Strategies to ensure your equity plans are “shock-proof”
As many employers begin to plan for their 2021 compensation, one topic is top-of-mind: resilience.
The financial recession created by the coronavirus has impacted the economic standing of companies nationwide. A poll by Fidelity Investments showed that 69% of firms were re-balancing existing dollars to address new needs, cutting benefits substantially or preserving cash at all costs in response to the impact of COVID-19.
The resilience of many firm’s compensation plans is being tested, especially in areas that are directly impacted by volatility in the stock market, such as equity awards.
“It's not a surprise to anybody to say that we've had a lot of volatility throughout this year,” Emily Cervino, Head of Thought Leadership at Fidelity Stock Plan Services, said at a WordatWork conference last week. “For a compensation tool that is inherently linked to stock price, market volatility really can have a profound impact on its ability to meet company objectives of attracting, retaining, motivating and incenting employees.”
To combat this volatility, and to stop it from wreaking havoc on your future incentive payouts, firms should consider “shock-proofing” equity award metrics, both to respond to the crisis now and to safeguard plans for the future, according to managing director at Equity Methods, Nathan O’Connor.
“A shock-proof metric has insulation, where these outside consequences are being filtered out so that focus is on how the recipient drives outcomes that are within their control,” O’Connor said. “The entire objective is filtering out shocks due to pandemics like COVID-19, or it could be hyperinflation, or geopolitical instability..”
There are a few different ways to shock-proof metrics, according to O'Connor.
One option is to use relative metrics, rather than absolute metrics. Whereas absolute metrics set a goal and compare against this unchanging number at the end of a performance cycle, relative metrics compare against a peer group. The most popular relative metric is relative total shareholder return, according to O’Connor, but any metric can become a relative metric.
“Relative metrics do a great job of realigning award payouts with actual performance of our recipients,” O’Connor said.
A second option is to shorten the length of the performance period. Shorter performance periods allow firms to reset and recalibrate goals in crisis situations ─ longer performance periods do not have this flexibility.
Finally, O’Connor discussed using more specific metrics, such as strategic or business-unit specific metrics. These metrics can be designed to be resilient to outside pressures, focusing more on internal achievement.
“Now that we're in comp design season, [employers are] shifting focus to the 2021 year,” O’Connor said. “It provides a natural opportunity to get out in front of this and make natural adjustments.”