Since the last oil price crash in late 2014, oilfield services companies and independent E&P companies have come under increasing fire regarding the design and administration of their executive pay programs. Entering 2020, a number of companies in the industry—particularly those tied to the US domestic market—were already preparing to make adjustments to the value and design of their long-term incentive programs to address persistently low stock prices. The series of economic shocks over recent weeks—COVID-19 and the commodity price collapse—has conspired to force the hand of companies across the sector, accelerating the rate and severity of program change.
So far, based upon our client experience, our research into recent proxy and 8-K filings, and industry-specific pulse surveys, this is what we are seeing and hearing in the marketplace:
Executive salaries are being cut
Only a few companies have publicly announced executive salary reductions, with numbers ranging from 10% to as much as 80%. Many more companies are discussing changes. Expect to see the “fairway” for executive salary reductions within the upstream sector settle somewhere between 10% and 20%, at least in the near-term.
We expect to see proportionality between amount of the executive salary reductions and the severity of employment reductions or furloughs. It is also possible that for some companies that are permanently smaller and less profitable in this new reality, that near-term salary reductions will become permanent.
Annual incentive plans remain largely unchanged, with some exceptions
Despite financial and operational goals that already look unachievable, most companies have not made changes to the goals in their annual incentive plans yet. For most companies, there is still too much uncertainty to know what a realistic goal looks like in this environment. However, there is hope that with greater clarity in May or June (and with the help of committee discretion) that some more realistic goals may be set, and that in the meantime the goals in the existing plan can be used to communicate priorities to the organization. For companies that do wait to reset goals in May or June, careful consideration should be given to whether there is a realistic goal through the end of the year that would justify a bonus payout, and whether target opportunities and plan leverage should be adjusted to reflect what will be in effect a truncated performance period.
Some companies have already determined that they will not be paying a bonus and have suspended their plans for the year. For some organizations, this approach may be appropriate in order to manage expectations and cut accrual costs—but caution should be exercised before completely cancelling the plan.
Long-term incentive values will decline
Most companies have already made their 2020 long-term incentive grants. While most companies sought to target similar grant values to 2019, share plan constraints and liquidity concerns forced a number of companies to cut award values for 2020. We expect the net impact will be a reduction of about 15% - 25% in LTI grant values for these companies.
For those who have not yet made grants for 2020, expect to see reductions in value of between 25% and 50% overall as companies apply one or more of the following adjustments in order to manage dilution and liquidity:
- 30/60/90 day stock price to determine number of shares
- Floor price to determine number of shares
- Fixing shares at 2019 levels
- Applying a direct haircut to 2020 award values
- Capping annual burn rate and scaling awards down accordingly
The balance that companies are trying to strike remains similar to prior years: providing meaningful retention and motivation with a reasonable price tag. One key difference in the current environment is that retention may not be as significant a concern as it was even two months ago.
Director pay will also be coming down
Very little has been disclosed publicly regarding director compensation changes, in part because director pay is usually not addressed until late April or May for calendar year companies. However, boards are already discussing how they should react. We expect to see the following changes to director pay for 2020:
- Cash retainers will be reduced by the same (or similar) percentage as the executive salary reductions
- Equity values will either be:
- Granted at current stock prices (because it’s immaterial to the overall burn rate)
- Converted to cash and be included in the reduction applied to retainers
- Granted, but cut back by the same value as executive reductions (using average stock price, fixed shares, direct haircut, etc.)
We continue to monitor the evolving situation. Over the coming weeks, check back here for further updates, including discussion of what we expect to see happen to plan design.
