Threading The Needle: A CARES Act Executive Pay Framework

How can CEOs navigate the tricky waters of incentivizing and retaining senior leadership when operating under the restrictions of the CARES Act?

Companies that are participating in the CARES Act are still facing a hot market for their top talent, particularly those recipients in distressed circumstances. Associated compensation restrictions freeze or reduce executive pay, requiring a different playbook than what companies have become used to. While being cognizant of windfalls, it is a time to ensure your best talent is responsibly aligned with recovery, while sending the right messages to stakeholders. As such, companies need to turn to a new playbook.

To help CARES Act recipients continue incentivizing and retaining their top talent, Korn Ferry created an alternative framework based on the following principles:

Five Pay Principles for CARES Act Recipients

• Operate within the spirit of the CARES Act

• Acknowledge and address the reduction in perceived value for recipients

• Align with—but do not exploit—shareholder recovery

• Recognize—but do not cater to—ISS

• Remember your key constituents – including your front-line employees

Today, the signals matter more than ever. Companies must operate with greater sensitivity to the impact of their executive pay decisions on front line employees and customers – and continue to do the right thing for the business.

With these principles in mind, Korn Ferry devised the following pay strategy alternatives for CARES Act recipients.

Executives Making Over $3M

While many companies will make the easy move to fit pay within the caps – by reducing equity grants and relying on stock price recovery to create retention value – an alternative framework to consider is to actually emphasize equity, responsibly. Conserve cash by using equity as the currency in the annual incentive (which more than ever should have strong links to recovery-based measures), along with a minimum funding threshold and with moderated payouts.

The long-term incentive strategy needs to pivot as well. Many companies will replay 2009 and move to time-based restricted stock. However, other companies may have more to gain with right combination of performance vs. time vesting, and options vs. restricted stock – which taken together can re-create a ‘full’ 2019 pay package. If the stock price has not yet recovered for shareholders by the time of next year’s equity grant, companies can consider a stock price threshold to the vesting of the restricted stock, or even a premium pricing to the stock options. The combination of leverage and a “floor” are a key component to executive retention.

Bottom line: Create some downside stability but focus more on leverage to drive shareholder value. Remember to make sure shareholders “get paid” first.

Executives with Frozen Pay Levels ($475,000 – $3M)

For this group, the total pay mix will be the most useful lever to create some pay stability and enhance retention. While this population is not facing the reduction being felt by the $3M+ population, people here are more likely to be reliant on their compensation for annual needs.

Assuming the business recovers enough to restore salary levels, companies may consider actually elevating base pay modestly, while delivering a portion of annual incentives in stock (without any holding requirements). Taken together, this can be structured to have a net cash flow-positive impact, and the dollars added to base will have disproportionate perceived value to recipients. To further align with this construct, the long-term incentive should emphasize restricted stock.

Bottom line: Focus on creating a floor with retention and continued long-term value creation.

Stock is a genuine asset (as long as you address burn rate) amidst the economic and regulatory restrictions CARES Act participants are facing: it conserves cash, has long-term value appreciation potential, and can be structured responsibly to allow shareholders to get their value restored first. Designed the right way, it can work for both impacted executives, and the other constituents in the discussion.

The world of executive pay was changing even before the COVID-19 crisis hit – and that change has since accelerated. More than ever, the design and quantum of executive pay will send messages about a company’s role in broader economic and social recovery. It presents a genuine opportunity to put money where mouths are, and to convey the right signals to a world that is hungry for signals of leadership – employees, shareholders and individuals alike.