Why current market conditions are driving companies to hedge their deferred compensation plans
Market volatility and equity losses in recent weeks have been unprecedented. As a result, many companies that had previously left their nonqualified deferred compensation (NQDC) plans unhedged are now moving to hedge these plans.* This will allow companies to not only eliminate volatility in compensation expense/operating earnings, but may also give them the opportunity to economically benefit from hedge gains once favorable market conditions return.
A SIMPLE AND INEXPENSIVE WAY TO HEDGE AGAINST VOLATILITY
For NQDC Plans, volatility has created substantial unbudgeted swings in compensation expense:
Executives are allocated to market-based investment options – similar to a 401k plan
Related expenses flow through compensation expense/SG&A/operating earnings
Companies are now moving to hedge these plans using a TRS in order to eliminate unbudgeted surprises to compensation expense/operating earnings
In addition to the volatility, the market decline has also made this an appealing time for companies to start hedging their plans, due to the economic benefit:
When markets go down, the company’s NQDC plan liability goes down – a positive economic impact if the plan is unhedged
Once the TRS is put in place, income from the hedge will offset any additional compensation expense due to fluctuations in the underlying investment options of a NQDC plan
Companies see the possibility of markets declining as much less likely now than just a few weeks ago and so are less concerned about a hedge neutralizing the benefits of a market decline
Lastly, the cost of the TRS is currently very low:
One-month LIBOR was 0.77% as of mid-March (with a 52-week-high of 2.5%)
Long-term financing alternatives are also at historic lows for TRSs
The TRS is also very easy to implement and administer with the support of Atlas's services.
Due to the recent market decline and unprecedented volatility, many companies are moving towards hedging their 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 volatility on the Income Statement. 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.