While some companies might consider shifting the long-term incentive mix back towards options to take advantage of low exercise prices, we caution companies to avoid over-reliance on highly leveraged equity vehicles that might encourage excessive risk taking.
For example, remixing the grant towards stock options to take advantage of what may be a low stock price should not by itself be viewed as an appropriate rationale for adjusting the mix, particularly amid concerns of stock option backdating. Further, the negative leverage drawback of options could be compounded if the markets experience further declines.
Also consider that any actions taken for 2009 grants will need appropriate disclosure in the CD&A (compensation discussion and analysis).
We recommend reviewing a draft disclosure of the rationale before making final decisions.
Companies will be busy evaluating executive remuneration strategies for 2009. We offer a list of areas for developing the 2009 agenda.
• Alignment of programme to business strategy: Ensure the compensation programme reflects adjustments that may be made to business strategy.
• Balance of incentives for short-term, mid-term and long-term performance: Market volatility invites a discussion of whether the plan appropriately rewards a balance of performance time horizons.
• Long-term incentive vehicles: Examine the appropriate role of options, performance awards, and restricted stock and cash-based plans.
• Performance measurement and target setting: Forecasting may be more uncertain in this environment. Companies should examine measure selection; goal setting and the range of performance corresponding to payouts; and the use of relative versus absolute measures.
• Business risk implications: Recent regulation has invited scrutiny of whether compensation plans within financial services organizations led to inappropriate risk-taking; 2009 is a good time to test.
• Global compensation strategy: Declining equity markets and currency fluctuations invite review of global compensation strategies to ensure appropriate alignment.
• Executive retention and wealth accumulation: Declining markets have left options underwater and equity programmes with much lower value. Assessing the impact on key talent and developing an appropriate strategy are critical.
• Stock ownership rules and holding requirements: Declining markets have impacted executive and director ownership guideline compliance. In some cases, shareholders have expressed concern about the timing of management award payouts, when share price declined and they suffered losses. This needs appropriate alignment.
• Equity strategy for director compensation: As with executives, there is a need to calibrate director compensation equity with falling share prices.
• Shareholder engagement strategy: Companies may find they need to seek shareholder approval of additional equity reserves sooner than expected, or undertake actions that may be at odds with shareholder policies that were adopted prior to the current market decline. Assessing how best to have a dialogue with shareholders will be an important consideration.
• Hot buttons for external shareholders: Executive severance, change in control, pension benefits and other executive perquisites are programme areas that have been the focal points for shareholders over the past several years. In a down market, the level of scrutiny on these increases.
Option exchanges, including repricings and cash-outs, are intended to meet a range of objectives: bridging the gap between accounting expense and value delivered to employees, restoring the retention value in outstanding equity awards and reducing overhang. Option exchanges are not feasible in all geographies because of regulatory constraints. In the US, they usually require shareholder approval and most companies exclude their named executive officers from the programme.
One thing we learnt from option repricings during the dot-com decline earlier this decade is that many companies act too quickly.
Options are intended to reward long-term performance and shareholders expect the stock price to be down for an extended period of time before companies try to correct the situation.
Given the current volatility, we suggest companies postpone consideration of exchanges until the market is more stable. At that point, value-for-value exchanges might be appropriate for underwater options held by employees below the senior executive level.
Another alternative is to exchange options for restricted stock, performance shares or cash incentives. So, while the same cautions apply, the range of solutions is broader than that during the last downturn. Companies are assessing how to respond to the volatile environment just in time, and the calculus is constantly shifting.
With market tumult comes opportunity. In this game-changing environment, companies have a unique opportunity to determine how best to configure their executive rewards and talent management strategies to align with key business objectives.
Much like the paradigm shift that occurred earlier in this decade with the fall of Enron, the adoption of the Sarbanes-Oxley Act and expensing of stock options, 2009 will see a dramatic rethinking of approaches to executive remuneration. With appropriate planning, this process will lead to more effective ways for companies to attract, retain and motivate executive teams, link pay to performance and align programmes with shareholder interests.
Padmaja Alaganandan is India business leader, and Gyan Anjan Kaur is consultant, human capital, at Mercer Consulting (India) Pvt. Ltd.
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This is the last in a three-part series.