This article, first appearing in Bank Director, highlights the impact of COVID-19 on executive compensation decisions for banks and how incentive plans will need to be adjusted.
As compensation committee chair, Susan knew 2020 was going to be an important year for the bank. The compensation and governance committee had taken on the topic of environmental, social and governance (ESG) for the coming year. They conducted an audit and knew where their gaps were; and Susan knew it was going take time to address all the shortfalls. Fortunately, the bank was performing well, stock was moving in the right direction and they had just approved 2020 incentive plans. All in all, as she finished her notes for the February committee meeting, she was looking forward to a bright year ahead.
Two months later, Susan longed for the “good old days” of February. With the speed and forcefulness of the COVID-19 pandemic and its impact on the country, states and areas that the bank served, February seemed like a lifetime ago. The bank implemented the credit loss standard at the end of March, but due to unemployment assumptions, the Current Expected Credit Loss (CECL) provision effectively wiped out all chances of 2020 profitability. This was on top of non-branch employees working from home, and the bank doing whatever it could to serve its customers through the Paycheck Protection Program.
Does this sound familiar to your bank? The unexpected whirlwind of 2020 has brought with it an increased focus on a number of issues, not the least of which is executive compensation. Specifically, how are your bank’s plans fairing in light of such monumental volatility? In this article, we briefly review annual and long-term performance plans and develop a construct for how to evaluate these programs in the current turbulent market.
The Impact of COVID-19 on Incentive Plans
The degree to which a bank’s annual and long-term incentive (LTI) plans have been impacted by COVID-19 hinge primarily on two factors. First, how much are the plans based upon Generally Accepted Accounting Principles (GAAP) bottom-line profitability? Second, and primarily for LTI plans, how much do performance-based goals depend upon absolute versus relative performance?
Annual incentive plans
In reviewing annual incentive plans, approximately 90% of banks use bottom-line earnings in their annual scorecards. For approximately 50% of firms, the bottom-line metrics represent the majority of their annual incentive plans goals. These banks’ 2020 scorecards are now at risk, as they evaluate how to address their annual plan for 2020. Do they change their goals? Do they utilize a discretionary overlay? And what are the disclosure implications if they are public?
Long-term incentive plans
There is a similar story playing out for long-term incentive plans — with a twist. The question for LTI plans is: how much are performance-based goals based upon absolute versus peer relative profitability metrics? Two banks can be the same size and have the same performance. Yet, one bank’s LTI plan can be fine and the other may have three years of LTI grants at risk of not vesting due to their performance goals all being based on an absolute basis. In the banking industry, slightly more than 60% of firms use absolute goals in their LTI plans. Therefore, many have a very real issue on their hands given the overall impact of the Covid-19 pandemic.
Firms that focus on absolute goals for their LTI plans must navigate a myriad level of accounting and SEC disclosure issues, while at the same time, addressing disclosure to ensure that institutional investors both understand and hopefully support any contemplated changes. Everyone needs to be “eyes wide open” with respect to potential changes on the horizon.
Principles, Process and Patience
As firms evaluate any probable changes to their executive performance plans, they need to focus on principles, process and patience. How do likely updates reconcile to changes for the entire staff when it comes to compensation? How are executives setting the tone with their compensation changes that will be disclosed, at least for public companies? How are they utilizing a “two touch” process with the compensation committee to ensure there is time for proper review and discourse? Are there any ESG concerns or implications, given its growing importance?
COVID-19 Disclaimer: This document has been provided as an informational resource for Aon clients and business partners. It is intended to provide general guidance on potential exposures, and is not intended to provide medical advice or address medical concerns or specific risk circumstances. Due to the dynamic nature of infectious diseases, Aon cannot be held liable for the guidance provided. We strongly encourage visitors to seek additional safety, medical and epidemiologic information from credible sources such as the Centers for Disease Control and Prevention and World Health Organization. As regards insurance coverage questions, whether coverage applies or a policy will respond to any risk or circumstance is subject to the specific terms and conditions of the insurance policies and contracts at issue and underwriter determinations.
Firms will need patience to see the big picture with respect to any changes that are made in 2020 and what that may mean for 2021 compensation.
To learn more about compensation planning or to speak with a member of our rewards consulting group, please write to firstname.lastname@example.org. You can view the original article, first published in Bank Director, here.
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