Companies Shifting Long-Term Incentive Practices

By Stephen Miller Feb 2, 2009

As large U.S. companies finalize their decisions about incentive payouts for 2008 and equity awards for 2009, they are giving significant weight to examining their year-end results and the current economy, according to a Mercer survey on annual and long-term incentives.

The survey report, Weathering the Storm in 2009, includes responses from nearly 200 U.S. organizations that have a median annual revenue of $2.9 billion. The majority of participating companies were still finalizing their decisions at the time the survey was fielded, but of those that had made early decisions by December 2008, approximately one-fifth are making changes to prior practices.

Most companies will finalize their plans in early 2009, assessing how to respond to the volatile economic environment on a ‘just-in-time’ basis,” says Bruce Greenblatt, a principal in Mercer’s executive remuneration consulting business. “We expect the decisions of our survey’s early deciders to be a bellwether of how things will play out.

A theme observed among many of those who have made early decisions is an anticipated reduction in long-term values for 2009. Other trends include:

  • Paying below target annual incentive payouts based on weak 2008 performance.
  • Moving away from stock options to use other long-term incentive vehicles.
  • Anticipating the use of selective retention awards.
  • Reducing long-term incentive participation.

“The early deciders are telling us that 2009 may be a game-changer for long-term incentive granting practices. Many companies are anticipating long-term incentive values that are lower than 2008 levels, perhaps a cut by 10 to 30 percent,” says Greenblatt.

Many anticipate long-term incentive values
cut by 10% to 30% from 2008 levels.


“Furthermore, while the number of shares granted may be flat or increase, the value delivered in 2009 will be lower than 2008 at many companies given current stock price levels,” he explains.

Long-Term Incentive Programs

  • 2008 payout levels.The majority of companies expect below-target payout levels for their performance-based long-term incentive programs in 2008. Additionally, more than three-quarters (78 percent) of survey respondents do not plan to reprice or exchange underwater stock options—at least not yet. ("Underwater" options have an exercise price that's now higher than the market price of the underlying stock.) Slightly less than half of companies are taking a “wait-and-see” approach to underwater options; fewer than 5 percent are planning to take action.

  • 2009 grant values. Approximately one-half of survey participants plan to maintain the 2008 grant value of long-term incentives for their 2009 grants, while the remaining companies were either still formulating their approach or decided to reduce grant values. 

  • Many companies expect that depressed stock prices will cause them to award more shares in 2009 vs. 2008. Approximately 40 percent expect share usage levels to increase in 2009— slightly over one-quarter (27 percent) are expecting their run rates to increase by more than 10 percent compared to 2008 levels. (The "run-rate" is a calculation to determine the net option use at a company in order to track dilution in stock value.)

Annual Incentive Programs

According to Mercer’s survey, the impact of the economy on company performance is reducing annual incentive payouts for 2008 performance. Nearly two-thirds (64 percent) of companies are expecting below-target annual incentive payouts.

However, 29 percent are considering some form of a discretionary award to select employees or all eligible participants—illustrating that companies recognize top talent have choices and needs to be appropriately rewarded for their contributions even in a difficult economic environment.

“With market tumult comes opportunity,” says Greenblatt. “Companies in this game-changing environment have a unique opportunity to determine how best to configure their executive rewards and talent management strategies to align with key business objectives.”

Action Steps: Revising Long-Term Incentives

Mercer recommends that companies evaluate a range of factors to determine how best to revise their long-term incentives (LTI) programs for 2009, including:

  • Impact of the economic environment on your company and industry.Grant value reductions are likely to be greater in those sectors with greatest share price declines.

  • Total share usage and plan capacity.Model the total share usage as a percentage of common shares outstanding under a range of grant scenarios. The amount of shares available may not support grant levels without adjustments, and it may take a while for performance to recover enough to obtain a significant new authorization.

  • Economic run rate.Consider the proportion of a company’s total market capitalization delivered in equity awards relative to the prior year, and relative to peer organizations. This provides perspective on the value transfer and executive “stake in the enterprise,” and is scrutinized by shareholders.

  • Retention value of outstanding awards.Analyze the value of unvested LTI awards under a variety of stock price scenarios over the next two to four years to understand the role 2009 grants need to play in retaining critical talent. Unvested gain of two to four times base salary for executives is a guideline to consider to counter potentially attractive offers from competitors.

  • Differentiation for critical talent and high performers.Assess the impact of maintaining values for critical talent and high performers, but reduce grants significantly for others to drive the allocation of awards based on impact and the need to retain. This may require making changes to LTI eligibility or participation rates at certain levels, or for specific job families within the organization.

  • Financial expense.Many companies that are aggressively cutting costs and equity expenses may come under review as well. Modeling the impact on accounting expenses will help frame the tolerance for LTI grant levels and how to balance dilution vs. value.

  • Shareholder and advisory guidelines. Institutional shareholders and proxy advisers such as RiskMetrics Group (formerly Institutional Shareholder Services) have guidelines on share and economic run rate levels. The impact of grants on those levels should also be examined.

  • Compare relative impact on peers.If peer share prices have declined more than your company’s, you may need to use proportionately more shares than your peers for this year, and vice versa. This may point the way to what your peers’ share usage may look like in 2009 to assess the competitive imperative for adjusting grant levels.

Stephen Milleris an online editor/manager for SHRM.​


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