How Material was the Earnings Volatility in Q1 and Q2 2020 from Deferred Compensation Plans?
Nonqualified Deferred Compensation Plans are provided by over 90% of Fortune 1000 companies. While they help attract and retain talent, they can cause earnings volatility. Executives often select from the same menu of investment options offered in the 401(k) plan. As the notional investments that executives select rise or fall, the company’s Compensation Expense is directly impacted.
How Material was the Volatility in the first half of 2020?
The following table illustrates the material volatility in SG&A/Operating Earnings due to a $100 million DCP liability allocated to an S&P 500 Index Fund. In Q1 2020 SG&A was positively impacted by $33.6 million while the following quarter (Q2 2020) SG&A was negatively impacted by $28.3 million – resulting in a total swing over the two quarters of $62 million.
There was also significant volatility in Q4 2018 and Q1 2019 – resulting in a total swing of $38 million over the two quarters. This is precisely why on recent earnings calls many CFOs have had to highlight significant swings in operating expenses due to their deferred compensation plans – and why many companies hedge their plan liabilities.
While hedging with physical assets does not eliminate this volatility, a Total Return Swap Strategy can effectively mitigate the volatility without tying up capital and with a significant tax benefit.