The 2021 executive compensation season will be more challenging than usual for most companies due to the financial and economic consequences of the COVID-19 pandemic. To meet these challenges, companies should be aware of several key issues relating to executive compensation as they design their 2021 executive compensation programs.
1. Revisiting Clawbacks and “Cause” Definitions
Expanding clawbacks and “cause” definitions to cover misconduct beyond financial matters may help ensure that a company will be able to recoup executive compensation in the event of reputational harm to the company or adverse publicity. Recently, the U.S. Securities and Exchange Commission (SEC) announced that it will issue revised rules to implement the clawback provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2021. The existing proposed SEC clawback rules generally require a public company to adopt a clawback policy to recover excess incentive compensation paid to current or former executive officers during the three fiscal years prior to the date the company is required to file a financial restatement due to a material error, regardless of whether the restatement is caused by an executive’s misconduct. Although the SEC’s clawback rules apply to public companies, private companies are viewing clawback policies as good corporate governance and are adopting similar practices. In anticipation of this new guidance, companies may want to review their clawback policies to confirm they comply with current SEC guidance. Companies might also consider implementing clawback policies that extend beyond financial restatements (e.g., requiring employees to return incentive compensation awards if grounds exist for a “for cause” termination), as well as revisiting the “cause” definitions in executive compensation arrangements to confirm that they adequately protect the company.
2. Change in Control and Severance Agreements
Due to financial challenges, a number of companies are facing difficult restructuring decisions. In addition, many financial buyers and competitors have not abandoned their strategic business plans and may initiate acquisitions of companies that are temporarily undervalued in the COVID-19–disrupted economic environment. Accordingly, companies may want to review existing change in control or severance arrangements or implement new arrangements. With respect to severance arrangements, it is important to consider whether they are subject to the Employee Retirement Income Security Act (ERISA) and Internal Revenue Code Section 409A, and, depending on how post-termination health benefits are provided, determine any continuing health benefits compliance issues under the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA). Companies should consider reviewing change in control arrangements to ensure leadership continues to be focused on the company’s business and is protected in the event of an unexpected or unwanted transaction.
3. Temporary Salary Reductions
In light of the ongoing COVID-19 pandemic, many companies have changed a number of their internal compensation policies or practices in 2020. For example, companies may have implemented temporary salary reductions with promises to repay forgone salaries either later in 2020 or in a future year. It may be a good time to revisit such arrangements and ensure that any repayment is completed prior to March 15, 2021 to avoid potential Code Section 409A concerns. In addition, companies may want to be aware of any state wage and hour laws implicated by these salary reductions. Publicly traded companies may want to confirm whether repayments are required to be disclosed under SEC rules. Companies that implemented salary reductions may be at risk of losing key executives to competitors and should consider whether restoring compensation (or, alternatively, offering discretionary bonuses or retention awards) would assist in efforts to retain and motivate key executives.
4. 2020 Performance Awards
The pandemic has affected the ability of many companies to effectively set performance goals and determine payouts for long-term and annual incentive compensation programs. In determining 2020 incentive award payments, companies that have been significantly impacted by the pandemic may choose to exercise compensation committee or board discretion to adjust performance metrics set earlier this year. In making these determinations, companies may want to confirm that incentive compensation plan documents provide the compensation committee or board with discretion to make adjustments. Companies should also consider establishing a framework that takes into account how discretion will be applied this year and in future years. Publicly traded companies planning to adjust performance goals should be aware of guidance from proxy advisory firms, such as Institutional Shareholder Services Inc. (ISS) and Glass Lewis, and institutional shareholders.
5. 2021 Incentive Compensation
Because the effects of the pandemic on the economy in 2021 and beyond remain unclear, it may be helpful to confirm that incentive compensation programs explicitly provide the compensation committee and board with the discretion to adjust performance metrics and determine payouts. In designing 2021 incentive compensation programs, companies may want to consider the current economic climate while keeping in mind that incentive programs serve the important purpose of effectively motivating and retaining key executives. For instance, some companies may change financial performance metrics to strategic metrics (such as satisfying diversity, equality, and inclusion objectives) to address the economic uncertainty or may delay setting performance goals until later in 2021 when there is more clarity regarding a company’s business outlook and macroeconomic trends. Other companies may include a lower maximum payout but also lower the eligibility threshold for receiving a performance award. To address the uncertainty of incentive compensation payouts, it might also be useful to provide retention bonus opportunities to key executives to maintain and motivate current business leadership.
Each of these key issues is important to discuss with outside counsel and compensation consultants when making decisions about executive compensation this year and when considering 2021 changes.