The COVID-19 pandemic is having a ripple effect on the business practices of companies of all sizes and in all industries. Among other things, wild fluctuations in stock valuations and other performance metrics are making it difficult for companies to grant incentive compensation awards to their key employees.
Below are answers to questions that companies may be facing.
Q1: We are preparing to grant our 2020 annual equity awards, but our stock price has just plummeted, which requires us to use far more shares to provide the intended grant values. We reviewed our pool of shares available under our stockholder-approved plan, and we will not have enough shares for our 2020 annual grants. How do we grant awards necessary to motivate and retain our key employees?
A1: The compensation committee might consider the following alternatives:
- If the company was planning to grant options, it could grant restricted stock units (RSUs) or performance share awards (PSUs) instead, which require fewer shares to deliver an equivalent value.
- Grant the equity awards at the regularly scheduled time, but make the awards contingent on stockholders approving an increase in the share pool at the 2020 annual meeting. Tax and securities laws permit all types of equity awards, including options, to be granted currently but be contingent on stockholder approval, although there may be an increased accounting charge reflecting any increase in stock value that occurs between the date of grant and the date of stockholder approval.
- Delay the grant until after the 2020 annual meeting if the company is seeking stockholder approval of additional shares at that time.
- Provide for the awards to be settled in cash to the extent that there are not enough shares. Cash-settled awards do not require stockholder approval, but they will have less favorable accounting treatment than stock-settled awards.
Q2: We granted options before the recent stock market declines, and now those options are “under water” and do not provide the incentives that we intended. Is there anything we can do?
A2: To reprice options without stockholder approval, the company’s equity plan would have to expressly permit repricing. Most public company equity plans (other than those maintained by companies that have recently gone public) do not permit the repricing of options without stockholder approval. These repricing restrictions apply not only to simply reducing the exercise price of an option but also to exchanging under-water options for another type of award, such as RSUs. Given the unique circumstances, the company might be able to successfully seek stockholder approval of a repricing at the company’s next annual meeting, although it is not yet known whether institutional advisers, such as ISS, would support such a repricing. Alternatively, the company could wait to see if the stock recovers and, if not, request a repricing at the 2021 annual meeting. If the repricing involves any change in the award other than a reduction in the exercise price, such as exchanging options for RSUs, the company would be required to comply with tender offer requirements under U.S. securities law. If a repricing is not feasible, the company could grant supplemental awards, but that would likely result in an additional accounting charge and would also have an adverse effect on the company’s stock dilution level and overhang.
Q3: The COVID-19 pandemic is having an adverse effect on the performance metrics that govern the payout of annual bonuses or long-term incentive awards. Can we adjust the payout under those awards to reflect this unforeseen circumstance?
A3: For new awards, it would be prudent for the compensation committee to expressly reserve the right to adjust performance measures to reflect the effects of COVID-19. In the case of outstanding awards, most incentive plans by their terms permit adjustments in either performance levels or payout levels to reflect unforeseen circumstances. This is especially the case after the 2017 Tax Cuts and Jobs Act, which eliminated the performance-based exception to the $1 million deduction limit under Section 162(m) of the Internal Revenue Code, thereby giving compensation committees greater freedom to exercise “positive discretion” to increase incentive payouts. Even if the plan does not currently permit positive discretion, the compensation committee should be able to adjust the performance levels or payouts of outstanding awards unless the plan includes stockholder-approved restrictions on such discretion. In most cases, it would appropriate to wait until the end of the performance period, or at least until the wreckage caused by COVID-19 can be assessed, before approving any adjustments. The timing of the adjustment does, however, result in slightly different disclosure in the compensation disclosure and analysis included in the company’s annual proxy.
Q4: We base our equity grants on the closing price of our stock on the date of grant. As a result, wild swings in the market can have a dramatic effect on the shares that are granted, depending on which day the awards are granted. What can we do to reduce the effects of these market swings?
A4: Some companies choose a grant date in the future, after compensation committee approval, and determine both the number of shares subject to awards and the exercise price of options using an average trading price over a period of time prior to the grant date. In the case of options, Section 409A of the Internal Revenue Code requires that the options be approved before the beginning of any averaging period and that the averaging period not be longer than 30 days. For companies subject to the New York Stock Exchange listing rules, it would be necessary to review the plan document to see if it permits flexibility in determining the exercise price. The 409A restrictions referenced above do not apply for purposes of determining the number of shares subject to RSUs or PSUs.
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