Adapting Executive Rewards for COVID-19

• Cost cutting to offset projected loss of business
• Executives have the highest accountability for organization performance and hence experience the greatest impact on personal rewards in both economic booms and downturns 
• Exhibit “lead from the front” mentality 

Key Considerations

• Magnitude of pay cuts should take into account the projected business loss for the financial year, i.e., commensurate with severity of the pandemic’s impact on the P&L
• Pay cuts should be applied to fixed pay, which in turn may also lower the annual incentive and long-term incentive (LTI) opportunities as those are typically set as a percentage of fixed pay
• Most appropriate for worst-hit industries – travel, hospitality, retail, auto, real estate, etc.
• Several companies like Oyo, SpiceJet, Apollo Tyres, Kotak Mahindra Bank, Zomato, Indiabulls Housing, etc. have announced fixed pay cuts ranging from 15%-75%. Most organizations have applied higher pay cuts for senior management than for mid-to-junior level roles

• Temporary cost containment to offset immediate business loss 
• Postpone incremental expenses until there is better visibility into future performance  
• Exhibit “lead from the front” mentality

Key Considerations

• Deferrals may apply to FY 2020-2021 increments, ongoing salary payments, or new incentive awards
• Application and length of deferral should reflect the expected timing of performance recovery
• Appropriate for companies trying to conserve cash and manage operational liquidity 
• Several companies like TVS Motors, PwC India, Zoomcar and Wipro have undertaken salary / increment deferral
• Companies undertaking pay cuts or deferrals could consider equity incentives, a non-cash expense, in lieu of fixed pay and annual bonus that are cash expenses

Rationale 

• Annual incentive for FY 2019-20 performance and in-cycle LTI grants are likely adversely impacted in terms of the payout value due to the steep business downturn
• Balancing ‘pay-for-performance’ philosophy with the fact that COVID-19 is an exogenous occurrence beyond employees’ control is important to ensure that the rewards system is deemed fair and continues to attract, retain and motivate top talent 

Key Considerations

• Most companies will refrain from any discretionary adjustments and let actual performance results dictate the incentive payouts to uphold the integrity of plans 
• Some companies may consider adjusting the performance results to mitigate COVID-19’s impact on incentive payouts. This may be relevant when the alternative of not taking such action would wipe out substantial rewards for otherwise strong performance 
• Some companies may consider repricing/exchanging underwater stock options (i.e., options with zero intrinsic value due to precipitous decline in share price). However, this approach is considered a poor pay practice since it creates misalignment between shareholder and employee experience
• Board NRC should carefully study the facts and circumstances to determine the need for adjustments to prior plans. If a modification is deemed appropriate, then the NRC would be well-advised to consider the potential legal and accounting implications before finalizing its decision

Rationale

• Financial performance metrics (revenue, profit, return on capital, cash flow, etc.) measure the performance outcome and hence may lag the non-financial metrics (key value drivers) during COVID-19 
• While financial performance recovery is critical, it will be achieved through effective execution of a well-planned strategy

Key Considerations

• Inclusion of non-financial measures – such as employee safety/productivity, customer satisfaction, efficient supply chain and inventory management, innovation – could help weather the storm better through emphasis on current strategic imperatives
• Other measures that promote CSR initiatives to support  the broader community may also be considered
• Non-financial measures should still be measurable / quantifiable to enable objective assessment

Rationale

• LTI instrument(s) selected based on earlier business conditions may not be effective in a prolonged economic downturn
• Continued alignment of LTI plan structure with the company’s evolving strategy and overall economic environment is critical 

Key Considerations

• Companies may consider granting more than one LTI award type to achieve multiple objectives including retention and performance motivation
• E.g., a portion of LTI in restricted stock units (RSUs) or long-term cash would boost employee morale and promote retention of key employees while a portion in stock options would incentivize long-term value creation / restoration
• Performance shares would help drive recovery in the company’s financial and operational performance

Rationale

• Challenging to set goals in times of high uncertainty due to low visibility into future performance
• Traditional goal-setting approach could lead to high volatility in incentive payouts (i.e., all or nothing) and hence may not be relevant in the current context

Key Consideration

• Target goals, which are generally aligned with budget, should account for the pandemic’s impact and hence will generally be lower than the earlier projections
• Wider performance goal ranges could be considered for target payout as well as the full payout range (i.e., threshold to maximum) to mitigate high pay volatility
• Relative goals, such as relative total shareholder return (rTSR), versus industry peers can help obviate the need to set absolute goals while appropriately aligning pay with relative performance
• Another bespoke approach is to set goals for shorter, truncated periods – e.g., 2 half-year goals for annual incentive and 3 one-year goals for LTI 

Rationale

• Precipitous decline in a company’s share price will require significantly more ESOP shares for value-denominated LTI opportunities. This will raise the aggregate shareholder dilution from ESOPs
• E.g., if a CEO’s annual target ESOP opportunity is INR 1 Cr. and the share price declines from INR 100 to INR 65, the number of ESOPs required to deliver the same grant value would increase by ~54%

Key Considerations

• To balance the competitiveness of ESOP grants with shareholder dilution, companies can use 30-day to 90-day historical share price average to determine the number of ESOPs, rather than a single day’s share price
• Alternatively, a temporary shift from value-denominated (e.g., INR 1 Cr) to share-denominated (e.g., 0.05% of total share capital) LTI opportunities may help with capping dilution at a level that is amenable to shareholders  

Rationale

• Given the nature of the pandemic, it is important that companies’ Boards establish a robust succession plan for key leadership roles to ensure business continuity 
• Conducive time for large well-funded companies to pursue aggressive recruitment strategy by luring top talent with large sign-on bonus and/or LTI awards

Key Consideration

• Developing bench strength requires an in-depth review of the current and required pipeline for future talent 
• Once the potential successors are identified, their compensation package may need to be revisited to close the deficit versus competitive pay levels appropriate for their future role 

Rationale

• As the value of executives’ pledged shares is negatively impacted in a market downturn, it can trigger a margin call (i.e., shares pledged as loan collateral can be sold by the lenders). This can lead the company’s share price to spiral downwards 

Key  Considerations

• Companies may want to consider adopting a partial or full prohibition on share pledging by executives to avoid the potential decline resulting from margin calls
• Especially relevant for companies where executives hold a substantial amount of company shares

Rationale

• Gift/donation matching programs are relevant in today’s times as companies can match donations made by employees to a third-party charitable organization to help advance a social cause

Key Considerations

• Positively impacts the broader community while amplifying brand goodwill
• Since this would have incremental cost implications, it may be viable only for companies that are able to withstand the adverse economic impact of COVID-19