“Our latest survey of compensation practices finds that most companies are holding the line on salaries by cutting their 2009 merit increase budgets, freezing salaries or even cutting base pay in some instances,” said Ravin Jesuthasan, a Towers Perrin Managing Principal and one of the leaders of the firm’s Executive Compensation and Rewards practice worldwide. “In addition, many employees will see smaller bonuses for 2008 performance, commensurate with their companies’ reduced financial results in a challenging economy.”
The survey also shows that many companies are rethinking their approach to determining the size of their 2009 long-term incentive grants in light of significant stock price declines and considering what to do, if anything, about underwater stock options.
Resisting Draconian Measures
“Most companies appear to be taking careful approaches to cost reduction in the current economic crisis, avoiding slash-and-burn pay and staffing reductions to the extent possible," said Jesuthasan. "In fact, as organizations continue to look for ways to reduce costs, many - approximately 62% of respondents - are concerned about the potential impact on their ability to retain high performing talent or those in pivotal roles. To address this concern, many are turning to salary increases and other forms of cash rewards even as they contemplate reducing such expenses for the rest of their workforce."
Far more common approaches to reducing staffing levels are hiring freezes or reductions (taken or contemplated at 74% of the responding companies) and targeted staff cuts focusing on less critical roles and poor performers (58%). Reductions in discretionary spending on travel and entertainment (taken or contemplated by 82% of the respondents), employee events (75%) and training (58%) are also common.
On the pay side, reductions in merit/salary increase budgets are the most prevalent response to the crisis to date. Salary freezes are completed or contemplated by about four out of 10 U.S. companies. Among the survey respondents that are not freezing their 2009 salary budgets, the average overall pay increase this year has declined to 3.0% from the 3.7% level companies were planning before the stock market/economic tailspin.
More than half (54%) of U.S. companies will pay smaller bonuses for 2008 performance than the prior year, reflecting their deteriorating financial results. And 40% of the survey respondents expect to pay executives bonuses 25% or more below last year’s levels.
Challenges With Establishing 2009 Incentive Programs
The new survey suggests that many compensation committees are struggling to set incentive plan performance targets in light of 2009 budgeted/planned results that are significantly below 2008 levels, coupled with considerable uncertainly about how quickly the economy will rebound. Almost three-quarters (73%) of the survey respondents say the financial crisis has had an impact on their approach to setting 2009 performance targets under annual incentive plans.
The most common considerations among companies reporting changes in their approach to goal-setting are greater use of discretion or judgment in determining awards, setting lower threshold performance levels and greater use of relative performance measures instead of absolute measures (e.g., setting a revenue growth target at 10% above median performance for the industry, rather than a fixed growth rate).
Depressed share prices are posing serious complications for many companies in trying to decide on the size of their 2009 grants under equity-based long-term incentive plans. Those that have followed a practice of granting a fixed number of options or shares stand to deliver far less expected value to executives if they continue this practice after the share values have greatly declined, though perceived value may be higher. Companies that have targeted a fixed value of long-term incentives to grant face the prospect of having to award significantly more shares to achieve the target value, increasing the number of shares used for incentive purposes and prompting possible shareholder concerns about dilution.
As a group, the companies surveyed have experienced stock price changes generally representative of the S&P 500 over the past year. The vast majority (86%) of the respondents report that their companies’ shares have declined more than 15%, while over a quarter (28%) report share price declines of more than 50%.
“Based on our research and discussions with compensation committees, it seems clear that executives in many companies are likely to see the value of their 2009 long-term incentive grants decline from last year’s levels,” said Doug Friske, a Towers Perrin Managing Principal and one of the leaders of the firm’s Executive Compensation and Rewards practice. “We expect those values to decline between 15% and 20% on average, though practices will vary widely based on company- specific circumstances,” he added.
While struggling with decisions about 2009 incentive grants, a growing number of companies are also wrestling with questions about how to deal with underwater stock options and whether or not to reset performance goals on outstanding awards under long-term performance plans. The survey responses suggest that relatively few companies have fully addressed these issues thus far, although more are beginning to focus on the issue. To date, just over a quarter (26%) of the companies either have addressed underwater options or are currently reviewing the issue, up from just a handful of companies in our survey last fall.
“If the market downturn is prolonged, we would expect to see more companies consider the issue as concerns mount about companies realizing no value from the reported compensation expense relating to past option grants, as well as motivational and retention concerns,” Friske said. “For now, however, many companies appear to be taking a ‘wait and see’ approach out of concern about shareholder perceptions and other pragmatic considerations.”
Even fewer of the companies surveyed appear to be moving toward adjusting the performance goals for outstanding cycles under their long-term performance plans to reflect the current business climate. Only a few companies (2%) have recalibrated performance goals or plan to thus far, although 11% of the respondents are now considering such steps.
“Once again, the longer the market downturn lasts, the more we would expect companies to consider actions like option repricings to help retain and motivate key talent and recognize some value from the expense associated with past grants,” Friske noted. “Most companies are concerned about the potential for losing their best performers and those in pivotal roles.”
