meaningful justifications such as that the company urgently needs to conserve cash, or that the company has exhausted reasonable alternatives to compensate employees.

Option Repricing: For companies in industries most highly affected by COVID-19, Glass Lewis may support option repricing provisions only if the company has demonstrated that it has considered all reasonable alternatives and that eligible options are close enough to expiration that a stock price rebound is unlikely.

Golden Parachutes: Glass Lewis will continue to scrutinize golden parachute provisions, weighing them against the quantum of pay adjustments in response to COVID-19 and other merger-related payments.

Glass Lewis acknowledges the havoc wreaked by COVID-19 on many compensation programs and urges boards to proceed carefully with any pay modifications to ensure companies remain faithful to a strong pay vs. performance alignment over the long run. Throughout its guidance, Glass Lewis emphasizes the need for strong disclosure for any COVID-related pay actions. Clear and thorough disclosure can help mitigate Glass Lewis concerns about changes to compensation programs in response to COVID-19. Disclosures should address the rationale for pay program changes and the impact of the pandemic on the company.

2021 proxy statements will be impacted – in many ways – by the COVID-19 pandemic. This includes SEC-required CEO pay ratio disclosure.

Companies should now be thinking about – and most will soon begin to work on – their 2021 proxy statements. Such disclosure this year will be impacted in many ways by the COVID-19 pandemic. This includes SEC-required CEO pay ratio disclosure, which compares the compensation of the CEO to that of the median employee.

2021 CEO Pay Ratio Disclosure

Selected practical considerations for 2021 proxy statements related to CEO pay ratio disclosure are outlined below.

1. New Median Employee. For most companies, 2021 proxies will be the fourth year of required CEO pay ratio disclosure. Given this, companies that have been using the same median employee for three consecutive fiscal years will have to determine a new median employee for 2021 proxy disclosure.

   Companies can use the same median employee for three consecutive fiscal years, assuming no changes to employee population and/or compensation arrangements that would be reasonably believed to significantly affect CEO pay ratio disclosure. Many companies experienced material disruption to their employee populations during the last year, and many companies made changes to their compensation arrangements during the last year. Given this, companies may have additional reason to re-calculate the median employee for 2021 proxy-based CEO pay ratio disclosure.

2. Furloughed Employees. Many companies furloughed employees during 2020, and this needs to be considered when determining the CEO pay ratio for purposes of required 2021 proxy statement disclosure.

   The SEC has directed companies to “determine whether furloughed workers should be included as employees based on the facts and circumstances.” To-date, CAP has worked through this issue with several companies with non-calendar fiscal year ends. Several issues need to be considered, such as the timing and duration of the employment actions.

3. Consistently Applied Compensation Measure (“CACM”). For 2021 proxy disclosures, we expect the approach companies use for their CACM to be consistent with what has been used in the previous years.

   Among the S&P 500, approximately 43% of companies used base salary plus other cash and equity compensation for their CACM in 2020, which was the most prevalent approach.

4. Determination Date. Many companies saw their employee population permanently or temporarily disrupted during 2020 due to the COVID-19 pandemic. Given this, companies should consider if selecting a determination date later in the fiscal year would likely lead to a less atypical result from the required CEO pay ratio calculation for 2020.

   CEO pay ratio disclosure rules dictate that companies may identify the median employee with an effective date any time within the final three months of the fiscal year. If a company decides to shift the determination date used for 2020, versus what was done in past years, the company must include a rationale for the change in the 2021 disclosure.

5. Supplemental Ratios. 2020 is likely to be viewed by many companies as having “one-time” events. As a result, there may be a significant increase in the prevalence of supplemental CEO pay ratio disclosures in 2021 proxies to reinforce that year-over-year change in the CEO pay ratio (up or down) should not be viewed as an ongoing expectation.

   Disclosing supplemental CEO pay ratios is allowed under SEC rules, as long as the prescribed CEO pay ratio is clearly disclosed as such. While disclosure of supplemental CEO pay ratios has been limited (approximately 12% of S&P 500 companies), when provided, supplemental CEO pay ratios are typically disclosed to explain a one-time event (e.g., CEO transition) that materially increased or decreased the ratio versus the prior year.

6. Narrative Disclosure. For the most part, we do not expect that companies will significantly expand their disclosures around median employee or workforce demographics in 2021 proxy statements, as it relates to CEO pay ratio disclosure. This is despite requests from certain large institutional investors and the New York State Comptroller.

   Any changes to CEO pay ratio narrative disclosure in 2021 proxies will likely be modest and focus on year-over-year comparability, and, where appropriate, use of a different median employee. It remains minority practice to include any description of the median employee as part of CEO pay ratio proxy disclosure. When descriptive information for median employee is included, companies most often disclose the geographic location, employment type and/or role of the median employee.

   When additional narrative disclosure is used, it will be important to not lose sight of what was disclosed in the newly required Human Capital Management section of the 10-K, to ensure consistent messaging around the employee workforce.

7. Comparability. Since inception, comparing CEO pay ratios across companies has been of limited usefulness. For example, beyond variability across industries, when looking at two competitors, the workforce of one may be largely U.S.-based while the workforce of the other may be mostly located in lower cost countries. Inconsistent disruptions in business and workforces in 2020 due to the historic COVID-19 pandemic, that may significantly impact the numerator and/or denominator of the CEO pay ratio calculation, has only reinforced the inherent issues with comparing CEO pay ratios across companies.

Year-over-year comparability of CEO pay ratios may also be difficult in 2021. For example, CEO salaries could have been temporarily reduced in 2020 and bonuses may pay out substantially lower than a typical year. In other instances, front line workers may have received additional pay, in the form of one-time bonuses, additional overtime and/or enhanced benefits.

Looking Ahead

While new considerations need to be addressed for 2020 CEO pay ratio calculations, we expect 2021 CEO pay ratio disclosures to remain primarily compliance-focused, in most cases with limited to no supplemental information. There will also continue to be pressure from outside stakeholders for greater disclosure around median employee information and related workforce demographics, though such workforce demographic information will most often be addressed and disclosed in other areas of the proxy statement and/or 10-K.

Additional CEO Pay Ratio Resources – Compensation Advisory Partners

• CEO Pay Ratio Tracker. CAP’s CEO Pay Ratio Tracker uses each company’s most recent pay ratio disclosure, and can be filtered on revenue, market capitalization and industry sector. The CEO Pay Ratio Tracker can be accessed here: https://www.capartners.com/cap-thinking/ceo-pay-ratio-tracker/
• A Deep Dive into the Second Year of CEO Pay Ratio Disclosures: https://www.capartners.com/cap-thinking/deep-dive-second-year-ceo-pay-ratio-disclosures/
• Pension Funds and Institutional Investors Weigh in on CEO Pay Ratio: https://www.capartners.com/cap-thinking/ceo-pay-ratio-shareholder-letter/
• Pay Ratio Disclosure: A Practical Guide to Implementation: https://www.capartners.com/cap-thinking/2017-pay-ratio-disclosure-practical-guide-implementation/