Reevaluating Executive Compensation in the Age of Covid
May 26, 2020 All Industries
Airlines faced an abrupt reckoning when Covid-19 precautions went into place.
With people staying at home and travel ceasing overnight, the U.S. Department of the Treasury approved an aid package of $25 billion to secure numerous airlines and contractors from bankruptcy. A caveat for taking the public funds: Airlines couldn’t conduct widespread layoffs until at least the end of September. Even still, thousands of airline workers remain on unpaid leave.
In a show of support for the employees and public, several airline CEOs waived a portion of their 2020 base salary. Among others, United Airlines Holdings chief executive Oscar Munoz nixed his salary through June, Delta Air Lines CEO Ed Bastian cut his for six months and Alaska Air Group CEO Brad Tilden reduced his pay to zero.
How long those cuts remain, and how boards compensate management moving into 2021 and 2022, are questions that compensation committees have started considering, both in and outside the airline industry.
The depth of Covid has changed much of the calculus that boards use to determine management pay and bonuses. It’s more important now than ever to strike the right balance, as organizations institute further or prolonged job cuts. A board must weigh incentivizing management while ensuring they don’t become the poster child for excess as employees struggle.
“It’s hard to forecast what life will look like,” says Ryan Resch, a managing director of executive compensation at Willis Towers Watson. But boards must look at “what sort of incentives should change.”
No One-Size-Fits-All Approach
In the response to the virus, management pay hasn’t required much focus, with far more pressing issues for organizations to address. That will soon change, as boards will begin to weigh 2020 bonuses and long-term incentive plans after the end of the second quarter, surmises Kelly Malafis, founding partner of Compensation Advisory Partners.
How companies do so will depend on how much coronavirus impacted the bottom line. At some organizations, sales and revenues might have improved. For many others, like airlines, it has created a nearly impossible environment to operate. How a board shapes the pay structure should work to retain executive talent, based on the macro-environment.
While the salary cuts announced by many CEOs are nice, it’s more of a symbolic gesture. With 80% of executive pay, on average, coming in the form of stock options and other incentives, it’s far more important that a CEO achieves bonus metrics. Covid likely destroyed those benchmarks, requiring the board to tweak goals.
Keeping management incentivized isn’t just good for morale. Studies have found that boards believe only a few people in the world could manage the organization they oversee. Trying to find the next CEO or chief financial officer in the midst of a crisis isn’t ideal. Boards know this, forcing them to address pay, even as recovery efforts continue.
Tying Compensation to Sector Performance
Determining new bonus metrics will depend on the fallout within the organization or sector. In the airline industry, where all companies are suffering from a sector-wide problem, Resch expects more incentives tied to how the sector rebounds.
But it’s important to incorporate some incentives to encourage management to perform “better than peers,” adds Resch. Whether it’s the level of cash flow in a troubled sector or the ability to show cost preservation, boards may want to calibrate metrics to a new normal level that the company and sector faces.
Since much of the compensation discussion will also relate to how the marketplace perceives the pay, it’s likely that many companies will use incentives based on more intangible goals, like employee morale or retention, says Malafis.
Opportunity To Increase Alignment
It’s difficult to overstate the depth of destruction the Covid recession could bring. The International Monetary Fund estimates that could take months — to years — before many businesses reach the level of output that they once did. The compensation plan should align with the same long-term goals as the business and account for the new reality.
As organizations recover, shareholders won’t want management boosting metrics unrelated to the long-term goals simply to improve pay. Instead, boards should ensure that the bonus structure incorporates the part of the business that must recover.
If, due to the Covid fallout, your management must work to redesign partnerships with supply chain partners, handle a larger influx of government oversight and re-attract customers again, incorporate those criteria and benchmarks into the payment structure.
It creates “greater shareholder alignment,” adds Resch, keeping everyone on the same page during the recovery.