Alerts

Incentive Compensation Considerations During the COVID-19 Pandemic

Alerts / March 23, 2020

Public company boards face myriad unforeseen issues due to the COVID-19 pandemic. Among these issues is how to keep their key employees incentivized to maintain and advance the corporate agenda during this crisis (when their minds, like ours, are likely on matters closer to home). Public company boards and their compensation committees have to assess incentive compensation on a regular basis, and at least annually. The economic uncertainty and market volatility caused by the pandemic now require public company boards and compensation committees to evaluate their incentive compensation programs and practices in light of such uncertainty and volatility and to make adjustments if required. Below are some key incentive compensation considerations for managing these circumstances:

  • Share Availability. Assess whether your equity award pools have sufficient shares to cover upcoming grants. As stock prices drop, equity award pools may be depleted more rapidly than anticipated, rendering prior burn rate projections obsolete. If adequate pool shares are not available, you may want to amend your plan to increase the number of shares. This, of course, requires shareholder approval. If you have not filed a proxy statement for your 2020 annual meeting, you may want to propose an equity plan amendment to address these higher-than-anticipated burn rates. If your 2020 annual meeting has come and gone, you may want to consider convening a special shareholder meeting to approve an equity plan amendment.
  • Equity Award Mix; Option Repricing. Reassess the mix of equity awards – the percentage of full share grants versus option grants – and consider whether any outstanding stock options should be repriced given recent market volatility. Applicable listing rules require shareholder approval of option repricing, unless your equity plan expressly authorizes it, which is unlikely.
  • Grant Dates.
    • If you have an annual equity award grant date coming up, consider delaying it. If you use grant date fair market value for equity awards, the number of shares subject to upcoming awards may be significantly higher than expected due to declining stock prices. Delaying the grant date could address this issue (assuming that the markets calm down and stock prices return to normal levels). Review your plan documents to confirm that they do not contain restrictions on grant timing.
    • Stagger award grants over a one-year period (i.e., on a quarterly basis). This may reduce the adverse effect of market volatility on the number of shares subject to each award (assuming, as above, that the markets calm down).
  • Pricing. Use a trailing average price, rather than a daily closing price, to set the exercise price. This could address any pricing irregularities arising from extreme market fluctuations. Review plan documents to determine whether alternative pricing methodologies are available. Keep in mind too that for options to be exempt from Section 409A of the Internal Revenue Code, the fair market value used to determine the exercise price may not be determined by a trailing average of more than 30 consecutive trading days (other equity awards may use a longer period and, given market volatility, it may be advisable to do so).
  • 2020 Performance Metrics
    • If you have not set 2020 performance metrics for your incentive compensation programs, you may want to consider:
      • Delaying setting performance targets, given the uncertain economic climate, until more information becomes available about the near- and long-term impacts of the pandemic. Recent amendments to Section 162(m) of the Internal Revenue Code allow more flexibility in the timing of performance goals – i.e., calendar year companies no longer have to set such targets by March 31 in order for the related compensation to qualify as “performance based.”
      • Setting performance targets based upon the current and projected impact of the pandemic on the company’s operations and stock price, if known, using alternative performance metrics, or using less formulaic approaches to assessing performance.
      • Drafting plan provisions that permit the plan administrator to adjust performance targets, if necessary, in light of pandemic-related impacts. Any such provisions must be properly drafted and narrowly tailored so that they do not transform performance-based compensation into discretionary compensation.
    • If you have set 2020 performance metrics, it may be best to “sit tight” and not rush to make any adjustments. Although it will seem in the near term that adjustments must be made, the full economic impact of the pandemic is not known at this time. If you make any adjustments now, and things change further, which they probably will, you may be forced to make additional adjustments at later dates. If you choose to make adjustments now, confirm that your plan documents permit such adjustments for extraordinary events. You should also consult with your auditor and tax advisor to determine whether such adjustments will trigger charges and/or other tax and accounting consequences.

In addition to the considerations described above, you must also be mindful of employee sentiment and morale, employee communications, proxy guidelines issued by proxy advisory firms, particularly with respect to incentive compensation (for example, how any changes to your performance targets will impact next year’s say-on-pay vote), and SEC disclosure obligations. If you materially amend an equity compensation plan or award to adjust performance metrics in light of the pandemic, you will need to report such amendment under Item 5.02(e) of Form 8-K if (a) your executive officers participate in the plan or award, (b) the amendments to the plan or award are material and (c) the plan does not contain the adjustment provisions discussed above. In addition, any changes to performance metrics for your “named executive officers” will need to be disclosed in your next annual meeting proxy statement. This disclosure, which will likely be reviewed by proxy advisory firms, should contain a detailed explanation of the reasoning behind any changes to performance targets or awards.

Authorship Credit: Janet A. Spreen and Michael L. Lawhead

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