Preparing Stock Plans for an Economic Downturn

While the U.S. economy has been relatively stable over the past several years, and a recession does not appear to be imminent, there is some chatter about the next recession. Although we don’t know exactly when that will occur, history tends to remind us that it’s a likely possibility at some point. Some economists speculate that this could come later this year or sometime in 2021. This raises the question as to what companies can to do mitigate the effects of an economic downturn on their stock plans.

A blog by law firm Morgan Lewis (“Executive Compensation Planning for an Economic Downturn” (Nov 13, 2019)) proposed ideas for companies to contemplate in crafting a strategic plan to preemptively address the scenario of an economic downturn and the resulting impact on compensation.  Below is an excerpt of suggested considerations relative to equity plans:

1. Align Incentive Compensation with an Economic Downturn Strategic Plan. Consider whether performance metrics should be updated to align with the company’s strategic approach to addressing a downturn. For example, companies can review their incentive compensation programs to minimize executive risk-taking, emphasize nonfinancial measures, and underscore near-term successes and sustainability.
2. Minimize the Need for Discretion in Performance-Based Awards. When setting performance goals for incentive compensation, think about how an economic downturn will affect the company’s ability to meet the performance goals. Setting performance metrics with a view toward appropriate achievability in a variable economy may minimize the use of discretion later.
3. Cap Payouts. Capping payouts under performance-based plans may alleviate unintended consequences, such as shareholder reaction to a payment substantially above target during a financial downturn. This can be an issue, for example, where one metric exceeds the maximum while another fails to hit the threshold.
4. Equity Plan Share Reserve. Consider how a drop in stock price would affect the share reserve in the equity plan, and consider getting shareholder approval of a share reserve increase sooner rather than later.
5. Denominate Awards in Dollars, Not Shares. If any equity grants are denominated in shares instead of dollars (for example, director grants), consider changing them to dollar amounts.

For many individuals and organizations, the response to an economic downtown can be both panicked and reactive. It’s something that many folks don’t want to think about until it actually happens – I don’t sense a ton of proactive foresight in this area. That approach isn’t likely to serve company’s needs if (when) a downturn occurs.

Instead of waiting for something to happen, companies can get ahead of the curve with advance planning aimed at mitigating the impact of an economic storm on their equity plans. Such preparation could go far in not only minimizing the financial and stock price effects of a downturn, but in retaining employees once they realize that their compensation has fared better than those working for a company that failed to make advance preparations.
 
-Jennifer