Incentive Compensation Strategies During Uncertain Times
Updated: May 12
As the COVID-19 pandemic began to unfold in early 2020, the impact on businesses varied widely. Depending on their industry, some companies’ operations ground to a halt, others enjoyed unprecedented growth, and most fell somewhere in between. The timing of the pandemic also meant that many companies were either in the process of setting performance goals for the current year or had already set goals that were no longer relevant due to the changing business conditions.
A survey of 775 organizations conducted by Willis Towers Watson in March of 2020 found that the majority of companies predicted that the pandemic will negatively impact their business results in the next six to twelve months. The most significant findings were that 85% of the surveyed companies anticipate negative impacts to their short-term incentive plan and 63% of those with a long-term incentive program expect negative impacts to that plan. The question of how to handle incentive compensation during these uncertain and unpredictable times is important to consider, but there is not a one-size-fits-all answer.
Among those companies that participated in the survey, many did not intend to make changes to their short-and long-term incentive plans at the time of the survey; however, results indicated that changes to the plan design or goal setting are much more likely for short-term incentive plans (43%) than long-term incentive plans (15%). Organizations who indicated that they planned to change their short-term plan stated that they intend to either use their existing goals (with discretion applied at the end of the performance period), adjust their existing target goals, or delay goal setting until a future date when business conditions have stabilized. Our discussions with clients suggest that more firms will make changes to their short-term plans than indicated by the survey, likely due to economic changes in the time since the survey was conducted.
At a high level, there are three categories of companies when considering the COVID-19 pandemic impact; those who have experienced either a serious and sudden decline in revenue, a moderate decline in revenue, or increased revenue (due an uptick in demand for their product or service). Since each of these three situations is unique, the implications for incentive plans, especially short-term plans, vary based on the business results.
Companies that have seen their revenue drop precipitously may have engaged in furloughs or layoffs, pay reductions for executives and/or employees, delays in annual pay increases, or taken other measures to survive. In this situation, short-term incentive plans are likely to be impacted significantly, whether or not goals have already been set for the year. If goa
ls have already been set, it is highly probable that the financial performance measures are no longer achievable. As companies consider adjustments to their incentive plans, it is important to balance the need to provide motivation with the context of other actions taken such as furloughs and layoffs. If the decision is made to recast performance goals (or to finalize goals that have not yet been set), companies may consider shorter term (i.e. goals for the second half of the year) financial metrics or metrics related to crisis response and/or positioning the business for growth once the pandemic begins to pass. We encourage caution in revising short-term plans to provide target level payout opportunity if employees in the company have been adversely affected, as this is not the time for management to be well paid at the expense of shareholders or the workforce. Alternatively, if the plan allows for discretion to be applied to payouts
at year-end, this year may be an appropriate time to use those provisions to minimally reward employees for their achievements, even if financial goals were not met.
Organizations with only a moderate decline in revenue and no need for job reductions may have taken less drastic actions, such as postponing hiring and pay changes. If financial metrics can be predicted with some degree of confidence and the incentive plan has a reasonable chance of paying out, we suggest not changing the performance goals for the year, ensuring a strong link between pay and performance. If the impact of COVID-19 will likely eliminate the chance for earning any incentive and the business may soon return to profitability levels before the pandemic, we advise recasting incentive plan goals to keep employees motivated and jump start the business once the restrictions are lifted. The updated performance goals should focus on the future results (i.e. the second half of the year), and it is also appropriate to decrease incentive opportunity in any revised plan to align with the impact of the pandemic on the business across the full year.
Companies that have seen a surge in demand due to the pandemic may be both hiring new employees and having existing employees work more hours than ever. Assuming that the increased demand results in increased annual profits, with no changes to incentive goals, short-term plans at these organizations are likely to payout well above target. If the current plan’s leverage provides significant upside for performance that is well above target, no adjustments may be necessary, as the plan may have a generous payout at the end of the year. If goals for the year were not finalized before the uptick in business occurred, performance targets should be set to recognize the strong business results, translating to incentive pay above target.
Regardless of whether a business is booming or struggling to stay afloat, employee communication around the pandemic’s effect on compensation is crucial. We are all feeling uncertainty, and an employer’s ability to minimize their workforces’ feelings of insecurity related to compensation is important for maintaining motivation. If the decision is made to recast incentive plan goals, it is appropriate to tell employees that changes to the short-term plan will be made when the pandemic’s influence on the business is better known, but companies should not delay developing and communicating a new approach by waiting for absolute certainty. We encourage companies to provide open, honest, and transparent communication around the pandemic’s impact to incentive plans, link plan changes to business results, and notify those who will be affected by updates in the plan of the changes as soon as possible to manage expectations.
Dan Steele and Joe Kager
of the POE Group