Key Takeouts
- With respect to bonuses for the last financial year, Glass Lewis states that its approach will be dependent on individual circumstances, including how heavily a company has been impacted by the pandemic.
- In addition to the extent to which COVID-19 has/has not impacted company performance, companies should consider 'employee welfare' and community expectations in the context of remuneration decisions. In addition 'pay for performance' should remain top of mind.
- Where a company's performance has remained strong on a 'relative and absolute basis' despite the pandemic Glass Lewis indicates that it will (likely) support payment of 'relatively generous' bonuses provided that the link between pay and performance is strong. That is, provided that the company's strong performance can be sheeted home to the efforts of executives and not to an unexpected windfall.
COVID-19 and executive pay heading into the Australian meeting season
Heading into the Australian, New Zealand and Indian meeting seasons, Glass Lewis has provided some insights into how it will approach payment of executive bonuses as well as its expectations around how boards should approach the task of setting short term incentives (STIs) for the next financial year.
Bonuses for the last financial year
Glass Lewis states that ultimately the likelihood that it will support payment of bonuses will be dependent on individual circumstances, including how heavily companies have been impacted by the COVID-19 pandemic. However, other factors including employee welfare, community expectations and ensuring bonuses are justified on the basis of performance are also important in this context. On the issue of employee welfare Glass Lewis comments,
'Not only will this be considered an alignment of pay and company performance, this is also a matter of reputational management – boards and executives would do well to ensure they do not appear disconnected from their wider employee base during this difficult time, particularly in Australia where compulsory superannuation (pensions) means almost every employee in the economy is also a shareholder'.
COVID-19 and bonuses: Glass Lewis' likely approach based on four different scenarios
1. Companies most heavily impacted by COVID-19: Situations in which a company has been 'devastated' by the pandemic and the company's prospects are on 'life support'
Support for the payment of bonuses? No: Glass Lewis expects that 'nil or nominal bonus payments should be made in respect of performance of the last financial year'.
A possible alternative? Glass Lewis suggests that companies in this position could consider 'forward looking retention arrangements' as a means of both retaining management and incentivising them to turnaround the company's prospects. However, where boards elect to do so, they should also: a) ensure that the arrangements are clearly differentiated from backward looking performance bonus outcomes; b) ensure the intention behind putting the arrangements in place is clearly communicated; and c) communicate to investors how the arrangement is justified in the circumstances ie 'justify the arrangements relative to the realistic employment prospects of executives in a badly impacted industry'.
Possible reputational damage: Glass Lewis also suggests boards should consider the reputational damage that could arise if the arrangements put in place later deliver 'windfall gains' to executives as a result of improved operating conditions that lie outside of executive control'.
2. Companies moderately (negatively) impacted
Support for the payment of bonuses? Probably not: Glass Lewis expects 'very limited STI [short term incentive] bonus payments, if any, for executives in this category'.
Glass Lewis comments, that
'The concept of pay-for-performance –with poor shareholder returns in mind – will be front and centre to our considerations of remuneration proposals…We have a low appetite for STI bonuses in this scenario. Sizeable STI awards will need to be accompanied by strong justification to overcome the misalignment with pay-for-performance to avoid an against recommendation from Glass Lewis and shareholder protest votes''.
3. Performance has been 'modestly and negatively impacted, and the company has outperformed the market on a relative basis'
Support for the payment of bonuses? Probably: Glass Lewis comments that 'well designed remuneration structures should lead to reasonable outcomes without significant board discretion'. However, Glass Lewis also makes clear that where bonuses are paid, there should be no 'upward adjustments',
'we do not expect any upward adjustments to pay for relative outperformance. Any upward adjustments in any of the described scenarios in this note will need to be properly justified as they will be scrutinised at the company's shareholder meeting'.
4. Performance has remained strong on a 'relative and absolute basis'
Support for the payment of bonuses?
Yes (for defensive companies): Glass Lewis will support payment of 'relatively generous' bonuses where the company's performance can be sheeted home to the efforts of executives and not to an unexpected windfall. Glass Lewis comments:
'Defensive companies that remain resilient throughout the COVID-19 crisis can expect Glass Lewis to support relatively generous bonus outcomes where the remuneration structure had been set up to pay counter-cyclically. We intend to support fit-for-purpose remuneration structures throughout the cycle and believe that failure to do so throughout this challenging time will undermine the credibility of any nonbullish remuneration structure'.
Probably yes for other strong performers (though companies are should exercise restraint): Where very strong performance is due to the current circumstances, rather than to executive performance, Glass Lewis considers that companies should exercise restraint when awarding bonuses – 'bonuses may be pulled back from stretch or maximum levels' Glass Lewis suggests.
Glass Lewis also considers that strong performers especially, should factor in community expectations. Glass Lewis states:
'These companies are likely to face significant scrutiny, including in the media, as such outcomes risk topping the rankings of executive pay for the year. In these cases, downward discretion should to be considered if pay does not meet community or shareholder expectations'.
Target setting for executive bonuses for the next financial year?
Acknowledging the difficulty of forecasting in the present environment, Glass Lewis states that it will be 'supportive' of actions taken by boards to adjust remuneration to meet current challenges. For example, boards may change existing remuneration structures to account for a range of different COVID-19 scenarios; or opt to reduce the variability of pay 'with a corresponding reduction in quantum'.
Where vesting of long term incentives become certain as a result of these adjustments, Glass Lewis expects boards to consider reducing them by 50%.
Glass Lewis also emphasises that should changes be made to remuneration structures, clear communication will be critical – boards 'will need to excel at justifying and communicating such changes' Glass Lewis states.
[Source: Glass Lewis blog 05/08/2020]
