ML BeneBits

While the economy continues to enjoy steady growth, financial experts warn that an economic slowdown is likely in the not too distant future. Preemptive action may cushion an otherwise bumpy financial ride. Therefore, it’s time again to plan for an economic downturn. We have compiled several suggestions for executive compensation planning for a downturn.

1. Align Incentive Compensation with an Economic Downturn Strategic Plan. Consider whether performance metrics should be updated to align with the company’s strategic approach to addressing a downturn. For example, companies can review their incentive compensation programs to minimize executive risk-taking, emphasize nonfinancial measures, and underscore near-term successes and sustainability.
2. Minimize the Need for Discretion in Performance-Based Awards. When setting performance goals for incentive compensation, think about how an economic downturn will affect the company’s ability to meet the performance goals. Setting performance metrics with a view toward appropriate achievability in a variable economy may minimize the use of discretion later.
3. Cap Payouts. Capping payouts under performance-based plans may alleviate unintended consequences, such as shareholder reaction to a payment substantially above target during a financial downturn. This can be an issue, for example, where one metric exceeds the maximum while another fails to hit the threshold.
4. Equity Plan Share Reserve. Consider how a drop in stock price would affect the share reserve in the equity plan, and consider getting shareholder approval of a share reserve increase sooner rather than later.
5. Denominate Awards in Dollars, Not Shares. If any equity grants are denominated in shares instead of dollars (for example, director grants), consider changing them to dollar amounts.
6. Severance Plans/Policies. Review severance plans and policies, and update them to be ERISA-compliant severance plans. From an HR perspective, posting a new severance plan in “good times” presents less employee concern than presenting a new severance plan in the midst of an economic downturn.
7. Employment Agreements. Review employment agreements and severance agreements to understand what the severance levels are, whether there is consistency among similarly situated employees, and how the “good reason” definitions would work in an economic downturn (for example, in the event of an across-the-board reduction in salaries).
8. Executive Diligence. Executives should personally review their employment agreements and severance arrangements, and identify areas of concern that may need to be updated.

If you have any questions or are seeking more information about executive compensation planning for an economic downturn, please contact the authors or your Morgan Lewis contacts.