CFOs Forced to Highlight Volatility from Deferred Comp in Earnings Calls Last Quarter
The market volatility this year has been unprecedented. From mid-February to mid-March, the S&P 500 was down 34%. It then rose from mid-March through mid-September by more than 50%. This volatility has caused significant earnings issues for many companies with Nonqualified Deferred Compensation Plans. On recent earnings calls, CFOs throughout the Fortune 1000 have had to highlight significant earnings volatility caused by these plans. A CFO of a Fortune 200 healthcare company noted that “higher deferred compensation expense due to strong stock market performance in the quarter also negatively impacted operating margin.” A CFO of a Fortune 1000 financial services company noted “deferred compensation expenses that were up quite materially in the quarter”.
Historically, companies have hedged the market volatility from their plans by purchasing physical assets. If an executive allocated $1 million to a mutual fund, the company would purchase $1 million of that fund. The issue is, while the plan expenses are recorded in Compensation Expense, the earnings from the assets hedging the plan are typically recorded in Other Income. This strategy therefore does not solve the issue raised in the earnings calls – and as it turns out, both companies mentioned above are hedging with physical assets.
This strategy also ties up capital and mutual funds are taxed currently. Fortunately, there is a solution to all these issues – one that provides optimal accounting treatment, is tax-efficient and relatively inexpensive, and is used by many large companies in the marketplace today. The solution involves utilizing a Total Return Swap (TRS).
Due to the recent market volatility, hedging deferred compensation plans has become front-of-mind for CFOs and their teams. Companies may wish to consider utilizing a Total Return Swap solution to optimally mitigate this market risk. Atlas assists many companies throughout the Fortune 500 in managing this strategy.