In this new study, Equilar and the Rock Center for Corporate Governance at Stanford examine how COVID-19 has affected CEO compensation. Are boards focused more on making sure that CEOs have the right incentives to continue their jobs under trying circumstances? After all, in the case of the pandemic, the trying circumstances are not of their own making. Or are boards more inclined to focus on showing the public and other stakeholders, especially employees, that CEOs are “sharing the pain”? CEO pay attracts a lot of attention in ordinary times, but in times of severe economic distress when corporate performance and stock prices plummet and companies engage in substantial layoffs, furloughs and pay cuts for employees—who likewise are not responsible for the economic crisis—CEO pay can attract intense scrutiny. In those circumstances, paying the same or greater levels of CEO comp can seem unfair to the employees and invite shareholder and public criticism. How have boards addressed this issue?
And then there’s the question of whether any change at all is appropriate? As the authors describe the conundrum:
“All compensation arrangements have some element of risk embedded in their design. Sometimes a compensation award will not pay out, while other times it will substantially exceed original expectations. While negative exogenous events have a negative impact on performance, positive events can have an unexpected positive impact (so-called ‘pay for luck’). Rarely do we see a voluntary reduction in payout to reduce a windfall payment that was not really merited. Both positive and negative operating environments should be considered part of the risk imposed on executives.”
The authors ask whether CEOs that usually benefit from positive outside events and rising stock markets should “be sheltered from reversals in these same factors? If so, what implications does this asymmetry have on CEO incentives? Does it create a condition in which the CEO benefits from any exogenous event?”
In the study, the authors analyzed the compensation disclosures made by companies in the Russell 3000 between January 1 and June 30, 2020, focusing on disclosures in Current Reports on Form 8-K and definitive proxy statements. The authors found that 502 companies (17%) disclosed adjustments to CEO salary, bonus or long-term incentive programs or director fees during this period. The authors observe that, of companies that would ultimately report changes to comp, only 14% did so in March, with airlines being the first to report executive salary forfeitures (along with employee furloughs), while, by the end of April, 73% had reported changes. CEO/director pay adjustments were most prevalent in the retail (45%), manufacturing (36%) and transportation (28%) sectors, and least prevalent in the food and tobacco (2%), utilities (4%) and finance and real estate (6%) sectors.
Predictably, companies that made CEO/director pay adjustments were also the companies that sustained the biggest stock price declines (average stock price decline of 23.6% compared with 10.2% for non-adjusting companies) and were compelled to lay off or reduce pay for employees (82% compared with 10% for non-adjusting companies). Companies that adjusted CEO/director comp were also more likely to reduce, skip or suspend their payment of dividends. One unexpected finding of the study was the absence of correlation to ESG ratings, with a median rating of companies making CEO/director pay adjustments at 38 compared with a median rating of 34 for companies not taking pay action (with 1 indicating lowest risk).
What types of pay adjustments did boards make? For the most part, the study reported that adjustments were made to CEO salaries (449 companies) and to director fees (316 companies). Most companies that adjusted CEO salaries reduced the level of salary (424 companies with an average reduction of 50%, but ranging from 10% to 100%), although some deferred salary or exchanged salary for equity or even took more than one of these actions. Of these companies, 86 eliminated CEO salaries entirely, while 118 reduced salary between 20% and 29%. Notably, however, the biggest proportion of CEO pay is typically in incentive bonuses and equity, not salary. As a result, while the median CEO salary in this group may have declined by 47%, total targeted comp declined by only 8%. For half of the companies, an expiration date applied to the adjustment, most often June 30 or December 31.
Three hundred companies also reduced director fees, with a few deferring fees or exchanging fees for equity; only 2.4% adjusted only director fees and not CEO comp. Almost half included expiration dates.
According to the study, fewer companies—only 92—took action with regard to annual bonus programs, including 44 that reduced bonus payments, 17 that deferred payments and 10 that exchanged cash bonuses for equity. Of the 92 companies, 31 changed the structure of the bonuses for the current year in a manner favorable to the CEO by making the award discretionary instead of target-based (three companies), changing it to a retention bonus instead of a performance award (eight companies) or changing the performance metrics by reducing the performance targets (20 companies). In some cases, the reduced goals were to be established later in the year as visibility increased.
The study found that only 33 companies changed their long-term incentive plans, including nine that reduced the target value of the LTIP, nine that decreased the portion of performance units and increased restricted units, eight that changed the metrics, seven that changed to a retention award and one to a discretionary award. Together, about 60% of changes to bonuses and LTIPs reflected reductions in value, while 40% “gave the CEO the opportunity to earn value they might otherwise have lost, such as by exchanging cash awards to equity with the potential to increase in value through a stock price recovery, changing structure to discretionary or retention awards, or easing financial targets/ metrics to determine the ultimate value of awards.”
The authors conclude that 83% of the Russell 3000 did not publicly report any changes to CEO pay during the covered period. Fewer than 2% tried “to preserve the incentive value of compensation offered to their CEOs during the first six months of 2020 by replacing or modifying short- or long-term bonus programs,” while 15% reduced pay to CEOs and directors “either to conserve cash or to signal to shareholders, employees, and stakeholders that corporate leadership intended to share their economic burden.” Of course, the authors note, action could still be taken at a later point to increase or reduce comp.
While CEOs may have lost only 8% of targeted total comp, the authors highlight that they nevertheless did experience significant reductions in their wealth as a result of stock price drops. In the study, the median CEO beneficially owned stock on January 1, 2020 valued at $9.2 million. By March 31, that wealth had declined by almost half to $4.8 million, but had increased by June 30 to $6.0 million—nevertheless, still a loss of 35% from January 1.