Vice Chairman, Executive Pay & Governance
This Week in Leadership (July 19 - July 25)
What the Delta variant means for office returns. Solving the labor shortage with returnships. Plus, tips for how to be a great board director.
By Irv Becker, North American Leader, Executive Pay & Governance
It’s one of the hallmarks of the Trump tax plan: repatriating an estimated $2.5 trillion in profits held overseas by U.S. companies. By some estimate, U.S. corporation have been holding billions in earnings and cash abroad to avoid paying a 35% tax that would be levied whenever the money is brought home. Now, the administration wants to offer a one-time incentive rate of 10% to get it back.
That would leave some companies in the apparently enviable position of having a lot of cash on the books. But, in reality, it’s a challenge for compensation committees that has to be carefully thought out and planned for if companies are to benefit and sidestep potential pitfalls.
One important consideration for compensation committees is the potential impact on common executive compensation plans as they have evolved over the last decade or so.
Many companies implemented performance share plans over the past several years, in which payouts were tied to achieving absolute goals in terms of revenues and stock price. But a rising stock market meant goals were reached too quickly, perhaps in the first year of a three-year plan, meaning they were no longer effective as incentive plans. Compensation committees, under pressure from management to tinker with the goals that had been set, were left with three basic choices: 1) continue with performance share plans that would have little ongoing value to the executives they were supposed to incentivize; 2) add new incentives (widely considered a poor pay practice); or 3) design an alternative performance plan that solved the problem of no-longer-effective incentives.
Use of relative performance plans
Against that backdrop, many companies adopted relative performance plans, where they don't know whether executives’ goals are reached until the end of the measuring period (typically three years), and performance is gauged against a peer group or index. Problem solved with a median performance measure rather than an absolute goal to be hit. But, as with any compensation plan, there are also downsides. These now widely used relative performance plans are less transparent, and executives don’t have as much influence on the outcome when they are being judged against other companies and not just on their own achievements or that of their company. While relative total shareholder return is the most common measure, other companies use relative earnings per share (EPS) or a relative earnings measure.
Potential impact of repatriation of funds into the U.S.
Should companies be able to repatriate dollars, they have to decide what to do with that capital, which could have unintended consequences for incentive plans whose measures can be affected by the use of repatriated funds.
Companies that let inflow of capital sit idle are sending up a red flag to activists, which target companies that are hoarding cash. Alternatively, companies could buy back shares of their stock, a popular option with shareholders; invest in mergers and acquisitions; or invest in the business. But each of these choices has ripple effects—on stock price and therefore also on relative performance plans—so compensation committees should plan carefully. For example, a company using relative EPS may find that some of its peers choose to repurchase shares, resulting in fewer shares outstanding and thus a larger EPS figure, which could distort the company’s position on a relative basis.
In short, President Trump’s proposed tax relief could spell more work for already burdened compensation committees. They will have to be even more careful in observing the peer groups and indices they use for relative share plan benchmarks. This will require a deep dive to understand who in the peer group is impacted, and any movement in key metrics will have to be appropriately factored into executives’ programs and goals for the next few years. Most important, compensation committees will need to ensure that they evaluate performance with the right lens, and that their perspective is not skewed by extraneous factors within other companies that comprise their index.