This post is part of a 7-part series addressing compensation adjustments that Compensation Committees could consider in order to continue to incent and retain their executive officers in today’s economy. The titles of each of the 7-parts in this series are listed at the bottom of this post. This Part 2 is entitled “Consider Changes to Increase Cash Flow,” and provides some ideas that a Compensation Committee could implement that could work to increase the company’s cash flow and produce positive proxy disclosure. Such ideas are (listed in no particular order, and not an exhaustive list):
Idea No. 1 – Temporarily Reduce Base Salary
The concept of reducing base salary is simple, but for companies with executives who have contractual rights to severance pay and/or change-in-control pay, it is likely such arrangements will need to be amended for the following reasons (though such amendment could take the form of a master amendment, with one document amending multiple documents):
- Temporary Waiver of Good Reason Trigger. If the executive has severance pay protection and one of the severance pay triggers is that the executive could quit for “good reason” (which most often includes a material diminution of the executive’s base salary) and receive severance, then an amendment should be entered into that temporarily waives good reason with respect to the reduction in base salary.
- Address Other Forms of Compensation Based on Base Salary. It is common for other forms of compensation, such as target annual and long-term incentive awards, to be expressed as a percentage of base salary. The amendment should address whether the reduction in base salary will flow through and reduce these forms of compensation or if such compensation will be calculated based on the unreduced base salary amount.
- Verify Base Salary Reduction Does Not Unintentionally Reduce Severance or Change-in-Control Pay. As background, severance pay and change-in-control pay packages are often structured as a multiple of the executive’s base salary and bonus. Therefore, an amendment will likely be needed to the applicable documents in order to avoid the executive’s risking a reduction in pay should the company have a change-in-control transaction.
- Address Stock Ownership Policy Denominated as a Percentage of Base Salary. If compliance with the company’s stock ownership policy is denominated as a percentage of base salary, then the executive should provide a waiver that any reduction in his or her base salary will not allow a reduction of his or her stock ownership.
Idea No. 2 – Reduce Cash Compensation in Exchange for Grants of Equity
This idea is easy to implement. Any concern that the executive is receiving an unfair advantage due to the company’s low stock price is defendable on the basis that the executive could have taken his or her cash compensation and bought stock in the open market. A data point to keep in mind is that the reduction of cash compensation in exchange for equity should be structured with respect to future services only, otherwise, constructive receipt and Section 409A issues, and equity classification issues under ASC Topic 718, will need to be navigated. Finally, this idea is not likely feasible for those companies with insufficient shares in their equity incentive plan.
Idea No. 3 – Consider a Treasury Stock Purchase Program (a Solution to Idea No. 2 if the Equity Plan has an Insufficient Share Reserve)
Under this concept the executive would elect to use his or her after-tax cash compensation to purchase treasury shares from the company (no shares from the equity incentive plan are used). As a result, the company’s cash outlay associated with the compensation, minus the executive’s income tax liability, is essentially returned to the company. [Note that this idea could also be used by the company’s non-employee directors] A plan document will be required, and this program will trigger a Form 8-K filing requirement. And too, a Form S-8 is often used to avoid Rule 144 resale restrictions. Some of the advantages of a treasury stock purchase program include:
- Shareholder approval is not required under NYSE and NASDAQ listing rules provided the program is elective and the number of shares of common stock to be issued in the transaction does not exceed either 1 percent (in the case of NYSE-listed companies) or 20 percent (in the case of NASDAQ-listed companies) of the common stock or voting power outstanding before the issuance;
- There is no draw from the share reserve of the company’s equity incentive plan, as a result, such share reserve is preserved for other grants;
- It encourages ownership in the company, thus serving the purpose of aligning the executive’s interests with those of the company’s shareholders;
- It can help to facilitate stock ownership requirements/guidelines, which can act as a mitigating factor to negate “materiality” in the risk assessment process;
- It is more efficient than open market purchases since all executives would be able to satisfy their ownership goals on the same day rather than over an extended period of time (the latter of which could otherwise result if there was low trading volume);
- It is more equitable than executive purchases in the open market because all executives will pay the same price (whereas open market purchases could result in price disparity depending on the timing of purchases):
- Scheduling of purchases shortly after earnings release provides transparency and reduces risk of allegations that the executive used insider information; and
- Issuances of treasury stock add a small amount to the outstanding share count, which increases the company’s market cap (thus helping the company satisfy ongoing listing requirements).
Blog posts that are part of this 7-part series include:
- “Considerations with Respect to Upcoming Equity Grants” (Part 1 of 7)
- “Address Outstanding Performance-Based Equity Awards” (Part 3 of 7)
- “Consider Retention Packages to Discourage Poaching” (Part 4 of 7)
- “Revisit Stock Ownership Policy Requirements” (Part 5 of 7)
- “Modifying or Terminating a 10b5-1 Trading Plan” (Part 6 of 7)
- “Does It Make Sense to Consider a Secular Trust for Deferred Compensation” (Part 7 of 7)