While the impact of the COVID-19 pandemic has varied across industries, most companies have had their performance impacted in one way or another. With respect to compensation programs, the fundamental balance of maintaining employee motivation and engagement while dealing with the fallout, economic disruption, and — in some cases — newfound cash and liquidity concerns are universal. The response, however, may differ significantly by company and across industries.

Our Viewpoint series has addressed many of the executive compensation considerations associated with COVID-19. The focus of this Viewpoint is on companies in the pre- and early-commercial biotech and pharmaceutical (“pre-commercial biopharma”) space as well as how these companies are dealing with the pandemic and its impact on compensation programs.

The pre-commercial biopharma business model operates with its own unique compensation and governance practices driven by two fundamental differences from other businesses:

1. Valuation based on product pipeline, clinical progress, and future expectations of scientific success more so than financial performance.

2. An inherent reliance on external financing to maintain sufficient cash flow for operations.

For example, a recent Glass Lewis paper [i] suggests that 40% of biopharmas utilize an annual incentive design categorized as non-formulaic, compared to just 7% across the full sample of small- to mid-cap companies Glass Lewis reviewed. We find that pre-commercial biopharmas’ incentive designs tend to differ from broader industry practices in the following ways:

• Heaviest weighting given to strategic milestone measures vs. financials
• Financial metrics focused on the balance sheet versus the income statement
• External fund raising as an ongoing corporate objective
• Increased use of human resources and talent attraction/retention as core metrics
• Less reliance on strictly formulaic results driven by an explicit pay/performance scale
• Greater emphasis on qualitative evaluations of performance achievement to determine bonus payouts.

What We Have Seen Year-to-Date in the Biopharma Industry

The biopharma industry overall has outperformed others through the pandemic’s economic disruption, resulting in fewer observed compensation cost-cutting actions. There is, however, bifurcation among biopharma companies: some have performed quite well year-to-date, while performance has slowed for others.

Those that may have recently closed an updated round of external funding have not experienced a slowdown in their clinical trials, or were able to shift to telemedecine appointments for patient follow-up are still operating largely business-as-usual, having been able to weather the storm to some extent. Further, a select few companies were able to shift focus directly to COVID-related therapies and have seen significant shareholder value creation and/or increased hiring plans.

Compensation Impact for the Balance of 2020 Remains Uncertain

As companies in all industries consider the fact that many of their 2020 performance objectives have little chance of achievement, questions are surfacing about the possibility of resetting performance goals or replacement bonus plans, using discretion in determining payouts or adjusting performance, and/or focusing more on non-financial metrics in the absence of threshold levels of financial performance. For pre-commercial biopharmas, in an environment where cash bonus payouts are not funded by financial performance, it can be informative to assess the expected impact of COVID on common categories of incentive plan performance metrics.

Other potential considerations and compensation program implications include:

Increased Merger and Acquisition Potential

• It might be an opportune time to review current employment agreements as well as company-wide severance and change-control policies to ensure post-termination benefits are competitive and consistent with current governance norms

Continued Stock Market Volatility

• An additional layer of caution with respect to equity awards and the impact of changing stock prices might be warranted; for example, equity awards calibrated based on desired value delivery could put pressure on equity pools without adjustment
• Further, companies considering a shift away from an all-options approach might accelerate their thinking in order to deliver a small portion of equity as full-value shares

Increased Need to Conserve Cash

• While being mindful of dilution and share usage concerns, consider the potential to deliver equity in lieu of cash — e.g., bonuses delivered in restricted shares.

Year-End Considerations

As we approach mid-year, those that adopted a wait-and-see approach and delayed setting 2020 goals may now be in a better position to decide where to focus the team. Others have started to discuss frameworks for 2020 performance and bonus determinations.

Come year-end, during Compensation Committee review of annual performance vs. objectives in determining bonus payouts, we expect robust discussion around the key principle of rewarding for performance results within management’s control. The scorecard approach used by many pre-commercial biopharmas for bonus payouts should help mitigate the potential for a down year in any one area to result in overall zero bonuses. Any adjustments to performance or discretionary judgments on the level of performance achievement should be considered carefully.

To the extent the discussion turns to it, areas that could support the application of discretion to adjust performance/payouts could be:

• Broader resiliency of operations including continuity of the supply chain, ability to ensure production of trial doses, etc.
• Management’s ability to adapt — e.g., adoption of tele-health / virtual follow-ups for clinical trials and prioritization of trials that can be completed over others
• Understanding the root cause of delays in deciding whether to relax any time-based performance objectives
• Prudent cash management — e.g., making the difficult decision to stop or delay trial starts if appropriate
• Any shift to COVID-related operations that have repositioned the company favorably in the short- and longer-term
• Long-term vs. short-term decisions — e.g., where objectives/strategy shifted, did Management favor long-term strategy at the expense of short-term performance objectives?
• Relative performance in comparison to direct peers

Of course, any such discussions should incorporate the broader context of the overarching economic and societal impact that the pandemic has had on all company stakeholders.

General questions about this Viewpoint can be directed to Brian Lane at brian.lane@paygovernance.com or Blaine Martin at blaine.martin@paygovernance.com.

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‍[i] Brianna Castro et al.“2020 Meeting Notes, Under the Microscope, Talking with Biopharma Companies About Their Unique Governance and Compensation Challenges.” Glass Lewis. 2020.

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