While the uncertainty created by the coronavirus wreaks havoc on public markets and the consumer psyche, many compensation committees are preparing to make annual equity awards to their executive team—as they do every year at this time. But this Spring is clearly not unfolding in a “business-as-usual” manner. Over the last two weeks our clients have been asking if they should be doing anything differently to account for the extreme volatility in share prices that shows no sign of slowing. And while we know many calendar-year companies may have already made their 2020 grants, for those who haven’t, here are four general approaches for committees to consider. Each has its own pros and cons.
- Keep calm and carry on
- Delay the award process until some stability is restored
- Grant some awards today, with the remainder over the next three quarters
- Grant the awards as scheduled, but use a trailing average share price to determine the size of the grant
Keep Calm and Carry On
In brief: we always have exogenous circumstances; we will follow our regular process.
While the impact on our daily lives is increasing, and the tragic implications of this disease cannot be understated, the long-term consequences of COVID-19 are still very murky. Several major investment firms have revised their 2020 S&P 500 guidance lower, although none precipitously thus far, and experience has shown us that “scares” such as these without deeper systemic issues can pass quickly.
In this information age where news (and rumor) spreads like wildfire, there’s an increasing tendency to act quickly and with conviction. We believe that cooler heads can still prevail and that there’s a strong argument for staying true to the process that has likely served you well for many years. Committees should ask themselves if the situation was reversed and there was a significant upward movement in the company stock price (perhaps due an earnings surprise resulting in a 20% to 30% price increase), would they be having this same conversation? Our guess is probably not.
Of course, we can’t overlook some very practical issues. First, with a depressed share price and most companies translating award sizes based on dollar values, the number of shares needed to deliver comparable value today will have increased meaningfully for nearly all companies. Does your company have sufficient shares to cover its obligations over the next 12, 24, or 36 months? Second, executive compensation remains under a microscope. Indeed, if this does pass quickly and companies make executive awards at multi-year lows, some public backlash might be expected. Given these issues, it’s well worth debating whether or not a change in approach is right for your company.
Delay the Awards until Some Stability is Restored
In brief: delay traditional first quarter grants for 60-90 days, hoping the market stabilizes.
So, you’ve decided that you cannot continue on your annual cycle as you have in the past, either for the reasons presented above or for some other reason, and you’d like to postpone the entire award process. That’s certainly an option. As time passes and new information arrives, you will likely be in a better position to make the “right” decision for your company. However, it’s possible that the situation becomes worse and share prices continue to fall and/or it may become apparent that we’re in this for the long haul and are dealing with a broader economic recession. While you’ve gained the comfort that comes with knowledge and certainty, you may also have exacerbated your share usage issue and, at the same time, frustrated your executive group. These are stressful times for everyone, and they might feel particularly painful for those with concentrated stock positions on the receiving end of an inconsistent and unclear award approach.
Grant Some Now, with the Remainder Over the Next Three Quarters
In brief: make quarterly (or semi-annual grants) to mitigate the impact of the current stock price.
This is a sensible idea that acknowledges the traditional grant valuation process, but also acknowledges the rapidly unfolding situation and the uncertain future. In what is essentially dollar-cost averaging, companies could smooth volatility over the next 12 months and theoretically grant awards at more representative share prices. However, this approach is also not without its risks. If current stock prices are a momentary “blip,” then quarterly awards could mitigate the criticism that executives received a “windfall” award based on artificially low prices. If, on the other hand, COVID-19 is simply a catalyst for a long overdue recession and share usage is a concern, a quarterly grant approach could burn more shares over the next 12 months than you would if you grant the entire award today.
Grant the Awards as Scheduled, but Use a Trailing Average Share Price Instead
In brief: use a historical stock price average to determine the number of shares/options to be granted.
It’s a similar concept to what’s discussed above, but with a few key differences. Under both approaches you can acknowledge the situation and generally maintain the integrity of the annual award process. However, we believe that if you do choose to change your award process, using a trailing average share price minimizes your risk from several perspectives. For most companies, a trailing average share price over the last 60 to 90 trading days will be higher than what it is today. Using this value to translate equity award sizes will result in lower share award sizes overall. We believe this is prudent in the context of potential shareholder/investor backlash which could arise in the future, while also partially recognizing the potential for a “new normal” going forward if COVID-19 has longer lasting implications for society and the economy. At the same time, from the employee perspective, it offers a reasonable balance between equity expectations (at least up until a month ago) and a potential for a new normal going forward. While it’s not much more than a tweak on the approach above, we suspect it may be perceived as much less of a “take away” for award recipients and much easier for objective employees to contend with.
In Summary
While the situation is still unfolding and there’s much more to be learned, committees would be well advised to consider whether an adjustment in the annual equity award process is warranted. At present, we think many may keep calm and carry on, but be willing to adjust “on the fly” as new information arises. In the event that a change in process becomes necessary, a “look-back” using a 60- or 90-trading day period will likely balance risk and optimize the situation for the company and stakeholders.
