Considerations for Executive Compensation During a Crisis

In a crisis, boards and management often confront difficult decisions with little warning and no time to consider all permutations of potential solutions. When a business disruption involves decisions on how to reward, motivate, and retain executives, those setting pay must consider the needs of the company, its shareholders, and other stakeholders. Compensating executives during a crisis must balance the retention of top talent with constraints set by stakeholders and the principles of good governance.

In this article, we look at typical crises, consider how to approach them, and focus on some of the pitfalls associated with pay decisions during a crisis. Finally, we offer some approaches to bolster crisis response.

Defining the Crisis and Understanding Context

Three categories of crises generally involve major executive compensation decisions:

1. Economic or social upheavals such as black-swan events, including global pandemics, recessions, or monetary collapse.

2. Business or industry turmoil, including a major product failure, cyberattack, industry collapse, or another significant disaster such as widespread supply chain issues.

3. Loss of key executives, whether from tragedy or bad behavior.

Knowing the kind of crisis, possible consequences, and duration is arguably the first step toward crisis mitigation and resolution. Boards need a keen understanding of the current, next-quarter, and next-year scenarios. Types of crises are limited only by the imagination, as witnessed by events in the last two decades. For example:

• Business or industry turmoil would most likely affect incentive plan outcomes. The board will need to look hard at whether incentive plans align with actual business outcomes and shareholder expectations. While it may become necessary to override existing plan design and payouts, the board and management must consider stakeholder concerns about deviating from plans and how those changes will be communicated
• While the loss of key executives may feel like a gut punch, particularly in cases involving executive wrongdoing or during business turmoil, turnover at the top rarely derails day-to-day operations in the short term. Directors often need to take a breath, consider what outside help may be required, consult with management, and rely on established succession plans to ensure that recruitment (and the successful offer it hopefully brings) reflects a methodical, rational process
• During the COVID-19 pandemic, some firms made pay decisions in the first few months of 2020 that seemed disconnected from the breadth and duration of the event. Knee-jerk pay decisions rarely lead to good outcomes; shareholders made their voices heard with low say-on-pay vote support at companies where one-time special awards were justified by management and the board as necessary for the retention of key talent. Meanwhile, there was less likelihood that talent was going anywhere due to the global nature of the pandemic and the desire of most companies to stay the course

Avoiding the Pitfalls

Understanding the type of crisis provides perspective on the approaches and tools likely to help in each situation. Risk appetite, for example, may need to be adjusted along with performance goals.

One of our business-to-consumer manufacturing clients, facing increased scrutiny from governments and customers on the environmental impacts of its products, recognized an urgent need to restructure its incentive program to motivate executives to transform the organization to better align with sustainability requirements. Key actions at the company included:

• Recognizing the urgency of the situation before it turned into a do-or-die crisis
• Tapping internal and external expertise to provide perspective on areas where management and the board needed help understanding the strategic landscape and how to tie potential business changes with effective incentive program design
• Establishing a change-management approach that involved key stakeholders to encourage buy-in across the company and with investors

Successful CEO transitions are typically quiet, orderly, and well-planned. Those that stand out immediately add value to the company and its shareholders. When a CEO is forced to resign, much is revealed about the strength of the board’s leadership development and talent pipeline. Farient’s observations about what makes for a smoother transition in these situations include:

• Once issues had been identified and investigated, management and the board act quickly and decisively to remove executives
• The company appears to have executives lined up to take over roles if only temporarily, to ensure leadership continuity
• The company does not run to the market and grab a high-profile (read: expensive) CEO. Nor did new CEOs receive windfalls because of the leadership vacuum. The compensation component of the transition was treated like a planned CEO turnover event. CEO pay was grounded in the candidate’s skills and within market norms

Many of our clients now face a real-time crisis due to questions and uncertainty about tariffs. Among the many concerns, management and boards may face disconnects between actual and expected performance in key business areas as measured by short- and long-term incentive programs. Our best advice to these clients, and any company facing challenges, includes:

• While executives may feel immediate pain from economic issues like tariffs and other economic realities, investors generally believe that when it comes to performance, “everyone benefits and suffers together.” Said differently, shareholders will expect that executive compensation programs should neither be changed dramatically nor augmented with special awards just because the business environment has turned sour
• Management and the board must understand how the pay program will evolve in response to new economic realities. Any substantial program change must consider stakeholder expectations on pay and how various scenarios could change given potential policy changes
• When it comes to changes in the executive compensation program, particularly to metrics and goal levels, the right decision today may be no decision at all. Chasing a wildly moving target such as daily tariff changes might only result in greater uncertainty, frustrated executives, and skeptical shareholders. Indeed, a well-designed and executed incentive program might provide all involved with the certainty needed in the current environment

Regardless of the crisis, any executive compensation decision should reflect the needs of the company and its shareholders. Those setting the course through turmoil must remember that compensating executives during a crisis must balance the motivation and retention of top talent with constraints set by various constituencies, including investors.

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By Trey Poore

Trey Poore is a director at Farient Advisors.