Rethinking Executive Comp for Tough Times

The Grinch is on the loose in compensation planning. At many companies, bonuses for 2008 will be lower than they were last year, and the outlook for 2009 is no better. In a recent poll of corporate executives, HR pros and outside directors by compensation advisory firm Pearl Meyer and Partners, nearly 88 percent of respondents said that the turmoil in the financial markets will have some impact or a significant impact on their organization's pay decision-making process over the next six months.

In about one-half of the companies polled, executive base salary increases for 2009 are expected to be less than those for 2008. And about 37 percent are considering freezing their executive team's base salaries.

Given the equity markets' dismal performance during 2008, the prospects for long-term incentives remain murky. With investors still reeling from this year's losses and the retirement assets of millions of Americans shrinking, compensation committees will need to think very carefully before taking any actions that might be seen as providing "pay for failure."

For example, post-separation pay packages such as change-in-control agreements will likely come under close scrutiny. Originally designed to cover senior executives during the time they would need to find a new position in the event that the firm changed hands, change-in-control multiples have risen steadily in recent years from one or 1.5 times annual base salary and target bonus to, in some cases, closer to three times that.

And companies are starting to question just how long execs need that reassurance. Jack Dolmat-Connell, CEO of Boston-based consulting firm DolmatConnell & Partners, believes some types of separation arrangements should be sunset as tenure increases. "What's the reason for having a severance or change-in-control agreement? Well, you're giving up a lot when you come in from another company, and you want some protection for some amount of time. But some amount of time should be two or three years -- not 10 years out, when things have gone totally haywire all of a sudden."

Most companies have put a lot of time and effort into getting the upside right over the past few years, making sure that executive comp packages align with shareholders' interests and that they reward performance when the company is doing well. Now it's time to re-examine the downside, says Dolmat-Connell. Bonus plans often pay out at 80 percent of target, he notes. "If you miss your numbers by a penny or two on Wall Street these days you get crucified, yet 80 percent could mean missing by fifty cents or more. So companies need to rethink this balance. I'm all for a lot of upside in plans, but it needs to be offset by a decent amount of downside risk."

CFOs are being drawn deeper into compensation discussions, for a couple of reasons. Decisions about bonus plans loom large when companies are firmly in cash management mode and CFOs, especially at smaller businesses, are looking over their shoulders at loan covenants. In addition, stock prices have dropped so sharply at some organizations that to grant the equivalent value of long-term incentive dollars as last year would require offering significantly more shares, so companies have to decide whether to adjust the grant methodology, and if so, how to tweak it.

A white paper from DolmatConnell & Partners sketches some key issues facing compensation committees, including:

• Underwater stock options. There's no cookie-cutter solution here; each company will need to weigh its own answers to questions such as: Is the stock price decline primarily due to outside forces? Do executives have competitive levels of equity participation? Are there adequate shares available in the equity incentive plan without seeking shareholder approval for more shares?

• Performance-based LTI plans. Companies may want to consider extending the timeframe for achievement in these awards, for example by adding a couple of years to a three-year plan. They may also want to consider using strategic objectives instead of financials as the primary metrics.

• 2009 bonus plans. Consider using a six-month or even quarterly design and more emphasis on non-financial metrics.

"I think CFOs need to play a bigger role," Dolmat-Connell adds. "In compensation committee meetings that I attend, it's normally the CEO and maybe the head of HR, but there's as much need for the CFO to be involved these days as there is for the head of HR. This is enough of a hot button issue, with enough going on to impact finance, that the CFO should be at the table."

The DolmatConnell & Partners white paper "Executive Compensation in a Troubled Economy: Different Thinking for Different Times" is available here.