Desperate times, desperate measures

Although we have been living with the ever-evolving COVID-related restrictions since the middle of March, there’s no definitive end in sight — and no idea of what the “new normal” really looks like.

One thing that is clear, however, is the effect that the pandemic has had on jobs and compensation across the country. From the warehouse to the C-suite, employees are facing uncertainty and apprehension. The pandemic was declared in North America at a time that made it challenging to make — or revisit — compensation decisions. Many organizations had already committed to incentive plan targets and salaries for 2020 when the entire economic landscape shifted drastically.

In addition, as companies’ share prices took a hit, thanks to declining sales and the unpredictability of the markets, equity awards for many employees — and executives, in particular — lost value.

Cuts, freezes and deferrals
In the short term, for many companies, the impact on employees has been drastic. Faced with so much uncertainty, many companies were forced to resort to severe measures — including temporary layoffs and mass terminations, as well as reductions in hours. In some cases, salary freezes and reductions for executive and non-executive employees were also implemented, and such measures continue to be used as cost-reduction strategies.

CEOs and senior executive teams at many Canadian companies saw their pay reduced — some voluntarily, others involuntarily — by anywhere from 10 to 100 per cent, according to Hugessen Consulting. Notably, the CEOs of Air Canada, Bombardier, Telus and Canada Goose agreed to forego 100 per cent of their salaries for varying periods of time. Board compensation at several organizations was also cut. 

Other companies — including Sleep Country Canada — saw their executives agreeing to defer a portion of their salaries until a future date when, the hope is, sales and cash flows return to more normal levels. Temporary salary deferrals can provide some relief to cash-strapped organizations; however, caution must be exercised to ensure that the deferrals do not have adverse tax consequences as a result of the salary deferral arrangement rules set out in the Income Tax Act (ITA).

If an arrangement is characterized as a salary deferral arrangement under the ITA, an employee could be taxed on the full amount before it is actually received. However, there are exceptions; and if the deferral fits into one of these exceptions, there should be no adverse tax consequences.

In some instances, (mostly private) companies have offered employees stock options — or made changes to outstanding stock options — as a means to compensate employees for accepting salary reductions. Again, these types of changes should be approached with caution as there may be unintended tax consequences under both Canadian and U.S. tax laws (applicable to any participants who are also U.S. taxpayers).

In addition, employers must approach material, detrimental changes to employees’ terms and conditions of employment with caution or risk facing employee relations issues and constructive dismissal claims where there is no express or implied right to make such changes.

However, there are strategies for reducing these risks or their related costs, such as obtaining consent and providing sufficient notice of a change in compensation.

Rethinking bonuses and long-term incentives
Of course, base salary is only one part of most executives’ compensation package. The vast majority also have annual bonuses, equity-based awards or other forms of incentive compensation based, at least in part, on the company’s performance. In addition to salary cuts, bonuses have been reduced or deferred or both while temporary measures have been implemented to redefine the targets and adjust metrics used to calculate bonus amounts to account for the impact of the pandemic.

In many cases, these changes were necessary because the factors underlying 2020 compensation programs have changed so drastically that they are no longer realistic. As a result, employers could either revise bonus plans that executives had already agreed to or face the fallout of trying to honour unrealistic compensation programs. In the longer term, it’s difficult to know how targets will be set moving forward. 

Like bonus programs, equity arrangements will also need to be re-examined. For some companies, equity grants may have lost all value in the short term, but there may be huge — and possibly unintended — upside results and potential windfalls for some employers and industries.

Despite the pandemic-reinforced success of a few companies — think Shopify, whose stock had increased by 165 per cent by Aug. 10 — equity has become worth much less for many organizations. As a result, many stock options are underwater — that is, the exercise price is greater than the fair market value of the shares underlying the option — and it may become necessary to consider restructuring the stock option program using a strategy such as repricing.

One way that option repricing can be effected is by reducing the exercise price of existing options to the current market price of the underlying shares, either by amending the grant agreement or by allowing option holders to surrender their underwater options for cancellation in exchange for new options. It should be noted that, for public companies, such changes may require shareholder approval.

Even if approval is not legally required, companies may be leery of proceeding without such approval given investor antipathy to these programs and the adverse publicity they can generate. In Canada, proxy advisory firms such as Institutional Shareholder Services (ISS) generally recommend voting against proposals to reprice outstanding options.

Of course, prior to making changes to any compensation arrangements, the terms of the plans must be carefully reviewed and considered to ensure that the company has the right, either express or implied, to make such changes and to determine what steps must be taken in order to implement changes (such as shareholder or stock exchange approval). As with salary reductions, the benefits of making changes must be weighed against the risk of employment-related claims and the impacts that such changes may have on motivating and retaining employees.

Looking ahead
Although a greater deal of uncertainty remains, we are beginning to see the ramifications of the executive compensation decisions companies have made over the past months. Many entities have had to balance competing interests such as saving money and motivating and retaining talent, while also considering the public’s perception of generous paycheques when a large number of Canadians are losing their jobs or agreeing to reduced wages.

In short, it may still be too soon to make any permanent decisions on executive compensation. Although we have certainly seen market volatility and financial crises before, there is no precedent for the current circumstances and no blueprint for the way forward. As a result, it may make the most sense to put target setting on hold for the time being.

Looking ahead, companies should focus on ensuring they retain — or gain — the ability to modify compensation programs, including equity-based arrangements, keeping in mind the influential role played by proxy advisory firms and the possible requirement for approval by shareholders, stock exchanges or both. Being able to make changes to employees’ terms and conditions of employment — without triggering constructive dismissal claims — will also become increasingly important.  

Both in Toronto, Lynne Lacoursière is co-chair of the Executive Compensation practice and a partner in the Employment & Labour group and Kelly O’Ferrall is counsel in the Employment & Labour group at Osler, Hoskin & Harcourt. For more information, visit www.osler.com.