Executive compensation: preparing for 2021

4 timely items for boards and management to review

The year 2020 has brought a renewed and sharper focus on diversity, equity, and inclusion (DE&I). In an uncertain economic environment, there has never been a more important time for management and boards to be aligned on their organization’s human capital strategy. Through Grant Thornton’s conversations with clients and industry colleagues, we have identified four human capital items for companies to review as they begin 2021.

1. Review 2020 incentive plan performance. Companies whose fiscal year coincides with the calendar year should have a complete understanding of their full-year performance, especially as it relates to their open annual and long-term incentive (LTI) plans. Compensation committees should begin discussions—if they haven’t already—about preliminary plan results, the specific ways that COVID-19 has affected their organizations, and how management has responded to the unprecedented circumstances. For many committees, the conversation should focus on their ability to use discretion, the appropriateness of doing so, and the extent to which payouts may be modified beyond the initial plan calculations. Organizations should be prepared to detail the justification and rationale if any such discretion is exercised in their annual proxy statement.
   
2. Evaluate 2021 plan goals. Organizations must also review their incentive designs and goal levels for the upcoming plan year. The first question to consider is, how much does 2020 matter? For organizations that have been particularly affected by COVID-19, such as the consumer discretionary, consumer staples, and hospitality sectors, how much should a down year impact goals when conditions may be just as uncertain in 2021? Committees, along with their human resources and finance teams, must balance calibrating goals amid uncertain conditions while ensuring that incentive plans motivate growth and profitability. One potential consideration may be widening threshold and maximum-goal levels relative to prior years. This adjustment would allow for a wider range of payout outcomes while putting less stress on setting plan targets. Compensation committees in sectors that have been less affected by the pandemic, such as information technology and some financial services firms, should continue to review the alignment of their incentive plans with short- and long-term strategy and the potential impact of COVID-19 and other economic factors on future performance.
3. Review long-term incentives from top-down and bottom-up perspectives. In tandem with reviewing annual plan goals, organizations should review their long-term incentive equity mix from top-down and bottom-up perspectives. From the top down, companies should review their overall equity use and dilution levels (i.e., burn-rate and overhang) before making any grants in 2021. Companies that have had negative share-price performance over the past six to twelve months will need to pay attention to their overall equity usage as more shares will be required to deliver the same company-wide long-term incentive value as the prior year. From a bottom-up perspective, organizations should review their equity mix by employee level to ensure their equity strategy supports the organization’s human capital goals. Alternative LTI designs such as shorter performance periods or cash-based plans may make sense depending on the organization’s confidence in multi-year goal set ting and their dilution levels.
4. Clarify board and management DE&I responsibilities. Companies should take the opportunity to clarify (or even deter- mine) DE&I responsibilities at the board, committee, and management levels. Social movements throughout 2020 emphasized the need for companies to define what statistics, items, and leader- ship positions need to be elevated to the board level. Compensation committees, which have historically limited their focus to compensation at the executive level, are beginning to take on new responsibilities for monitoring hiring, promotion, and employment levels by gender, race, and other protected group status. Management, which has access and works with DE&I data daily, is increasingly asked to update boards and committees on DE&I progress. Regard- less of historical practices, organizations should take this moment to clearly lay out responsibilities for relevant parties and identify opportunities for improvement.
   
   Economic and DE&I developments from 2020 will undoubtedly affect human capital decisions at all employee levels in 2021. Boards, their committees, and management must be prepared to respond to the new realities and resist adopting a “same as last year” mentality when it comes to goal setting and incentive plan design. Organizations should continue to engage their key stakeholders and outside advisors to ensure they are aware of new developments and contemporary best practices as they begin 2021.

5. For more pragmatic board insights, visit our boards and audit committees page.
   

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