Pay Pressure Boils Over

Nothing is off the table this year in revamping executive compensation programs.

In the Towers Perrin survey, 26 percent of responding companies have addressed underwater options or are reviewing the issue, up from just a handful of companies in the firm’s fall survey.

Options that are 5 or 10 times lower than their strike price may be worse than worthless. In Poerio’s view, they are psychologically debilitating: “It’s a thorn in your side — a constant reminder of what the company used to be worth and what it is worth now.”

The Long Haul

Even before the current crisis and the new public focus on executive compensation, companies were giving long-term and performance-based awards greater weight in pay portfolios. That shift promises to accelerate markedly now.

But it will raise a significant issue: What happens if there is a three-year cycle for an award, and it is clear at the end of the first year that the goal cannot possibly be achieved — for market reasons, say — regardless of an executive’s performance over the next two years? Here too, retention would be jeopardized. Some boards are already saying they may keep the discretion to recalibrate long-term awards every year, or even every six months. Poerio calls such a strategy “quicksand.”

It does smack of an attempt to do an end run around shareholders’ preference for performance-based awards. Smart boards won’t make that mistake. “There will be a real premium on very, very careful design of long-term incentives, working in both performance and adjustments based on the market, as well as peer-group performance,” Poerio says. “That complexity is worth it, if you really want to have incentives that work.”

Give It Back

Borrowing a page from the Troubled Assets Relief Program for bailed-out financial firms, many companies will be rethinking their clawback provisions. Also expect changes to severance-and-control benefits.

Currently, many companies either have no forfeiture provisions for someone leaving to join a competitor — the traditional meaning of “golden handcuff” — or they have inconsistent ones that evolved individual by individual. That will change in 2009, but the discussion won’t end with disloyalty scenarios. More companies will institute clawbacks that will kick in if an executive is guilty of fraud or abuse, if there is a financial restatement, and even if the company miscalculated the award.

Theoretically, the more clawback provisions there are, the less appealing the award is. But, Poerio points, out, loyal executives who do their jobs properly are not at risk. He mentions one client that was talking about having a clawback for financial restatements that would apply to the past three years’ awards. “At that moment the executive team jumped up and said, ‘No way we’ll agree to that!’ And everyone else in the room was thinking, ‘Something must be wrong here.’ “

More companies may make clawback provisions retroactive, though trying to get back money paid three years earlier could pose some legal challenges. Paul Hastings favors designing provisions under which the company holds most of the money for a year; if the payout is $100,000, the executive will get $25,000 immediately and the rest after a year if he hasn’t left the company or not fulfilled his obligations.

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