Fall is executive compensation planning season. Board compensation committees are busy with familiar tasks, such as gathering performance data and establishing metrics for next year. But 2020 has been anything but typical, and based on recent discussions, we see three additional areas of concern in the months ahead:
- Incentive pay adjustment
- Next-generation leadership issues
- Non-employee director pay
Typically, compensation committees are responsible for these issues. As they arise, committees should consider certain legal and tax implications, particularly when modifying existing compensation arrangements. If changes are significant or impact director compensation, the committee may be required — or may want — to obtain full board approval.
Short- and Long-Term Incentive Pay
Committees will undoubtedly confer with compensation advisors to determine adjustments to formulas and metrics, review comparison peer groups and evaluate the impact of Covid-19 on annual and multi-year performance measurements. When doing so, committees should also:
- Review plan documents and employment agreements to avoid violating contractual terms. Committees should determine whether alteration of incentive pay could allow executives to terminate their agreements for “good reason.” Such terminations may entitle executives to severance benefits, and/or limit the scope of restrictive covenants.
- Consider Code Section 409A. This is critical if modifications could be viewed as a replacement or substitution for other pay. These deferred compensation rules are wide ranging; even inadvertent violation can subject executives to significant income taxes, interest and penalties — potentially causing legal disputes.
- Consider “golden parachute” issues under Code Section 280G. If a strategic transaction is in the near term, committees should carefully evaluate potential impacts on Section 280G calculations, including whether payable amounts could be nondeductible or taxable to executives.
- Consider applicable disclosure requirements. Public banks may need to file a Form 8-K and determine how to communicate changes in future proxy statements. It is important to accurately disclose and explain changes to educate and engage with interested shareholders. In addition, public banks should evaluate any impacts on “grandfathering” under Code Section 162(m).
- Evaluate any impacts on stock ownership guidelines. A decrease in equity grants or in share price (where guidelines are denominated in dollars) may hinder executives from satisfying the guidelines.
Most banks are comfortable with their succession plans, allowing for a renewed focus on the next generation of bank leaders. The topic is challenging, particularly when considering the impact of Covid-19, and generational and cultural differences that influence the motivation of younger employees.
For years, these employees have requested more responsibility and less face time than required in office-centered cultures that were common at most banks as recently as March. The pandemic resulted in greater acceptance of such requests, making 2020 a valuable trial run for how well remote arrangements and more flexible schedules can work. Now is the time for banks to evaluate whether, and to what extent, they will embrace these changes, potentially obtaining a competitive edge.
In connection with next-generation issues, committees should:
- Consider whether HR policies (e.g., company property, privacy, social media, business hours) are up to date.
- Determine what incentives are most impactful — current compensation or future, potentially tax-deferred compensation.
- Understand restrictive covenants to which external candidates are subject and the extent to which remote work interacts with their obligations.
Non-Employee Director Pay
Bank directors have been tasked with more and more since the financial crisis in 2007. With the pandemic, as well as environmental, social and governance concerns, this workload shows no sign of abating. Pay has not always kept pace with the workload and understandably, directors desire fair compensation for their time and efforts.
But director compensation decisions are subject to a strict “entire fairness” review, under which there has been significant litigation in recent years. Committees should obtain adequate legal advice and keep appropriate documentation with respect to all director compensation decisions, and consider obtaining full board approval for all alterations in pay.