Executive compensation is a perennial engagement topic for the State Street Global Advisors Asset Stewardship team. We believe that executive compensation presents risks, such as creating perverse incentives, as well as opportunities, such as demonstrating a commitment to environmental, social and governance (ESG) priorities. When structured appropriately, executive compensation can be well aligned with operational goals and shareholder results. However, this topic is receiving elevated attention because the COVID-19 pandemic has rendered many compensation-linked performance targets unattainable. During our engagements with our portfolio companies, most report that they plan to update their executive compensation programs but acknowledge that they have not yet acted.
Because the impact of COVID-19 is not uniform across businesses, we will rely on our case-by-case approach to voting on executive compensation, evaluating each board’s decisions and the specific circumstances of each company. Enhanced disclosure of the board’s decision-making process will be key to our evaluation, as described below. Some boards will need to consider the applicability of executives’ performance against predefined performance goals, as well as the relevance of executives’ decisions to pursue layoffs, furloughs and other extreme cost-cutting measures. Conversely, other boards may need to weigh dramatically improved near-term performance against the sustainability of such results in a post-pandemic world.
Enhanced Disclosure Expectations
We continue to expect clear, concise disclosure of executive compensation and how it is aligned with a company’s strategy. Where boards elect to use discretion in making award determinations, we will focus on the disclosure and narrative describing the board’s decision-making process.
We have always asked our portfolio companies to use discretion in their compensation programs. However, as the proportion of pay awarded based on qualitative assessments increases, so too do our expectations for detailed disclosure. We anticipate heightened investor scrutiny of discretion decisions during the COVID-19 pandemic, and compensation that is driven primarily by the board’s discretion without appropriate justification will likely lead to low levels of shareholder support on pay. A well-executed discretionary element of the annual bonus program provides an opportunity to communicate how a company has performed on non-financial priorities that are foundational to the strategy, including ESG elements. This form of communication to shareholders becomes even more important when a company has pulled financial guidance.
In our evaluation of compensation programs that have been amended to reflect the current macro environment, we will look for the following:
Deep, explicit alignment between compensation and the current strategy;
Clear disclosure of performance against expectations, including how and why expectations may have changed in reaction to COVID-19;
How payout opportunities have been adjusted alongside changes in performance expectations (e.g., whether the maximum opportunity has been lowered to match target adjustments); and
How executive compensation decisions, including adjustments to performance goals, align with changes to compensation at the company more broadly, including layoffs and furloughs.
While many of our discussions have focused on short-term performance considerations, long-term equity compensation has also received significant attention because of current market volatility. This is not surprising, as equity compensation represents an increasingly large proportion of executive pay.
Shareholders allow the dilution and expense of equity grants in order to more closely align executives and employees with shareholder interests. Though the impacts of COVID-19 are currently short-term, we have already observed companies taking concerning actions with respect to their long-term compensation programs.
We are likely to vote against executive compensation programs at companies that:
Make retention awards that do not have a longer vesting period than the company’s normal equity grants;
Reprice or replace underwater options, or make grants to replace options that expired out of the money;
Make off-cycle equity grants at the bottom of the market; and/or
Change their equity structure, such as increasing the proportion of stock options to take advantage of market volatility.
We share a common goal with our portfolio companies: ensuring long-term, sustainable returns. We recognize that compensation committees and boards will have to make many difficult decisions regarding compensation in the coming months. The perspectives we have outlined answer the most common questions we have received on this topic, and we look forward to discussing new issues as they arise. The State Street Global Advisors Asset Stewardship team can be reached at firstname.lastname@example.org.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
Investing involves risk including the risk of loss of principal.
The returns on a portfolio of securities which exclude companies that do not meet the portfolio’s specified ESG criteria may trail the returns on a portfolio of securities which include such companies. A portfolio’s ESG criteria may result in the portfolio investing in industry sectors or securities which underperform the market as a whole.
The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without State Street Global Advisors’ express written consent.
This information is for informational purposes only, not to be construed as investment advice or a recommendation or offer to buy or sell any security. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed herein are those of the author(s), are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. There are no guarantees regarding the achievement of investment objectives, target returns, portfolio construction, allocations or measurements such as alpha, tracking error, stock weightings and other information ratios. The views and strategies described may not be suitable for all investors. SSGA does not provide tax or legal advice. Prospective investors should consult with a tax or legal advisor before making any investment decision. Investing entails risks and there can be no assurance that SSGA will achieve profits or avoid incurring losses.
Performance quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted.
Images of NYSE Group, Inc. are used with permission of NYSE Group, Inc. Neither NYSE Group, Inc. nor its affiliated companies sponsor, approve of or endorse the contents of this program. Neither NYSE Group, Inc. nor its affiliated companies recommend or make any representation as to possible benefits from any securities or investments.