Rethinking Performance Awards for Market Uncertainty

Economic uncertainty has a way of exposing the fault lines in equity compensation design—especially when it comes to performance awards.

What seemed like rigorous, well-calibrated goals at the start of a three-year performance period can quickly become unrealistic (or, in some cases, irrelevant) when market conditions shift. As a result, companies may find themselves grappling with awards that no longer serve their intended purpose: motivating executives and aligning pay with performance.

W hat’s the right move when performance awards are tracking below expectations? And how can companies design awards that hold up better in the face of volatility?

Addressing Existing Performance Awards

Let’s start with what can be done for performance awards that are already in progress or nearing the end of their performance period.

The Good News: Expense for Non-Market Awards Is Reversible

Before exploring potential actions, it’s worth noting one positive aspect: companies recognize expense for awards in which vesting is contingent on financial or operational metrics only if the targets are met and the awards vest. If the awards are forfeited due to failure to meet performance conditions, the company does not recognize any expense.

This is a key distinction from underwater stock options, which—once vested—result in expense even if the stock price never recovers and the options expire unexercised.

This accounting treatment can help guide decisions regarding how to handle underperforming performance awards.

Option 1: Wait It Out

Depending on where your company is in its performance cycle, staying the course may be the most prudent approach. This is advice I’ve given previously and it remains relevant in today’s uncertain market environment.

Given investor and media scrutiny around executive compensation, adjusting performance goals prematurely—only to see a market recovery—can create the appearance of opportunistic behavior.

Additionally, multiple adjustments to the same awards can raise red flags. If there is still a year or more remaining in the performance period, it may be best to wait until you have greater visibility into the potential outcome before making changes.

Moreover, if non-market performance awards are expected to pay out below target, the company can reduce the expense it recognizes for the awards while delaying the decision on what to do about the awards (or, if awards aren’t expected to be paid out at all, expense recognition might be reduced to $0).

Option 2: Adjust Performance Targets

Another approach is to revise performance targets to make them more achievable—or eliminate them entirely in favor of service-based vesting (potentially with an extended vesting period to address investor concerns).

From an accounting perspective, this is treated as an improbable-to-probable modification, similar to a vesting acceleration. The company reverses any previously recognized expense for the unvested portion of the original award, and the modified award is treated as a new grant based on its fair value at the time of modification.

However, there are disclosure considerations. If the award holder is a named executive officer (NEO), the modification must be disclosed in the proxy statement. Even for non-NEOs, disclosure may be required under ASC 718 if the modification is deemed significant. This could impact shareholder support for Say-on-Pay votes or future equity plan proposals.

Option 3: Rely on Board Discretion

Some companies choose to wait until the end of the performance period and rely on board discretion to adjust payouts.

The accounting and disclosure implications are similar to modifying performance targets. An advantage of this approach is that the board can make a fully informed decision based on actual results. A downside is that executives may feel disincentivized during the performance period if payouts appear unattainable.

Option 4: Grant New Awards

Issuing new, off-cycle awards is another possibility. However, any new awards granted to NEOs must be disclosed to shareholders, and investors may view these awards skeptically—particularly if they are in addition to standard compensation.

This approach also carries risk: if market conditions improve and both the original and new awards vest, companies may end up overcompensating executives, increasing both expense and share usage.

Adjusting Your Strategy for Future Grants

Beyond addressing current awards, companies may want to rethink their approach to future performance awards to better withstand economic uncertainty.

1. Broader Performance Ranges

Lowering the minimum payout threshold can help ensure some level of payout even when performance falls short of expectations. This can be balanced by raising the maximum payout threshold.

2. Annual Growth Targets

Instead of a single three-year performance period, consider three one-year performance periods, with each year’s target based on growth from the prior year.

3. Shorter Performance Period with a Service Tail

Use a shorter performance period combined with extended service-based vesting (the “tail”). For example, performance may be measured over one year, but full vesting requires three years of service.

4. Relative Performance Metrics

Increasing reliance on targets that are based on how the company performs relative to its peers can be an effective solution for market uncertainty by reducing the need to determine absolute targets. When overall market performance declines, executives can still earn payouts by outperforming peers. To address investor concerns about payouts when absolute performance is negative, payouts can be capped at target.

5. Increased Use of Service-Based Awards

Shifting a greater portion of equity compensation to service-based awards can improve resilience. Extending vesting periods to at least five years can help mitigate investor concerns about time-based awards.

Conclusion

There’s no one-size-fits-all solution for managing performance awards during periods of economic uncertainty. The right approach will depend on your company’s circumstances, the design of your awards, and where you are in the performance cycle.

But one thing is clear: decisions made in the midst of uncertainty—whether to wait, modify, or grant new awards—can have lasting implications for accounting, disclosure, and shareholder perception.

Taking a thoughtful, measured approach—while also reassessing how future awards are structured—can help ensure that your equity programs continue to motivate executives and align with investor expectations, even when the market doesn’t cooperate.