Currency volatility took a $31.7 billion bite out of the earnings of American and European multinationals in the first quarter of 2015, according to a survey by FiREApps. That’s the highest level in years.
The magnitude of the hit raises questions about how the impact of currency fluctuations should affect compensation of corporate executives. According to Michael Kesner, principal and national leader of Deloitte Consulting Compensation Practice, “the treatment of FX in calculating incentives has become a boardroom topic.”
Kesner lists three approaches companies take to the effects of FX on compensation:
First, there are companies that believe no changes should be made, given that changes to budget assumptions occur all the time, “and it is up to management to adopt and adjust to the new conditions.” According to this school of thought, as the company experiences lower earnings, management should earn less in incentive pay.
Second, there’s a “hold harmless” approach. In this case, companies neutralize the impact of certain unplanned or unbudgeted items that affect profits, including FX. The idea is that those items are largely outside management control. This goes both ways, of course. When the dollar is weak, the effects on performance are also excluded.
Finally, there’s a third approach often referred to as the “corridor approach.” In this case, Kesner said, “the board holds management accountable for a portion of the variation in FX,” Management is not completely insulated from the fluctuations in currency rates. The idea is to encourage management to take prudent steps to protect the company’s results from the impact of FX moves through hedging and sourcing decisions.
As the volatility in the currency markets grows, it’s more likely that boards will adjust compensation plans to reflect the effects of FX moves, “so that there will be a mechanism in place when and if the value of the U.S. dollar sinks against other currencies and the giveback in terms of incentive compensation will flip around,” Kesner said.
For further insights on currency volatility, download the CTC Executive Perspective, Five Ways Treasurers Can Protect Earnings from FX Swings.