The Hertz story
Let’s consider the Hertz story. On 26 March, Hertz announced employee furlough programmes at the same time as announcing “senior leaders at Hertz are taking a significant reduction in pay and CEO [Kathryn] Marinello is relinquishing 100% of her base salary”.
Less than two months later, Hertz restored those senior executive salaries: “Effective May 11, 2020, the base salaries of senior leaders will be restored to pre-voluntary reduction levels except that the Company’s Chief Executive Officer, Kathryn V. Marinello has voluntarily agreed to a 10% salary reduction going forward.”
Shortly afterwards, on 18 May, Marinello resigned and the company announced that Paul Stone, formerly its Chief Retail Operations Officer, would become CEO. Marinello will be staying on in a consultancy role for a year, and, though no announcement has been made so far, will probably be rewarded with consultancy fees.
One day later, on 19 May, the company announced a retention bonus programme, for which Stone, who has only just been promoted, will be eligible for a $700,000 payment. This provided approximately $16,221,000 to key employees at the director level and above. The purpose of the payments was to reward these employees for the substantial additional work they were doing as a result of a “reduced workforce”, because they had forfeited rights to participate in the 2020 annual bonus plan – which, let’s face it, was unlikely to pay out – and to ensure that these key employees were retained. One is tempted to ask, where would they go? Other car hire companies are hiring? And, then again, why not increase the workforce, spread the work and the money around?
Voluntary reductions in pay
Hertz is not the only US company to have announced pay cuts for its executives and, in some cases, non-executive directors (NEDs). Research by data firm ESGAUGE and The Conference Board shows that, as of 22 May this year, 553 companies in the Russell 3000 saw reductions to pay of some kind, mostly smaller companies, and mostly in the consumer discretionary sectors, which includes hotels and specialty retail, for example, and in industrials. Most pay reductions are focused on base salary and, for NEDs, cash retainers, but some cancel out bonuses. 553 seems like a lot, but it is less than a fifth of companies. One is tempted to ask, why so few?
Of course, base salary accounts for only around 10-25% of total pay for executives so it could be said that this is a sacrifice that is one of the easiest to make. Except that it is likely that cash and equity incentive payments will be severely hit by faltering performance and stock prices – unless you take action like Hertz to mitigate that.
Investor sentiment will be pretty clear about such mitigations, however. For example, Alan MacDougall, founder and managing director of shareholder advisory firm PIRC in the UK, wrote an op-ed in the Financial Times that called for “companies to suspend all payments to executives other than basic salary from the 1st April, until the end of your financial year”. And he wasn’t just talking to the US. While MacDougall’s stance might be among the more exacting of positions, it is likely to find a great deal of unspoken sympathy from investors whose holdings have seen significant reductions in value.
But retention bonuses are not the only imaginative, one might almost say imaginary, ways that companies and their advisers have come up with to ensure that executives get paid in the US despite the largest pandemic since the 1918-1919 flu. Discretionary bonuses, changing performance targets, stock option repricing – where worthless stock options are exchanged for new, lower-priced options that could bring windfalls – shifting pay from annual bonuses to long-term incentives, changing the timing of equity grants, these are all options being considered.
Glass Lewis and ISS viewpoints
Both ISS and Glass Lewis pay policies, in general, appraise discretionary payments negatively, whether that discretion comes through dropping performance metrics altogether or revising them significantly downwards. For example, Aaron Bertinetti, senior VP of research and engagement at Glass Lewis, writing in a Harvard CorpGov blog, said: “Companies with strong pay structures will be challenged to abide by them, and firms with less robust programs will be forced to choose between lying in the bed they’ve made or changing arrangements and all but guaranteeing shareholder ire.”
Although ISS does not specifically say it will recommend voting against Say on Pay resolutions or members of remuneration committees if they make ‘changes’ to metrics, it does give some warnings subsequent to the onset of the crisis. Most significantly, it warns companies that are adjusting performance metrics to disclose this now and not make shareholders wait until next year to find out.
If companies want shareholders to look at these ‘adjustments’ positively, it would be advisable to make sure the entire workforce is treated similarly to executives, and that such discretionary payments are not made at the same time as large parts of the workforce are ‘furloughed’. Simply paying bonuses when metrics were not met or changing metrics to make targets easier to meet is likely to run into opposition during engagement meetings with shareholders and at the annual meeting in 2021, which, despite ISS’ advice, is likely when most investors will learn of such pay changes.
When a bonus is not a bonus
In the US, cash incentives are reported under two different headings in proxy disclosures. Regular annual bonuses, with preset targets, are reported as non-equity incentive compensation. Retention payments and discretionary bonuses are reported as ‘Bonus’. Any company – such as Hertz – which switches disclosure of its cash incentives from the former column to the latter is likely to come under significant scrutiny. That will not stop some companies from doing it anyway, but it will discourage some.
While decisions about most annual and long-term incentives to be paid out for 2020 will have been made in late 2019, advisers are already thinking about how to mitigate the effect of the pandemic on pay for 2020 and 2021. Many companies have suspended earnings and other forecasts, so making decisions about what short-term targets might be appropriate for later this year is going to be very difficult. Options for avoiding this difficulty that are being proposed are to shift annual incentives into the long-term portion of pay, either as performance-based awards, which vest according to achieving performance targets, or as restricted stock, which vests over time.
While the latter provides more payout certainty, the former ensures that the majority of pay is performance-related.
Individual performance adjustments
US pay consultancy Pay Governance recommends adjusting individual performance measures so that they are more appropriate in the face of the pandemic. For example, it suggests replacing “predefined objectives… with the redefined priorities of the business” because crisis-related goals are likely to be more pressing than those developed prior to the beginning of the fiscal year. “The CD&A [Compensation Discussion & Analysis proxy disclosure],” it advises, “should provide a thorough description of the rationale and process for realigning the IPF [individual performance factors] criteria and the evaluation approach used to assess this performance.”
Timing of equity grants
Timing of equity grants is also becoming an issue. Most recent equity grants were decided in late 2019/early 2020 when stock prices were at an all-time high in the US. They are now worth significantly less or, in the case of stock options, are underwater – the exercise price is higher than the current stock price. In such cases, the options are currently worthless.
If additional grants are made later this year, when stock prices are at historic lows, not only will many more shares need to be granted to achieve similar levels of compensation, but a market recovery would lead to massive windfalls for executives. In such a situation, one would think that the obvious thing to do would be to suspend making equity grants altogether until the market has resettled. But, of course, this is the US, and, for many, the issue is, ‘how do we make sure executives still get paid?’
On the other hand, some advisers, such as Pay Governance, advise spreading out grants over time to take account of significant market volatility rather than simply taking account of historically depressed prices.
Stock option repricing
I’ve already warned about the potential for stock option repricing. ISS’s policy, from the same crisis advice, is that companies will be penalized if they reprice without stockholder approval; most equity plans also require it. And even if companies seek approval, it will only recommend approval if it doesn’t increase share usage, if replacement awards don’t vest straight away, and if directors and officers are excluded.
Unfortunately, the new style SEC has completely undermined the shareholder approval part of stock option repricing, by granting fast-track approval to a New York Stock Exchange request to provide temporary waivers of approval for some equity issuances. It has also granted a similar request for NASDAQ. This rule change may allow companies to issue/sell stock to executives at a ‘minimum price’ to replace underwater stock options without any recourse to stockholders’ approval.
Some are trying to do the right thing, but there are so many that are trying to figure out how to get around the current situation that it seems time to say: enough is enough.