Wachtell Lipton Discusses Executive Compensation Considerations – Looking Ahead and Staying Nimble

Unpredictability has dominated the economic climate over the last six months and likely will continue in the months ahead. Companies that swiftly and thoughtfully assess and respond to evolving challenges will most effectively manage through the pandemic. This theme applies with equal force when it comes to executive compensation. The volatility of the business cycle challenges compensation committees to proactively assess compensation programs and to pivot, fine-tune or stay the course, as events warrant.­­­

Assessing 2020 Performance. Director discretion will be as important as ever when it comes to assessing and rewarding 2020 performance. If a company’s preset financial goals for 2020 no longer provide a meaningful measure of company performance due to the impact of the pandemic, directors may need to exercise discretion and rely on subjective judgments regarding individual and company performance. Compensation committees that rely more heavily on discretion to assess 2020 performance should consider establishing a framework of key factors, including, for example, protecting and preserving the workforce and fortifying the company’s long-term liquidity. Creating a framework to assess performance will validate director determinations regarding incentive compensation payouts and will facilitate communication of these determinations to all relevant constituents.

Designing 2021 Incentive Compensation. Forecasting 2021 annual and long-term incentive performance goals may prove challenging, in particular for those companies that have experienced fundamental disruption due to the pandemic. The competition for talented leadership remains fierce, and properly structured incentive arrangements that accommodate market and business volatility are a key to maintaining a stable, motivated leadership team. Greater committee discretion, alternative performance goals and changes to the mix of long-term incentive awards are among the design levers that may best address the uncertainties of the current business environment. Likewise, performance goals that promote a strong, positive company culture and other ESG objectives are a valuable feature of a well-designed incentive program. A balanced approach to goal setting that includes traditional financial objectives, together with ESG-related metrics, may strike the right balance and produce the best results.

Managing Reversals of Compensation Reductions. Many companies that instituted reductions in force simultaneously reduced executive and director compensation. As companies begin to return employees to work or reach other performance milestones, boards may wish to consider restoring compensation to pre-pandemic levels, giving due consideration to the impact of any such changes on company-wide employee morale. Companies that do restore compensation levels for named executive officers should consider whether these actions require current disclosure under SEC rules.

Preparing for the 2021 Proxy Season. With the 2020 proxy season largely behind us, it is not too soon to prepare for 2021. Say-on-pay likely will present unique challenges in 2021. It will be essential for companies to explain 2020 compensation decisions, particularly so for those companies whose directors revise performance goals or exercise significant discretion in determining 2020 incentive compensation payouts. Assuming that companies provide clear, detailed disclosure regarding the rationale for executive pay decisions, we are hopeful that ISS will take into account the exceptional circumstances at work in 2020. For those companies anticipating a challenging say-on-pay vote in 2021, early, proactive shareholder outreach will be as important as ever.

Maintaining State of the Art Change-in-Control Protections. The more unpredictable the environment, the more important it is to be prepared for the unexpected. While the stock market has recovered much of the value lost at the outset of the pandemic, that fact should not lull companies into a false sense of security. The threat of shareholder activism and/or opportunistic, unwanted takeover attempts remains. And it remains vital to review, understand and strengthen, if necessary, compensation-related arrangements that maintain stability in the face of an activist challenge or a change in control.

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As companies manage through this volatile business environment, the challenges and priorities facing compensation committees may rapidly shift. One constant in an unpredictable environment is the need for proactive, engaged leadership. Under the circumstances, it may be prudent for compensation committees to get a head start on monitoring and assessing 2020 performance and designing incentive compensation programs for 2021.

This post comes to us from Wachtell, Lipton, Rosen & Katz. It is based on the firm’s memorandum, “Executive Compensation Considerations – Looking Ahead and Staying Nimble,” dated August 20, 2020.