Many companies offer variable compensation with performance measurement over a period of several years. These are known as long-term incentives, or “LTIs” for short. This coincides with the economic crisis caused by the COVID-19 pandemic – a period of shrinking markets and as yet unforeseeable consequences for companies and the economy. What then should be done with the LTI awards for 2020? The compensation experts Dr. Christine Abel and Nina Grochowitzki provide answers in an interview with hkp.com.
Dr Abel, Ms Grochowitzki, what does the corona crisis imply for the award of LTIs in 2020? What has changed?
Christine Abel: What has changed? Put crudely: Uncertainty as far as the economy as a whole is concerned, but also uncertainty for each individual company. There is a lack of perspective for planning.
Nina Grochowitzki: And that is exactly what is essential for the Long-Term Incentives. It is important to define reliable targets for performance periods of three to four years.
It is difficult to imagine that companies are currently able to carry out any planning as in the past. What do you suggest?
Christine Abel: Businesses should first examine whether they need, want or are still able to award the LTI 2020 at all. The contractual terms and conditions should be reviewed - i.e. for example, whether there is a binding provision in the employment or service contract that renders compensation obligatory.
This is also the case for Executive Boards of listed companies.
Nina Grochowitzki: True. It is even required for regulatory purposes, as the long-term variable elements must exceed the short-term ones.
Christine Abel: But it must also be checked, if it is still sensible to award them under current practice. The objectives should also be reassessed. Are these still relevant in the current context, or does granting them as before even lead to a misleading incentive? At present, cash and liquidity protection is prioritized above all else, but the LTI may incentivize the increase of returns. In this case, it is also necessary to consider stopping them in 2020 or even setting new targets.
If granting of LTIs is already under scrutiny, are there any other aspects to reconsider?
Nina Grochowitzki: A lot. When considering, for example, the appropriateness of the award, it should also be considered how far an LTI can offset any possible shortfalls in the 2020 bonus as a result of an upturn in the coming years. This would ensure a continued high retention effect and the beneficiaries would be able to participate in the collectively agreed value recovery. This is a lesson learned from the financial crisis of 10 years ago.
Assuming a company concludes that it is indeed reasonable to award an LTI for that year: What must be borne in mind when setting targets in these unstable times?
Christine Abel: If you use relative performance targets with benchmarks to peer groups, you are on the right track. The objective is to outperform the peers and thus overcome the crisis better and faster. This has the advantage of not having to define absolute targets for a currently unforeseeable period of three to four years. Companies listed on the stock exchange have the option of using share or share-related targets given that the data are readily available for the benchmark companies. However, there are a few key aspects to consider when selecting the peer group.
And stability is certainly a key aspect here...
Nina Grochowitzki: Exactly. Stability is essential for a meaningful benchmark. Often entire industries are affected by the COVID-19 crisis. Just think of tourism and aviation. Here, a significant reduction of the peer group can quickly occur, for example, through subsequent mergers and insolvencies. A comparison is not useful anymore or can lead to misleading results. That is why it is important, among other things, to check whether the peer group includes a sufficient number of peer companies, we would say at least ten, and is considered stable over the performance period. And provisions for dealing with smaller peer groups must already be included in the plans. Therefore, an important factor prior to awarding a bonus is certainly detailed calculations in order to determine possible sensitivities.
Christine Abel: And not to forget: when it comes to share plans, companies should be aware that in the present share price environment, awarding them can lead to a comparatively large number of rights being conferred. This provides a strong leverage for the recovery of share prices. But it also creates a motivation to participate in the value recovery. Current tranches, which are still subject to fluctuations, can thus be compensated if necessary.
What is the situation for non-listed companies?
Christine Abel: It is much more difficult to implement performance targets with comparable benchmarks to peer companies. In some cases it is not even possible because information about key figures of peer companies is not sufficiently available in a comparable form. Consequently, many LTI plans refer to internal targets based on corporate planning. If the general conditions for planning change, or if there is even a change in strategy, it will be difficult or even impossible to define internal and reliable targets for a period of up to four fiscal years.
A challenging task! What is your bottom line, then? Are LTIs a good idea during the Corona crisis?
Nina Grochowitzki: If possible, LTI awards for 2020 should be carefully assessed as long as the effects of COVID-19 are difficult to assess for the company. The focus is not only on the objectives, but also on the target figures to be considered. This is because bottom line figures or returns may be irrelevant in times of crisis.
Christine Abel: I think every company that is about to award LTIs should ask itself a few key questions. What is a sustainable corporate development based on today's perspective? How can it be measured? How are the corresponding targets set and later measured? What would future stakeholders say if the award of the LTI 2020 were to be paid? Is that reasonable? And to ensure transparency and acceptance, I would advise all companies to minimize complexity and promote continuous communication.
Ms Abel, Ms Grochowitzki, many thanks for the interview!