Director Pay: Leading by Example
The COVID-19 pandemic is challenging leadership everywhere. Like political leaders are making difficult decisions and are differentiating themselves through their ability to execute and keep people safe, corporate leaders are forced to make decisions about their employees and business strategies in an environment of great uncertainty and immense risk. For corporate directors, 2020 is a year when the value of the oversight and guidance they provide to management will be at a premium.
Directors can be the sounding board to test management’s thinking:
- Are they doing enough to keep employees safe?
- Have they adequately cut costs to address the decline in top-line revenue?
- Should they reduce headcount or maintain employment at a reduced work schedule?
- How do they balance doing the right thing for employees, communities and shareholders?
These are difficult decisions and the experience of the board of directors is critical to assisting management in formulating answers that best address each company’s circumstances. That said, while 2020 will require high levels of engagement and effort from boards, it is not an appropriate time to increase director pay. For companies making painful decisions to lay off or furlough employees and cut executive pay, the board can demonstrate leadership by reducing its own pay for the duration of the COVID-19 pandemic or for the remainder of 2020.
This is consistent with what we are seeing in the sectors that are hardest hit by the COVID-19 pandemic. Of companies in the S&P 500, as of May 8, 15% have disclosed cuts in director pay. We have seen even more decreases at smaller companies, with 19% of companies in the S&P SmallCap 600 index reducing director pay. In general, director pay cuts have been done in conjunction with actions that have adversely impacted employees or executives. Among S&P 500 companies reducing director pay:
- 47% furloughed employees,
- 31% reduced pay for employees beyond the executive level,
- 17% suspended raises or bonuses
- 13% reduced the workforce, and
- 9% reduced or suspended 401(k) contributions.
In addition, all of the S&P 500 companies that reduced director pay also reduced the chief executive officer’s (CEO’s) base salary. The degree to which director pay is reduced varies significantly across companies. In most cases, the director cash retainer was reduced by the same amount as the reduction in the CEO’s salary. Approximately half of the S&P 500 companies that reduced director pay eliminated the cash retainer completely, while the remainder of these companies reduced the retainer by 25% to 50%.
For the majority of companies that are adversely impacted by COVID-19 but to a more modest degree, 2020 may be a good year to hit the “pause” button on director compensation reviews. If the compensation committee or the nominating and governance committee wants to review director pay to understand whether levels are in-line with the market, that is a reasonable exercise to go through. However, we do not recommend making any increases to director pay in 2020, particularly if the company has already made decisions that adversely impact management (e.g., salary reductions) or employees (e.g., salary reductions, furloughs, layoffs, etc.), or is likely to take such actions later this year. We think it sends a strong signal that directors recognize the challenges facing employees and do not want to take extra compensation in a year when employees and shareholders are struggling.
By the beginning of 2021, we may be in a position where the companies that reduced director pay levels can restore pay to pre-pandemic levels or even consider a pay increase. While we hope that the economy will rebound in 2021, there is no guarantee that this will be the case. Any companies that make increases to director pay in 2020 following the onset of the pandemic may be subject to future additional scrutiny by shareholder advisory firms, shareholders, the press and potentially even employees.
Eric Hosken is a partner with CAP. Eric’s areas of focus include compensation strategy development, evaluating the pay and performance relationship for senior executives, annual and long-term incentive plan design, performance measure selection and board of director compensation. Daniel Laddin is a founding partner with CAP. He consults with Boards and management in all areas of executive compensation, including annual and long-term incentive design, performance measurement, target setting, and regulatory/compliance issues, as well as outside director compensation programs.