One-time compensation awards can be a useful tool for boards to attract and retain key talent. While such awards have drawn considerable scrutiny of late, shareholders and proxy advisers are not always opposed to their use. This article explores how boards can evaluate the need for such awards and, if appropriate, design and disclose a one-time incentive that is effective and acceptable to shareholders.
In the normal course, a well-designed compensation framework should negate the need for one-time awards. These awards should not be used as a band-aid solution to an ineffective framework and should be limited to circumstances where there is a clear business case. So when might they be necessary?
A sign-on award is often required to attract and “make whole” an executive who is departing another company and consequently forfeiting awards. By and large, shareholders understand this need and recognize that such awards can generate a significant return when the right talent is acquired.
One-time awards to ongoing employees are more likely to attract scrutiny than sign-on awards; however, they too may be appropriate in limited circumstances. Retention awards to individuals working in the currently depressed energy sector may be one such example. For many oil and gas companies, outstanding equity awards made prior to the downturn are worth a fraction of their grant value, largely eliminating their retention value. While the reduced outstanding award value is aligned with the shareholder experience and there is (for the most part) currently a surplus of talent in the labour market, there may nevertheless be opportunities for some high performers to move to new companies and receive fresh equity awards. In such circumstances, boards may feel it prudent to provide one-time awards in order to create adequate retention “handcuffs.”
One-time awards for closing transactions or extraordinary performance tend to be the most difficult to develop a strong business case for and are generally less advisable. As a rule, the existing compensation framework should reward such achievements.
While circumstances will dictate the appropriate design, longer-term and performance-based one-time awards are less likely to trigger negative shareholder response (providing there is a cogent business case for the award). For sign-on awards, best practice is to replicate the time frame and performance conditioning of forfeited awards as closely as possible. Boards should also consider the ability to negotiate partial payment for forfeited compensation, particularly when the hire is a promotion and the individual’s annual compensation will increase materially compared to his or her previous role.
In the case of retention awards, boards should consider the required retention time frame and the perceived value to recipients (awards with long deferrals may have less perceived value). In determining the appropriate quantum, a key consideration will be the size of equity award the recipient would receive upon joining a new company.
Finally, clear disclosure of a board’s decision-making and design processes for these awards is critical for gaining shareholder acceptance. Disclosure should include discussion of how the directors took into account the existing compensation framework and pay levels, and the potential value of future take-home pay. Additionally, as shareholders become increasingly open to engagement with directors to discuss executive compensation, boards considering one-time awards may be well-served by proactive engagement with major shareholders (and proxy advisers) in this area.
In today’s environment, boards must apply their independent and informed judgment in determining the need for and the size and structure of one-time awards. Directors should also anticipate that thorough, transparent and possibly proactive shareholder communication will be necessary. Well designed and effectively communicated, these awards can play an important role in retaining and incentivizing critical talent.
Ken Hugessen is founder and president of Hugessen Consulting Inc. E-mail: firstname.lastname@example.org. Christine Vinette is a manager at Hugessen. Brian Lees is an analyst at Hugessen.