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The crisis also hits corporate governance...and the compensation structure

COVID-19 also hits corporate governance systems, starting from the ability to effectively launch the upcoming period of stockholder meetings. The article by Marco Visani, Head of Governance & Executive Compensation, The European House – Ambrosetti.

The crisis also hits corporate governance … and the compensation structure

COVID-19 also hits corporate governance systems, starting from the ability to effectively launch the upcoming period of stockholder meetings.

The “Cura Italia Decree” attempted to solve this by allowing companies to postpone their stockholder meetings and fostering all possibilities for remote participation, notwithstanding the statutory requirements. This second measure is extremely important because, analyzing the articles of association of FTSE MIB quoted companies, we find that in 50% of cases, no provision for holding “virtual” stockholder meetings is provided for.

But the health emergency has also severely challenged remuneration systems based on financial instruments. For example, the dramatic collapse in stock prices has seen the FTSE MIB lose approximately 40% of its value, compared with February 21, 2020. In many cases, in fact, even in the face of superlative economic financial performance, managers find themselves with shares “devalued” by 40% or options “under water” because of an absolutely extraordinary event completely out of their control, with the result that:

  • top management becomes demotivated;
  • if managers need to sell the shares to pay taxes (sell to cover), they risk doing so at rock-bottom prices.
This is all accentuated by a significant increment in the volatility of share trends and consequent greater uncertainty.

But how widespread are remuneration systems based on financial instruments (shares, options and performance indicators such as TSRs)?

We analyzed the 100 FTSE MIB and MID CAP quoted companies. Overall, these mechanisms are used by 61 companies out of 100 (29 out of 40 in the case of FTSE MIB companies and 32 out of 60 in the MID CAP sector). Therefore, it is a very common practice among Italian issuers.

Figure 1. Diffusion of remuneration systems based on financial instruments in quoted Italian companies. Source: The European House – Ambrosetti elaboration based on remuneration reports of quoted companies published in Spring 2019.

Therefore, there are very many quoted companies (in particular the Remuneration Committees) that are wondering about the best way to manage this emergency situation. With this bit of knowledge: often, the regulations regarding these instruments provide for the modification of the operating mechanism, specifically in the context of extraordinary conditions and, to be frank, it is hard to imagine a more extraordinary moment than the one we are currently experiencing.

But exercising potential discretionary power in modifying the incentive plan must come to terms with a fundamental point:

“sterilizing” the impact of COVID-19 from the management bonus could be “inconsistent” with the interest of shareholders who must suffer the effects of this crisis without any hope of appeal.

So, on one hand, we have the need for companies to respect Pay For Performance (P4P), i.e., the principle by which bonuses must be paid on the basis of value creation for shareholders (and when a company loses 40% of its capitalization, in no way can it be said that P4P has been met). On the other, companies must be able to assure the sustainability of the issuer, which is difficult to attain if top management is demotivated or if it perceives that the good performance it produced—not reflected in a market gone mad—is not recognized.

There are a number of solutions, but we believe the guiding principle must be that of sustainable success, as set forth in the New Self-Regulating Code of quoted companies issued at the end of January 2020. If the management team has demonstrated its worth and is believed to be “absolutely necessary” for growth, “sterilizing” the effect of COVID-19 on bonuses could be opportune.

Given that the perspective of shareholders, and in particular institutional investors, is long-term, the market will unquestionably understand that extraordinary situations require extraordinary solutions. But that these solutions must be one-time only.




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