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Article | Executive Pay Matters

You’re acquiring a company, so what do you do with your incentive plans?

Mergers and Acquisitions|Executive Compensation
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By Ken Kuk and Scott Oberstaedt | May 6, 2019

We’re often asked by clients in the midst of a merger how to treat incentive compensation at both the target company and the acquirer. Here’s what experience has taught us.

We’re often asked by clients in the midst of a merger how to treat incentive compensation at both the target company and the acquirer. The solution is usually straightforward for the target: in most cases, outstanding bonus and equity compensation vehicles would be settled at the deal’s close, and plan participants would start with a clean slate at the acquirer. A retention award may be given to critical employees to deter turnover. But for employees at the acquirer, things are not always that simple.

Annual incentive plans in an acquisition year

One of the biggest challenges with acquirers’ incentive compensation is performance scoring when financials of the acquired company gets consolidated. Let’s start with annual incentive. In our experience, the prevailing approach on adjusting incentive compensation in an acquisition year tends to vary based on the timing of the deal’s close.

  • When a deal closes at the beginning of the year, acquired company financials are almost always reflected in the acquirer’s financial goals for the entire year, with any necessary adjustments to back out one-time acquisition-related costs.
  • This treatment is typically reversed for deals that close in the fourth quarter, with acquired company financials excluded from both the goals and the results, as the acquirer’s executives would not have sufficient time to impact the results.
  • For deals that close in the second or third quarter, the treatment of an acquirer’s annual incentive plan tends to vary by deal circumstances and integration strategy. If an acquirer wants to integrate the acquired business into its own operations, it’s more likely to consider the acquired company’s financial performance from the close date to the end of the fiscal year in bonus scoring.

In previous years, many public companies resisted changing bonus plan financial goals midyear, because it reduced or eliminated the tax deductibility of bonus payments to the CEO and other named executive officers. However, the 2017 Tax Cuts and Jobs Act eliminated the performance-based compensation exception under Internal Revenue Code Section 162(m), so there is no longer a need for acquirers to consider any potential impact on tax deductibility when deciding what to do with outstanding bonuses.

Long-term incentive (LTI) plans

LTI plans (performance-based share plans in particular) are less sensitive to deal timing due to multiyear performance periods. Acquirers typically do not adjust financial goals for in-cycle LTI plans, but they may exclude the acquired company’s financials in the performance calculations. Many LTI plans use total shareholder return or stock price to determine payouts, and wouldn’t require any adjustments post-acquisition.

Deal-related incentives

We are often asked about special or onetime incentive pay for the successful execution of a transaction in addition to the treatment of in-cycle incentive plans.

  • For the nonexecutive population, a bonus for successful project completion is typically only given to employees who “wear two hats” during the due diligence and/or integration process for major transactions (e.g., midlevel finance or HR leaders). The value of these awards is not typically significant, and is either granted as a spot bonus or tied to a deal milestone (e.g., deal close).
  • Executives are most often excluded from these project success bonus plans because M&A strategy is considered a core part of their job responsibilities. That said, boards may elect to recognize executives’ achievement for a successful major acquisition through higher annual incentive scoring (e.g., a maximum score on the bonus’s nonfinancial component), or an increase in target compensation/LTI target value over time due to higher revenue and/or company value. Special onetime equity grants or synergy incentives designed to reward cost cuts are reserved for extraordinary circumstances only.

What are you trying to accomplish?

Ultimately, the rule of thumb on compensation decisions during M&A is to maximize alignment with shareholders’ best interests. In our experience, the most effective approach is to focus on what this deal is trying to accomplish and how the two companies will work together going forward rather than looking only at competitive practices. Major acquisitions often disrupt culture and strategy, and a deal’s announcement may create uncertainty in the workforce. The most successful acquirer compensation plans reflect not only the alignment of business outcomes and pay programs, but also the culture and values that the combined organization embodies.

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