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.
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