Many directors find themselves in an “operational limbo” due to the ambiguous effects of tariffs on compensation programs. On the one hand, the impact of tariffs aligns closely with changes in tax law (e.g., unpredictable, out of Management’s control, frequently adjusted out). On the other hand, shareholders expect management to take greater control of tariff impacts, as they can have meaningful long-term effects on the business (analogous to the COVID-19 macroeconomic changes).
Due to the inherent uncertainty of any proposed or potential tariffs and the speed at which they may be implemented (as seen in the recent push and pull between and within governments), it is more vital than ever that boards and compensation committees consider a working framework for responding to possible tariffs before they are announced. This will help them best serve both management and shareholders.
Two Lenses for Understanding a Tariff’s Impacts on Incentives
Tariffs may significantly impact long-term business planning and goal setting, influencing incentive planning through two distinct lenses.
- Adjustments Made to In-Flight Incentives
Generally, shareholders and investors view tariffs as having an operational impact that businesses are expected to work through. Any programmatic changes will be scrutinized, particularly on long-term programs versus annual programs. Accordingly, adjustments made to in-flight incentives will generally attract stronger shareholder criticism, as there is an expectation that executives should have had the foresight to consider potential business impacts and, in certain cases, hedged or shifted course where necessary. - Goal-setting For New Incentive Awards
Looking forward, it is easier to justify taking tariffs into account in goal setting, utilizing the longer time horizon to avoid the appearance of knee-jerk changes. Still, shareholders may be wary about insulating executives from lower payouts if the direct and indirect business impacts from tariffs can’t be measured precisely. When adjusting goals to account for tarriffs, it is helpful to have appropriate metrics that ensure changes respond to the tariff’s impact instead of compensating for a lack of foresight.
There are nuanced considerations on a company-by-company or industry basis that do not lend themselves to a one-size-fits-all approach, and shareholders will take a critical eye to any adjustments. For example, if tariffs force an organization to make rapid changes to short-term plans, adjusting in-flight incentives might be justified to ensure that everyone is aligned toward new priorities. Similarly, companies may find that long-term goals can still be met through organizational changes without adjusting incentive plans.
Taking Action in the Face of Uncertainty.
Given the level of uncertainty around potential tariffs and their impacts, it can be difficult to identify concrete steps to address them. However, there are a variety of proactive, near-term actions that boards can consider now that will set them up for success in any scenario:
- Discuss the possible scenarios where adjusting incentives may be necessary. No matter what happens in the future, the committee can build consensus about how to plan for future actions when and if tariffs are imposed and outline likely scenarios where tariffs may require a change to incentive plans.
- Size potential adjustments. Following alignment on a framework, estimate the cost of any changes and their resulting impacts under various tariff scenarios outlined above.
- Build flexibility into existing plan language. This ensures appropriate discretion/actions can take place should an adjustment be deemed necessary.
- Conduct a deep dive into the existing incentive plans. Keep an eye on ways incentive plans might be made more durable. This could be by adding emphasis on relative metrics, expanding threshold and maximum goal ranges, or adding an additional operational modifier that allows for subjective year-end assessment (note: this list is non-exhaustive).
In most cases, there is too much uncertainty to build protections into goals today. However, it is critical that boards size the potential business impacts in both the worst and best-case scenarios and then ideate on which situations might warrant an adjustment.
Planning Ahead: A Proactive Framework
We encourage Boards to put in place/agree to the following framework when assessing whether potential adjustments to in-flight plans should be made and what the correct course of action would be:
In most cases, shareholders will react negatively to adjustments made to in-flight incentives, and in any event, boards could consider that choosing not to adjust anything may ensure lessons from the goal-setting process are incorporated into future grants.
One Size Does Not Fit All: Three Case Studies
The following hypothetical scenarios illustrate how the above framework can be implemented to best respond to tariffs.
In each sample case, the estimated size of impacts and the designs of existing programs were primary considerations in determining whether the board considered remediation tactics. Directors’ fiduciary duty requires them to use selective and appropriate judgment when considering adjustments or actions regarding executive compensation, even if financial performance is lumpy.
Conclusion for Navigating Tariffs
The general expectation for most companies is to adjust operations and not accounting, but boards will be expected to run through the appropriate thinking when considering making changes to in-flight incentives and goal-setting on upcoming awards, particularly in the long-term plan. The thinking on the above framework may shift as the policy landscape evolves, and compensation approaches may be re-evaluated consistently with the principles outlined above. In any case, proper disclosure will be critical when communicating the rationale for any changes to stakeholders going forward.
