Businesses in Distress or Filing Bankruptcy Should Reassess Compensation Arrangements

Published: June 2020

 

The wave of companies operating in distress or under bankruptcy protection due to a global economic slowdown should consider rules and best practices for employee and executive pay.


For many companies, the current environment is prompting business conditions and financial challenges not seen since the 2008-09 Great Recession. There are several actions distressed companies, including those in bankruptcy, need to take to protect the future of their business, their employees and other stakeholders. A critical strategic factor to consider is how to retain and motivate executives and key employees to execute on the company’s strategy and propel the business forward. If a company’s compensation arrangements become less effective, employees lose motivation or become a flight risk, which poses a key concern for any business navigating a turnaround.

In this article, we highlight the key questions and actions businesses should take when it comes to employee compensation during a period of distress or bankruptcy.

Compensation Considerations for Distressed Companies

Company “distress” can manifest itself in many forms, including challenges with cash flow, reduced profits and declining revenues, which often trigger a deterioration in share price. When a company is in distress, compensation programs need to be reevaluated to ensure they are doing the following:
  • Keeping executives and employees motivated and engaged during a challenging period
  • Retaining talent that is deemed most critical to preserving the company’s value and driving a turnaround
  • Aligning pay with performance, as well as shareholder interests
  • Aligning incentive pay with company strategy
Recognizing that each organization is unique, a company may prioritize one of these objectives over the others, and there may be additional goals depending on what each company views as a successful outcome. Once key priorities are identified, we typically observe companies assessing their existing compensation arrangements and developing new ones to fit their unique circumstances. 
 
For this assessment and implementation process, the following factors should be considered:
  • Degree of severity with respect to financials (e.g., distressed vs. bankruptcy), as well as visibility on turnaround timeframe
  • Short-term and mid-term operational and people strategies
  • Effectiveness of existing compensation arrangements (e.g., motivating, retaining and driving performance)
  • Current and prospective use of equity as a motivational and retention tool
  • Cost implications of cash and equity programs
  • Identification of executives and employees most critical to the business
  • Industry and/or peer practices
  • Alignment with shareholder interests
  • Proxy advisory firm implications (for public companies)
  • Good governance practices and/or limitations imposed on compensation by bankruptcy courts
Some of the factors noted above may compete with each other, so it is important to have a laser focus on the company’s short- and long-term objectives and balance that view with what is feasible.

Bankruptcy Compensation Considerations

The filing of a petition for bankruptcy is not the end of a business, but rather the beginning of a new and critically important stage of the business. To maximize the potential for a successful outcome, debtor companies need to ensure continuity and incentivize their management team and key employees during this period of uncertainty.  Given the limited value of equity in this situation, companies must retain their key employees with cash-only plans. Bankrupt businesses most commonly utilize the following plans to retain and motivate key employees and management:
  • Pre-filing Retention Plans: Companies on the verge of filing bankruptcy often decide to increase base salaries, pay bonuses to executives and/or initiate a cash-based retention plan prior to filing. A pre-filing retention plan is appealing because it is not subject to bankruptcy court approval. However, it’s crucial to remember that these payments may strain the company’s relationship with its creditors at a time when cooperation is essential and many payments within a year of a bankruptcy filing may be clawed back if they are deemed to unjustly enrich their recipients. Therefore, it is critical to understand the competitive market for such payments and have a compelling rationale for why these payments were made.
  • Key Employee Retention Plans: After filing for bankruptcy, companies often adjust compensation for key employees that are not part of the management team through a Key Employee Retention Plan (KERP). This is a time-based compensation plan that is intended to lock-in key employees. KERPs are subject to bankruptcy court approval, so companies need to demonstrate that the payments are necessary.
  • Key Employee Incentive Plans: Senior management is generally prohibited from participating in KERPs. To ensure these leaders remain motivated and engaged at a time of significant work and uncertainty, top management is most commonly compensated through a Key Employee Incentive Plan (KEIP). As the name suggests, KEIPs incentivize management to hit established performance goals and are also subject to bankruptcy court approval. If the goals are too easily achievable, courts will deny the KEIP.
  • Post-Emergence Plans: These type of equity and bonus plans must be approved by the bankruptcy court before a company can emerge from the bankruptcy process. When establishing these plans, companies should consider peer practices in both their industry and other firms that have recently emerged from bankruptcy, as well as overall cost and equity dilution.

Next Steps

Aon’s competitive market data, backed by governance and technical expertise, can support the design of companies’ compensation programs while in distress, as well as before, during and upon emergence from bankruptcy. Our strong data capabilities provide a market perspective on appropriate compensation levels for executives and other critical employees that can help guide your organization forward.

If you would like to learn more about our services for companies in distress or have questions about this topic, please contact one of the authors or write to rewards-solutions@aon.com

To read more articles on how rewards professionals can respond to the COVID-19 pandemic, please click here.

 


Related Articles