Advice for Rem Com Chairs in the light of Covid-19
April 17, 2020
We are now living in the strangest of times, certainly the most difficult that the vast majority of us will have ever experienced. We are, for all intents and purposes, in unchartered waters as far as executive remuneration decisions are concerned.
However, we at MM&K have seen major economic downturns on a number of occasions in the past and we have learnt something from those.
We feel very strongly that businesses need during these hard times to try to maintain the loyalty and support of all their employees, including their executives. Companies can do this by treating all their employees fairly and with respect during this period. It is vitally important that when the economic tide turns around and when this pandemic is over, businesses are able to call upon their executives and employees to get back to business at a time when those individuals feel enthusiastic, motivated and appreciative and not when they might all be looking to find a new employer because they felt that the business did not treat them fairly or with respect during the hard times.
Clearly, each company and each business will be different. Some (the few) may be benefitting financially from the pandemic, such as supermarkets and some pharmaceutical and medical appliance businesses. For these firms one would advise that for their executive remuneration policies, it should be business as usual, albeit with some recognition of the huge extra efforts being put in by executives and staff.
For other types of businesses, the current situation and the outlook may appear bleak.
It is for these companies that the following advice and commentary is mainly aimed at.
For those companies with 1 January and 1 April salary review dates, most of these will have agreed and communicated the salary increases (if any) for the current year and these will have been implemented. In general, we have seen very modest inflationary increases in base salaries, typically at the 2% or 3% level, for executive directors. A number of companies with 1 April review dates have made a decision to defer any increase in salaries for six months. We are supportive of companies doing this where their business is suffering and recommend that it should be presented as a deferral and not as a decision to freeze salaries for this year.
In recent days we have also seen a number of companies decide to reduce the salaries of their executive directors and senior executives on a temporary basis until business is back to normal. Clearly this is happening in businesses where the Government’s enforced lockdown has had a dramatically negative effect such as housebuilders, leisure businesses and non-essential retailers. The reduction in salaries has tended to be in the 20% to 40% range and in most cases it has been structured as a deferral and not a permanent loss.
Clearly each company will need to react to their own particular circumstances.
However, for most companies who have reasonable levels of reserves and where their business is able to continue, albeit at reduced levels, we believe that companies should keep paying salaries to executives in full where they can. Even PIRC (Pensions & Investment Research Consultants Ltd, Europe’s largest independent corporate governance and shareholder advisory consultancy) seems to accept this. In a recent letter to all listed companies’ company secretaries it has stated that “PIRC calls on companies to suspend all payments to executives other than basic salaries with effect from 1st April.”
(a) Bonuses payable for last year’s performance
For those companies with December year ends, most of these companies will have paid the cash elements of their year end bonuses by now. We are aware though of some companies that have deferred the physical payment of cash bonuses for six months (i.e. to September 2020) and have retained a discretion to defer the payments for longer. This seems sensible for those firms that have been severely impacted by the current situation.
For most of those companies with March year ends, the decision as to what level of bonuses should be paid and whether they should be paid in the normal timeframe is still to be taken.
PIRC are suggesting no cash bonuses should be paid from now on.
We do not agree with this. We do recognise that conserving cash will be an important factor for many businesses, so this may necessitate either a deferral of bonus payments for six or nine months or possibly paying part or all of bonus entitlements in shares, possibly with just a one year restriction on selling.
We do believe that simply cancelling bonus payments for senior executives because there is some political pressure to do so will not endear companies to their executives in the future. The same applies to all employees. If bonuses have been earned because of historic performance, they should be paid, although if the finances of the business require it, yes of course payments should be delayed. If paying bonuses in shares is an option for companies, we believe that this may be a particularly attractive idea and executives should be supportive of this, especially given that they may consider their company’s share prices to be low at the moment. Institutional shareholders should also be supportive of this approach, recognising that it will help businesses conserve cash as well as further align management’s interests with shareholders.
For most companies with March year ends, bonus payments for executives are not made until after the company has had its accounts audited and it has announced the results to the market. We would advise remuneration committees to alert executives to the fact that the payment of bonuses this year may be delayed because of the current economic uncertainty, or may be paid in company shares. Remuneration committees could even consider offering executives a choice between deferral or payment in shares, where their remuneration policy allows.
(b) Setting annual bonus targets for the current financial year
For those companies with December year ends, they will by now have agreed the short term bonus performance metrics and communicated these to executives. In a large number of companies, these metrics will already appear out of reach.
For these companies we believe that it will be appropriate sometime soon for the remuneration committee to let the executives know that the committee recognises this and that it will use its discretion to review the bonus metrics at say the half year stage when it will consider whether revised targets aimed at incentivising and rewarding performance in the second half may be appropriate. Of course, it is quite possible that even at the end of June, there may still be no real clarity of what will happen in which case the committee may need to adopt a much more discretionary approach to the determination of bonuses come the year end.
For those companies with financial years commencing on 1 April, in most cases we would recommend that remuneration committees should refrain from setting any targets for the new financial year until there is some more clarity as to what the effects of the pandemic will be. In the meantime, boards should be focusing on what their short term KPIs are in these circumstances and communicating these to their executives as well as to the wider workforce. It is quite likely that these KPIs will be different to the normal ones that the executives are used to seeing and being bonused on. Committees may wish to communicate to executives that year end bonuses are still possible but will be based more on how successful the company is in achieving these new (and maybe temporary) KPIs.
Having said all that, remuneration committees will need to take into account that the likes of the Investment Association and ISS will expect to see much lower bonuses being paid for current year performance if the effect of the virus has resulted in a significant fall in profits and / or share price. Likewise, if the company has decided to cut its dividend payments to shareholders.
In our experience, many companies have held off from making new LTIP awards this year. This would seem sensible. We are in extraordinary times and it is nigh on impossible for companies to predict what might happen over the next twelve months let alone over the next three to five years.
Most company LTIP rules do allow awards to be made at times outside of the normal periods (typically within thirty days after the announcement of results) and we would suggest that remuneration committees take advantage of this to see if things become a bit clearer over the next two to three months.
Another complicating factor revolves around what quantum of awards (in terms of number of shares) companies should grant in the current climate where in nearly all cases share prices have come down by such a large amount. Since 2 January, the FTSE All Share index has fallen by nearly 30%, while the FTSE Small Cap has fallen by just over 30%. Institutional investors will expect to see companies not taking ‘full advantage’ of these share price falls by basing award levels on a historically higher share price, or possibly simply on typical historical award levels (in terms of numbers of shares).
The current circumstances should also provide remuneration committees with an opportunity to consider whether the performance metrics that the company has used previously remain the right metrics for forthcoming awards. Clearly care will need to be taken if the committee decides that the metrics should be different in that this may go against the remuneration policy that has been approved by shareholders. This might lead some companies to change their remuneration policies at their forthcoming AGMs to provide greater flexibility for the remuneration committee in terms of types of LTI awards and the performance measures applying thereto.
One possible outcome for a number of companies may be a decision to change their LTIP policies more fundamentally and move over to just awarding restricted stock rather than performance shares. It is in these types of situations that the benefits of awarding restricted stock on an annual basis really stands out. The decision each year is much simpler. There is no need for companies and remuneration committees to agonise over the setting of long term performance metrics or for participants to worry that their past awards are now not going to vest because events have occurred which are outside their control. Some companies are considering making this change now. For many they will need to change their remuneration policy to enable them to do this. It is certainly something that we believe remuneration committees should be looking at.
We will be writing a separate article in the coming weeks on the concept of restricted stock or deferred share awards which we will be circulating to all our contacts.
All employee share schemes
The recent falls in share prices will have shocked many employees participating in company share plans. However, those employees in SAYE share option plans should take comfort from the fact that their savings are protected and that they can cash those savings in at any time.
We would suggest that now may be a good time for companies to think about making a new Sharesave invitation to employees, offering them the opportunity to buy into the company’s shares at an attractive price. We also suggest that for those companies that have not got an all employee share plan, now would be a really good time to put one in. Institutional investors have come out recently suggesting that they are supportive of companies having such plans. It should also be well received by employees, if marketed in the right way, instilling in them a feeling that they are recognised as being extremely important to the business.
Companies may also take the opportunity of considering the introduction of a share incentive plan (or “SIP”) through which employees may be gifted some free shares (in a tax efficient manner) in recognition of their efforts through these difficult times.
We will be writing and publishing a separate article in the coming weeks on the subject of all employee share plans which will consider further the relative merits of share incentive plans and SAYE share option plans and how introducing such plans may really help with your employee motivation and engagement.
If you wish to discuss anything arising from the above commentary, please contact your usual contact at MM&K or if you do not have a usual contact please email any of the following executives:
Nigel Mills: firstname.lastname@example.org
Paul Norris: email@example.com
Stuart James: firstname.lastname@example.org
Margarita Skripina: email@example.com
Please note that this article is intended to be a summary of our thoughts and recommendations for remuneration committees in these most challenging of times. The advice given in it is meant to be of a general nature and whether it is applicable to a particular business or company will depend on that company’s actual circumstances. We cannot accept any responsibility for actions taken by any company as a result of reliance on any statements made in the article.