COVID-19 – What might be the impact on employee compensation and benefits? Part 1 – Long Term Incentives

There is so much to read about when it comes to short and long term effects of this global pandemic. How will it impact handshakes? The cruise industry? The speed of transition to greener fuels? Inner city property prices? China/US relationships? That list could go on forever so I will stop it there and instead introduce the topic for today – COVID-19 and long term incentives (LTIs). What are the short term and potential for any long term impacts on employee Restricted Stock Unit (RSU) Plans, Employee Stock Options (ESOs) and other LTIs?

COVID-19 has and will continue to have a huge influence on stock prices around the world, this means it is also having a big impact on the value of employee share plans. First let’s look at basic, simple RSU plans.

Previously granted RSUs fall (or rise) in value along with the share price, no big surprises there. Where this type of plan can be more impacted is in how big the award allocations are during a depressed stock price. If awards are given as a % of base salary then the number of units delivered while the share prices is down by 40% will be 40% higher than previously. Potentially very good for the employee and bad for the shareholder through increased dilution. If awards are given as a number of units then this could be very bad for the employee as they suddenly are getting below market levels for their annual stock award.

What about a Performance Share Plan (PSP)? Performance Share Plans can be heavily impacted by an unexpected event like COVID-19, it depends on the performance metrics that are attached to the plan. If the performance metrics will be hit by reduced revenue like earnings per share (EPS) or EBITA then the number of units vesting could be decimated for employees through the impact of COVID-19 on earnings. If the metrics are more related to company performance vs peers or another measure that is still achievable in a global/industry downturn then the plan is more likely to pay out fairly based on relative company performance. Similar to RSUs the number of new units delivered during a period where the share price is depressed or inflated is also worth understanding.

Finally let’s look at Employee Stock Options (ESOs). These can also be highly impacted by a volatile shareprice and it is likely that immediately following the stock market crash in March there were many options ‘underwater’. If COVID-19 leads to a period of prolonged volatility in the market then that could benefit some employees who are granted regular option awards. Large option awards granted in a downturn with a low strike price can become very valuable in the future if the economy and relevant industry/company recover strongly.

So we can see in the short term there is potential for big winners and losers from the volatility caused by the pandemic. What about in the longer term, will any permanent changes triggered?

Unlike the last big global recession this one was not encouraged and assisted by compensation plans encouraging high risk behaviour in our financial institutions. Therefore we will not see the kind of regulatory and market driven changes to long term incentive design and treatment that followed the 2008 financial crisis. There may be an increase in M&A activity as smaller companies struggle and certain industries remain depressed but the current way long term incentives are designed and operated should not greatly change. Some companies may consider moving away from performance shares that worked well to drive performance in a more stable landscape but delivered nothing in 2020. Others may do the opposite and look to performance shares and options plans as a way to drive the performance required to recover in the coming years. Overall however I do not see any significant changes on the horizon to LTI design and application due to COVID-19.

As always there is no better time than now to better understand the value of any awards you do hold so please take advantage of our free valuation report contact us for more specific help.

Look out for Part 2 of this series where we examine the impact of COVID-19 on the Gig economy and the trend towards more transient, flexible workforces. Will this continue in a post-pandemic world or will workers crave more protection and better job security?

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