As we start a new year and begin to move into better economic times, it’s an important time for companies to re-engage employees in the employee value proposition (EVP). For some organizations, the EVP may have changed. Towers Watson’s recent Communication ROI Study clearly shows a distinct difference in financial performance when employees understand a company’s business goals, the steps that must be taken to reach those goals and rewards, and benefits they receive.
The Communication ROI Study also shows that companies who actively communicate the EVP, leadership changes or changes to benefits are more likely to see their employees engaged, focused and productive, even in uncertain times.
“The question becomes how to communicate effectively to a multicultural, multigenerational audience,” says Rosalind Watson, a communication consultant for Towers Watson. “And for many companies, it’s often a question of how to communicate more effectively with less resources.”
Smart Business spoke with Watson about the value of innovative communication and how executives can measure the return on investment of effective communication.
How does effective communication impact financial returns?
Companies that are highly effective communicators have the courage to discuss changes to their EVP and the discipline to communicate continuously with employees so that they understand the changes and can link them to the attainment of the company’s business goals. Companies that communicate effectively have posted a 47 percent higher total return to shareholders over the last five years than their less-effective counterparts.
In comparing the returns of 328 companies over five years, a $100 investment made in 2004 in a company with a highly effective communications program is now worth $130, whereas that same investment in a company with a less-effective communications program is valued at $83.
What’s the best way to communicate change?
Each company should tailor its media selection toward the specific message, the employee population and the culture. Top communicating companies often explain major changes through face-to-face meetings with trained managers, where employees can ask questions in an informal setting. Town-hall meetings give the CEO the opportunity to deliver a personal message, reinforcing the reasons behind the change. Personal involvement is crucial, because it allows the CEO to step down from the balcony and shorten the distance between himself and the employees at a critical time.
Electronic communication is starting to replace traditional paper communication, and highly effective communicators have embraced social media, often pre-testing their media selection and their message with an internal advisory group to see if the communication will be well-received.
What are some examples of innovative media?
Because media preferences vary by country or employee group, many employers use a variety of sources to deliver the same message.
- Wikis: A wiki page on the corporate intranet site provides a one-stop resource for information and is useful for explaining defined terms and knowledge management.
- Blogs and chats: Ghost bloggers can assist executives with daily posts and HR leaders can host online chat sessions about compensation and benefit changes.
- Town halls: Small group sessions allow executives to communicate directly with employees in an intimate setting and answer employees’ questions. Remote employees can attend via webcast and participate by e-mailing their questions during the session. The meeting can be recorded and uploaded onto the company’s intranet, so employees can view the session at their leisure.
- Webcasts: These can be used to deliver information about benefit changes, via a PowerPoint presentation delivered over the Web. Executives can host the meeting or provide the voiceover for the presentation.
- Interactive PDFs: Create an interactive PDF to help employees understand the changes, including links to videos, Web sites and important documents.
What is the investment rationale in social media?
Although many employers cite a lack of funding as a reason for not embracing social media, electronic communication is often more cost-effective than distributing printed materials and the duties can be handled by a few trained staff members. Communication is often viewed as a soft cost that is expendable during a downturn, but driving engagement and higher productivity levels is vital when there are fewer people to do the work. Helping employees to understand the rationale behind difficult decisions and provide feedback enables everyone to move forward together.
What’s the best way to measure the ROI from communication?
Employers can measure clicks and views to see which media sources are generating the greatest employee interest; surveys and focus groups can determine whether employees are embracing the message. Top-performing companies develop a documented communications strategy and assess its effectiveness by benchmarking key measurements, sometimes against other companies.
Although the ultimate litmus test of a company’s ability to engage its employees is its financial performance, many companies track return on sales or top-line growth during a specific campaign to measure ROI. Communication functions need to be held accountable for results just like other departments, because in business, what gets measured gets done, acknowledged and rewarded, and communicating effectively now helps companies to steer their way through to better times.
Relationships between employees and employers often morph with the changing economy. But the current conditions, including record productivity levels, a jobless recovery and the possibility of health insurance reform, are driving one of the most dramatic shifts since World War II. Savvy employers are seizing the opportunity to permanently lower labor costs by restructuring benefit and compensation plans and even shifting the burden of sourcing health care coverage onto employees.
“I believe we have seen the end of one-size-fits-all benefit plans,” says Rick Beal, managing consultant with Watson Wyatt Worldwide. “Executives may encounter some internal resistance to these nontraditional ideas, but employers will ultimately opt for a less paternalistic role by offering two-tier benefit programs or simply requiring employees to find their own health coverage.”
Smart Business spoke with Beal about the emerging changes to employment relationships and how employers can benefit from the “new normal” economy.
How have employment relationships evolved over time?
In a manufacturing economy, employers managed to maintain a stable work force by offering generous benefit packages that often included defined benefit pension plans and the promise of long-term employment. As the highly educated and less-structured baby boomers entered the labor market, relationships began to morph. Technology-driven productivity increases drove an emerging economy centered on global services and workers assumed greater responsibility for managing their own careers. During the 1990s, employees held the upper hand in the labor market and employers focused on winning the talent war by creating and branding distinct employment value propositions.
How is the ‘new normal’ economy impacting employment relationships?
As labor costs escalated, traditional management models dominant in industries such as auto manufacturing have all but disappeared. While employers will always need to compete for top performers and scarce knowledge workers, the balance of power has shifted toward employers as recessionary layoffs have cut deep. This has created an abundance of workers, especially among lesser-skilled populations, and this shift in supply and demand is redefining the relationship between employees and employers.
What changes are employers considering?
Employers will continue to offer competitive base salaries, but they’ll offer smaller annual raises while relying more on incentives like full value restricted stock units or stock grants. The stock will feature lengthy holding requirements, especially for senior executives.
Most surprisingly, some employers may limit access to company-sponsored health plans to critical knowledge workers. Other companies may establish steep healthy behavior requirement hurdles before employees can participate in company-sponsored benefit plans or limit health care coverage to consumer-driven health plans with health savings accounts.
Health care and retirement plans will be increasingly portable, like current 401(k) plans, as employers provide employees with the tools and technology to manage their own financial and physical health. In short, the days of uniform benefit offerings are likely over.
What upsides and downsides might result from these changes?
Employers generally stand to benefit from these changes, but each company has to consider its current and future work force and its employment value proposition before initiating wholesale modifications to compensation and benefit plans.
- Cost management. Employers will be able to reduce the cost of benefits administration and will benefit from predictable health care and retirement costs. Unless the next wave of technological change can increase productivity, cost control will play a dominant role in driving bottom line returns for the near future.
- Empowerment as an employment brand. Employers will compete for talent by branding themselves as enablers of employee empowerment. Independent workers attracted to increased freedom and self-determination will be highly engaged and more productive.
- Less control. Employers offering portable benefit plans will have less control over the timing of employee work force exits, which could negatively impact industries facing shortages of skilled workers.
How should executives proceed?
Employers need to set plans in motion before the recovery gains momentum.
- Conduct a strategic review of total rewards programs to see if they still make sense for your company’s future work force.
- Consider segments of the current work force where a new approach might be appropriate, such as part-time employees in the retail or service industries.
- Ask employees to weigh in during the review process so expenditures are targeted toward the benefit programs employees value most. Employees can make prudent choices if they are presented with the facts, and some groups might actually prefer making their own health plan arrangements, especially if it increases job security.
- Challenge the HR paradigms that impede progress. Owners may face resistance from benefits managers or company lawyers over revolutionary ideas like creating a two-tier benefits structure. Seek external opinions or hire a benefits manager from outside the HR field to stimulate nontraditional thinking.
Rick Beal is the managing consultant for Watson Wyatt Worldwide. Reach him at (415) 733-4310 or Rick.Beal@WatsonWyatt.com. At the time this article went to press, Towers Perrin and Watson Wyatt have announced their intent to merge and become Towers Watson. The merger is anticipated to close around the New Year.
As pension plan administrators wrestled with the new funding mandates and the mark-to-market requirements imposed by the Pension Protection Act (PPA), the bottom dropped out of the financial markets, pummeling asset returns. As a result, many employers froze existing plans and adjusted asset allocations on the fly.
Now that officials have granted employers a brief reprieve from PPA funding mandates and the financial markets have rebounded from their 2008 lows, embattled plan administrators have a brief window of opportunity to revisit the fundamentals and craft a comprehensive pension strategy that reduces volatility and risk and increases asset levels to meet future funding targets.
“Although the calamity has abated to some degree, the risk of market volatility persists, the government has not backed away from its original funding targets and current investment strategies may not be appropriate for a post-PPA world,” says Pete Neuwirth, senior consultant for the retirement practice at Watson Wyatt Worldwide. “Employers should use this time to prepare for future crises.”
Smart Business spoke to Neuwirth about the challenges facing employers offering defined benefit pension plans and the elements they should revisit during this brief respite.
How can employers mitigate escalating pension costs?
Many employers have opted to pay the least amount possible into their plans, without considering how those decisions might impact required contributions down the road. This strategy may ease short-term cash flow, but even companies with currently well funded or frozen plans need to manage their risks. If assets are currently sufficient, plan liabilities will still likely grow faster than assets as future benefits accrue, and even for frozen plans, the value of accrued benefits will continue to grow as employees near retirement. Since the ultimate cost of a pension plan is the cost of benefits paid minus investment income and contributions, the best ways to mitigate increasing costs are through plan redesign and improved asset performance. Employers should use this breathing space to reassess their liabilities and asset allocations to reduce income volatility and control costs.
How has PPA impacted funding policies?
PPA drives employers toward 100 percent funding for pension liabilities and most have been well below that target. This means that many employers will have to pay normal costs plus a seven-year amortization payment on any unfunded liability. Additionally, PPA curtails an employer’s ability to pay more in good years and draw against those credit balances in bad times. When reviewing existing funding policies, employers need to know their funding target date and be cognizant of credit balances, so they can make informed decisions on whether and when to use or give them up. On the positive side, PPA gives employers some limited flexibility to use spot market rates or 24 month average rates in their funding assumptions, but those decisions need to be calibrated with the company’s investment strategy, because each option has advantages and disadvantages and one solution will not fit all.
Should employers review plan design?
Roughly one-third of the Fortune 1,000 offering defined benefit pension plans have now frozen those plans. Others have changed to a hybrid model, and 55 percent of the Fortune 100 now put new hires into a defined contribution plan. Employers need to reassess these decisions to see if this is the right strategy going forward, especially now that assets have rebounded. A recent Watson Wyatt survey reveals that traditional pension plans are highly valued by employees, so employers must consider the impact of changes on other HR objectives as well as the financial risks associated with interest rates, asset returns, longevity and inflation. If an employer is committed to a defined plan, sharing the risk with employees through a lump sum option, cash balance or a hybrid plan or moving the benefit calculation from a final average to a career average can help to mitigate the risks.
How can employers manage the volatility in asset returns?
Many employers were caught off guard by the quick drop in the market and were then reluctant to sell devalued equities for fear of missing the rebound. Given the improvement in equities, now may be a good time to revisit your company’s risk position in light of future funding requirements. Traditionally, many administrators favored high-risk positions offering higher long-term returns. Those positions no longer make as much sense because under PPA the risk is asymmetrical, meaning that the possible downside from high-risk investments exceeds the possible upside. In a recent survey conducted among 80 financial executives, two-thirds have made or are planning to make policy changes in 2009 and 2010 to asset allocations, while more than half have already made changes or are planning to make changes to investment lineups.
How has PPA impacted the assumptions and methods for calculating pension expense?
Key assumptions such as the discount rate, salary scale and long-term rate of return can impact the pension expenses reflected on a company’s financial statements, so it’s important to forecast cash and expense using a range of assumptions. For example, simply changing asset allocations from equities to a more conservative mix of bonds may cause auditors to reduce the expected rate of return in the assumptions. Since this can have a broad impact on company finances, including the interest rate paid on borrowed funds, it’s important to consider how an investment strategy integrates with funding and accounting strategy. Despite an anticipated adjustment in the accounting rules, for now, a holistic management strategy remains the best way to avoid the impact of the next crisis.
Pete Neuwirth is a senior consultant for the retirement practice at Watson Wyatt Worldwide. Reach him at (415) 733-4139 or Peter.Neuwirth@watsonwyatt.com.
Many employers have undertaken dramatic cost reductions since the start of the recession. But in the process, they may have inadvertently created consequences that will linger well into the recovery period.
In the minds of many employees, reductions in staff and total rewards packages have breached the promises of their employers. The result has been a nearly 10 percent drop in employee engagement levels since last year and, among top performers, a precipitous decline of 23 percent, according to a recent survey by Watson Wyatt Worldwide. To prevent diminished productivity and high turnover, employers must take immediate steps to re-engage top performers by reinventing their employee value proposition (EVP).
“Employees place a great deal of emphasis on employer promises, whether those assurances are explicit or implied,” says Laurie Bienstock, U.S. practice director for strategic rewards at Watson Wyatt Worldwide. “Unfortunately, a diminished EVP is a blind spot for many employers, because they fail to recognize the gap between what’s promised and delivered and the EVP’s role in motivating employees.”
Smart Business spoke with Bienstock about the impact of cost reductions on employee engagement and the steps employers should take to eschew the fallout.
What is an EVP and why is it significant?
An EVP is the total value an employee receives for working for a company and it influences his or her decision to join or stay with an organization. It is composed of tangible remuneration like salary and benefits as well as intangible rewards like a positive work environment, job security, promotional opportunities, and training and development programs. Some employers strategically design their EVP, so it attracts the right candidates and delivers maximum return, while in other companies, the EVP may have evolved over time. Although employers often view an EVP as an informal agreement, 74 percent of employees consider it to be a formal pledge according to our survey, so when their deal changes, it alters an employee’s commitment.
What’s been the impact from cost reductions?
According to Watson Wyatt’s ‘2009/2010 Strategic Rewards Report,’ which surveyed 1,300 employees, there was a 26 percent decline in satisfaction with advancement opportunities and a 14 percent decline in likelihood that they would remain with their current employer, while the number who would recommend others take jobs at their company has declined by nearly 20 percent. Top performers are particularly frustrated by their inability to deliver quality work or adequate customer service due to staff reductions, and many say these conditions are impeding their company’s ability to recover from the recession. In fact, 36 percent say their employer’s situation has worsened in the past 12 months.
Another byproduct of widespread layoffs is a 15 percent increase in employee discrimination claims (based on claims data filed with the EEOC in 2008). And the recently passed Lilly Ledbetter Fair Pay Act places an additional burden on employers to ensure evidence/records of methodology for compensation administration and decisions (both in the past and future) as well as to review past compensation decisions.
Was the impact similar for all employers?
Financially high-performing organizations took the fewest actions in response to the downturn, mostly freezing programs as a preemptive measure and reducing fewer core components of total rewards such as salary, benefits or bonuses, and high-performing organizations averaged staff reductions of just 7 percent. Lower-performing organizations were forced to make deeper cuts in staff, averaging 9 percent, and total rewards, and they were less effective at using performance data to conduct layoffs. As a result, firms entering the recession in a stronger financial position are likely to emerge in better shape aided by a largely intact staff that is more highly engaged and productive.
How can employers reverse the trend?
Employers need to redefine their EVP and restore pay and benefits packages and rehire employees where appropriate as soon as business conditions allow. Bonus plans and performance metrics need to be aligned with current business goals to make sure they motivate employees. Permanent head count reductions or industry changes need to be considered, as they may render previous performance expectations unachievable. Closure of an on-site child day care center or elimination of telecommuting opportunities requires employers to reassess their tangible and intangible benefits in rebuilding their EVP so they aren’t making promises to employees they can’t keep. Focus expenditures on benefits that are most relevant to employees so your EVP delivers the maximum impact.
How does EVP redesign relate to changes employers may be making in response to the Lilly Ledbetter Act?
The actions needed to redesign your company’s EVP and set a foundation for compliance with the underlying laws affected by the Lilly Ledbetter Fair Pay Act (e.g. Civil Rights Act, ADA) are similar. Employers can respond to the legislation by using a systematic and documented approach to govern pay plans, assign job classifications and titles and to assess and document employee performance, especially for promotions. While a systematic approach to pay does not ensure pay discrimination will not occur, it provides a foundation for analysis, review and audit. Clearly outlining and governing an approach to defining jobs and setting and administering pay not only will assist managers in hiring and retaining employees but also engenders employee engagement through increased understanding of pay and career opportunities.
Laurie Bienstock is the U.S. practice director for strategic rewards at Watson Wyatt Worldwide. Reach her at (415) 733-4311 or Laurie.Bienstock@watsonwyatt.com.
Employers surveyed by Watson Wyatt Worldwide acknowledge that maintaining the status quo in the health care system isn’t a viable option. On the other hand, they express concerns that reform might create more problems than it solves. They fear new legislation may threaten existing group plans, increase an employer’s costs and counteract emerging gains in cost management.
To understand the proposed legislation and calculate its true impact, employers should get the facts and convey their concerns to legislators before a bill is finalized.
“Any plan to reform health care must address the issue of supply and demand and individual accountability to be viable and sustainable,” says Caty Furco, FSA, MAAA, office practice leader for group and health care at Watson Wyatt Worldwide. “The introduction of a play-or-pay system or the weakening of ERISA pre-emption may actually drive up costs by threatening existing employer programs.”
Smart Business spoke with Furco about the potential impact of health care reform on businesses.
Which reform elements are endorsed by employers?
In July, Watson Wyatt held round-table discussions with 95 large U.S. employers, which employ more than 400,000 workers and provide health care coverage to more than 970,000 individuals at an annual cost of $7.3 billion. Similar sessions were held in the Bay Area and local employers have echoed the sentiments of employers nationwide. In general, employers agree that we need health care reform, but how those changes are delivered and paid for is a major concern. The areas of consensus include the need for quality health care at a reasonable cost along with the need to reduce the ranks of the uninsured, the cost of which has been passed along to employers offering group plans. Improving efficiencies in our health care system, such as those achieved through the automation of health care records, and maintaining ERISA pre-emption were also endorsed by employers.
How might reform threaten employer-sponsored health plans?
Unless ERISA pre-emption is maintained, employers with multistate operations could be forced to comply with a multitude of local insurance laws, escalating the administrative burden for geographically dispersed employers. And the introduction of a play-or-pay mandate will specify a minimum benefit level. A ‘one-size fits all’ minimum benefit package could result in employers paying more, as currently many employers tailor their benefits to meet the specific needs of their own population.
What are the unintended consequences of reform?
Employers fear that reform will create a two-tiered insurance system, forcing them to offer a lower-cost government option to lower-paid workers, or perhaps leaving them with a high-cost population of insured workers if lower-paid workers are allowed to opt out of group coverage in favor of the government option. If the government option contains coverage limitations, competition could force employers to offer workers additional benefits to supplement the minimum mandates. Legislation needs to take into account today’s mobile work force — where an employee moves geographically but stays with the same employer. Reform could add layers of complexity and bureaucracy that drive up costs. And small business subsidies could yield an unfair advantage while shielding them from the true cost of health care.
Employers have been using claims and employee demographic data to customize employee wellness programs and create initiatives that encourage the proactive management of chronic conditions. When employee education programs are combined with high deductible plans, health savings accounts and other incentives, they are showing real results. Employers expressed apprehension about a government option undermining their progress in controlling costs if they end up without access to data or the autonomy to encourage personal responsibility and positive employee behaviors.
How can costs be controlled?
Three things must be included in any health care reform plan to control costs.
- Cost transparency. Patients are currently shielded from detailed cost estimates before consenting to a procedure. Consequently, no one really knows or understands why the cost of a knee replacement in the U.S. is $98,000. To create wise consumers, patients must know the costs and consider alternative treatments before making a decision. Greater cost transparency will not only invite scrutiny, it will encourage competition.
- Consumer education and responsibility. Consumers need to know the risks and outcome history for a particular treatment and provider to make prudent decisions. Complexity determines the price for a procedure, so consumers need to question whether a high-cost procedure is really necessary.
- Reduction in worker shortages. Unless reform addresses the supply side of health care by increasing the number of front-line, cost-effective health care professionals, such as physician assistants, nurses and primary care physicians, costs will continue to escalate.
How can executives help?
Legislators are currently seeking input, so executives must understand the details and the consequences of each proposal, then voice their concerns and recommendations. The bills are lengthy; executives may review a summary of the proposals at www.watsonwyatt.com/topics, under Controlling Health Care Costs, or by contacting their Congressional representative.
Caty Furco, FSA, MAAA, is the office practice leader for group and health care at Watson Wyatt Worldwide. Reach her at (415) 733-4309 or email@example.com.
It’s hard to hit a moving target. So when faced with the convergence of a volatile economy, new government legislation on executive pay and the growing momentum behind say-on-pay initiatives, many companies adopted a wait-and-see approach when constructing 2009 executive short-term incentive plans, opting for scaled-down or discretionary incentives until the dust settles.
Despite the complexities of developing realistic performance objectives and payout opportunities, as well as navigating a multitude of legislative changes under the watchful eye of investors, companies need to maintain the motivational and retentive qualities of their incentive plans. Compensation committees and executive management are being challenged to develop short-term incentive plans that are fundamentally sound, do not promote excessive risk-taking and can withstand increased scrutiny from the SEC and shareholders.
“Based on the fallout from the stock option backdating scandals, we learned that duck-and-cover is not a viable strategy for resolving executive compensation issues,” says Jason Taylor, senior compensation consultant for Watson Wyatt Worldwide. “Failure to act may result in the withholding of board member votes and negative press to financial settlements.”
Smart Business spoke with Taylor about the best ways to redesign and document executive short-term incentive plans in the current environment.
What’s influencing the trend in executive short-term incentive design?
Bonuses paid to executives in financial firms receiving government funds (TARP participants) exacerbated the already growing shareholder sentiment that executive pay is not appropriately calibrated to company results and needs greater oversight. So now the legislation originally created for TARP recipients may lead to broader intervention in all companies, including a stated review of the relationship between incentive pay and excessive risk taking and clawbacks of bonuses or incentives that were awarded to executives based upon materially inaccurate financial statements. This trend will likely influence pay actions in privately held companies as well, as stakeholders will want to ensure their short-term incentive plans meet corporate governance practices.
Additionally, as a result of enhanced disclosure requirements and the introduction of say-on-pay legislation, shareholders and investors have more access to compensation data, and are being more vocal with their opinions. Further, the SEC continues to review proxy statements to determine whether they contain sufficient rationale, background and information in describing the incentive plan design process, which requires the compensation committee’s validation and confirmation.
How can companies strengthen their incentive plan design process?
The overall theme is to apply more analytical rigor to the process. While citing the practices of industry peers is a good start, compensation committee members and executive management need to take their documentation and testing process to the next level by demonstrating why the plan mechanics and payout opportunities are appropriate for the company’s unique situation. We often find that, in many cases, there is historically little correlation between the metrics used to calculate executive short-term incentives and year-over-year shareholder return. Further, companies often fail to analyze the probability of performance achievement, which can result in sandbagging or windfall bonuses and no-confidence votes from shareholders.
The analytical process should include, at minimum, determining which metrics support the company’s short- and long-term strategic and financial objectives, analyzing the correlation between changes in shareholder value and various combinations of performance metrics, as well as reviewing incentive opportunities in relation to set performance levels. Additionally, incentive structure and mechanics should be analyzed to determine to what extent, if any, the plan promotes excessive risk taking. Last, document the process and findings in order to meet disclosure requirements and justify the appropriateness of the plan design.
What are the best incentive design work steps to follow?
- Continue to benchmark against peer companies and credible compensation survey data with comparable jobs. Avoid small sample sizes in both peer company and survey data, as well as any statistical summaries that have low confidence levels.
- Consider incentive opportunities within the context of executives’ total compensation package, not on an element-by-element basis.
- Evaluate incentive plan components independently to assure they incent appropriate behaviors and outcomes that have strong relation to improved shareholder returns.
- Use performance thresholds and bonus caps to avoid unintended consequences.
- Most importantly, calibrate incentive levels to appropriate performance. For example, 75th percentile pay opportunity should require 75th percentile, or above, performance.
What is the best way to set realistic year-over-year performance goals in a turbulent environment?
If projecting next year’s goals is too challenging, consider linking incentives to operational or qualitative improvements that historically have a strong relation to financial performance. Consider shorter-term incentives (e.g., quarterly, semi-annually) for hitting interim benchmarks, with overall year-end adjustments based on annual performance. Although discretionary plans are always an alternative, these plans may have a hard time passing muster with investors and the SEC in the current climate. Additionally, they can lead to management ‘gaming’ and/or entitlement issues, which makes conversion back to a true pay-for-performance incentive plan extremely painful for everyone.
Jason Taylor is a senior compensation consultant for Watson Wyatt Worldwide. Reach him at Jason.Taylor@watsonwyatt.com or (415) 733-4125.
It’s not the typical tax liabilities that can hurt you after an acquisition — it’s the hidden ones. Executives often inherit tax liabilities because unpaid federal, state, local and foreign taxes follow the acquired company, and those liabilities do not go away just because the company has new shareholders or owners. Also, many buyers have a false sense of security because they obtain representations, warranties and indemnifications for tax-related liabilities during the acquisition. But potential liabilities covered by a warranty should still be identified, as the best security involves setting aside funds in an escrow account to cover potential tax debts.
The only way to expose hidden tax liabilities is by conducting a thorough due diligence.
“In these tough economic times, staff reductions can hit tax departments hard, so acquirers don’t always have the resources to conduct due diligence,” says Gary Curtis, corporate tax partner with Haskell & White LLP. “In some cases, companies haven’t been examined for years, yet they remain subject to audit at any time. Given today’s budget deficits, taxing authorities are stepping up examinations in search of additional revenues.”
Smart Business asked Curtis about the problems of hidden tax liabilities and how due diligence can help.
What situations contribute to hidden tax liabilities?
Many middle-market companies do not have large internal tax staffs, yet those companies are dealing with multistate and multinational operations, which frequently results in overlooked tax issues. Public companies have been subject to financial reporting standards requiring them to inventory their uncertain tax positions and disclose potential liabilities. But private companies have been granted an extension to that requirement through 2009; so the chances of encountering an unrecognized tax liability increase when acquiring a private company. Also, if you acquire a company that was part of an affiliated group, which has been filing a consolidated income tax return, the acquired company remains liable for the group’s prior taxes after its acquisition.
Which state and local taxes are often overlooked?
Employing out-of-state personnel may result in hidden income tax liabilities. For example, if a sales representative is soliciting business in another state and the product used to fill the orders is warehoused outside the state, under federal law the company isn’t required to file a state income tax return. If that salesperson performs other duties, such as warranty and repair work or issuing sales credits to customers, then the federal law does not apply and the company must file a state tax return. If separate state returns have not been filed, the liability for unpaid taxes, penalties and interest can mount up quickly. Frequently, companies are able to negotiate a reduction in this liability, but they must initiate the discussion prior to an examination and there are still the professional fees of negotiating, correcting and filing the returns to consider. It’s also possible that sales and use tax as well as franchise returns may be required, even when state income tax returns are not.
Which foreign tax liabilities are frequently overlooked?
When companies price and sell goods in another country, how the transfer pricing is established can result in significant U.S. or foreign tax liabilities. It should be a red flag to buyers if a company has not conducted a recent transfer pricing study by a credentialed professional. Another problem is failing to withhold tax on interest or dividends paid to foreign companies that are not exempted by tax treaties. Sometimes the company may not have filed the required federal informational returns with respect to its foreign affiliates and the penalties for failing to file these returns can be up to $10,000 per failure. The IRS has announced that it intends to crack down on this problem during 2009, so buyers should be aware of the potential liability.
What steps should executives take to avoid financial surprises from hidden tax liabilities?
- Conduct tax, financial and business
due diligence concurrently and budget for
those costs when considering the total
- If significant tax exposures are uncovered, consider converting to an all asset
deal or reducing the purchase price.
- Require the seller to deposit funds into
an escrow account covering any potential
liability revealed during due diligence.
Funds should only be released when the
statute of limitations expires or when the
tax issues are resolved.
- If you are unable to implement any of these solutions, consider passing on the deal.
Remember that due diligence doesn’t just uncover hidden tax liabilities. It can identify and quantify tax assets, such as net operating loss carryforwards, that can be used to offset post-acquisition taxable income, and it can also identify unclaimed refunds. Conducting tax due diligence often pays for itself.
GARY CURTIS is a corporate tax partner with Haskell & White LLP. Reach him at (949) 450-6311 or firstname.lastname@example.org.
Having enough staff to handle unpredictable workloads has always been a management challenge, especially in customer-facing departments like call centers or hospitals, where managers must deal with a high volume of incoming calls or constantly shifting patient censuses. In addition, employee absences allowed under the Family and Medical Leave Act (FMLA) make difficult scheduling tasks almost impossible. The result is often increased overtime pay or expenditures for nursing registry temps as managers scramble to close unanticipated staffing gaps. Changes in FMLA regulations effective Jan. 16 may allow employers a greater ability to manage FML absences.
“One of the challenges has been that employees can take FML absences without calling in advance of the absence and are able to use the time in small increments,” says Janice Dragotta, senior consultant for Health and Productivity at Watson Wyatt Worldwide. “Employers have little control because their ability to contact a treating health care provider is quite limited and, in the past, such contact could only be made by a health care professional that was either on staff or contracted by the employer.”
Smart Business spoke with Dragotta about the new FMLA changes and how employers can mitigate the business impact from intermittent employee absences.
How has intermittent FMLA impacted business and created administrative challenges?
FMLA allows employees who have completed one year of service and 1,250 hours of employment to take up to 480 hours (for full-time employees) for qualifying conditions. Under FMLA’s intermittent time off provision, employees have not been required to call in before the start of their shift, impacting customer service, workflow and productivity. Employees can also take partial days off or use small increments of time for their absences, which makes keeping track of time off difficult, especially for salaried workers.
What are some of the new FMLA provisions?
Now, in addition to a health care professional, a company HR representative, a nonimmediate manager or the company’s leave administrator can contact the employee’s treating health care provider to clarify the FMLA request. For example, a treating provider may have suggested four days off per month but if a supervisor notices a pattern of absences (e.g., every Monday), a company HR professional can now clarify with the provider if such a pattern is to be expected based on the employee’s health condition. If an employee is taking a full day of absence for a medical appointment, the leave administrator or HR professional can contact the treating provider to determine if the appointment requires a full day of absence. Also, employers are now able to ask the treating provider for the frequency and duration of expected absences, which provides a greater ability to manage attendance. Also, unless there are unusual circumstances, employees must adhere to their work group’s call out policy when they miss time from work, so managers should expect earlier notification when employees need to take an intermittent absence.
How can employers better manage intermittent FML?
By following a few best practices, employers can reduce the business and administrative burden imposed by employee absences.
- Educate supervisors about FMLA,
including how to track employee
absences and set appropriate expectations. FML is an entitlement but it can be
managed more effectively.
- Coach outsourced FML providers or
in-house leave administrators to offer
resources to workers requesting time off.
For example, offering respite care or EAP
services to an employee who is caring for
a terminally ill family member might help
provide support and assistance but also
lessen the number of days an employee
may need to take off.
- Manage FML consistently across the enterprise, including a standard method for reporting time off, so you can track FMLA time off as well as determine the business impact.
What else should employers do?
While every company’s policy is unique, many employers craft their time-off policies so employees must use their allotted sick time or PTO in conjunction with FML, which avoids ‘stacking’ of unpaid time off and PTO, for instance. FML can help employees manage through a difficult period, but with some changes in the regulations, employers have a greater ability to manage FML, particularly intermittent absences.
JANICE DRAGOTTA, L.C.S.W., is a senior consultant for Health and Productivity at Watson Wyatt Worldwide. Reach her at (415) 733-4404 or email@example.com.
Downsized operations or a scarcity of tenants has temporarily left many business partnerships with too much real estate and too much debt. Refinancing is often the solution of choice, but doing so isn’t always viable. Owners may owe more than the property’s current value, or they face a maze of lenders and servicing agents behind highly securitized notes, making it nearly impossible to identify the lender, let alone build a relationship that would favor loan renegotiation. Even if selling the property were an option, partners want to be positioned to resume expansion plans and occupy the space when the economy rebounds.
“Down the road, these businesses will benefit from owning the facilities, but they have to survive in the short term,” says Tom O’Rourke, tax partner with Haskell & White LLP. “Raising capital is tough, so restructuring the debt may be the best option. But there are pluses and minuses to each alternative, so partners should consider each one carefully before proceeding.”
Smart Business asked O’Rourke what partners should know when evaluating options for restructuring real estate debt.
Why is renegotiating the debt terms the best option?
If possible, lengthening the debt terms would be the most expedient solution, because it will reduce the payments now, while giving owners the opportunity to recoup value and utilize the property down the road. But partners must use caution, because what appears to be a simple modification could end up generating forgiveness of debt income, which creates tax implications. The workout needs to be accomplished so that the modified debt issue price is not less than the old debt, which can be a complex calculation. Partners can research the tax impact under the original issue discount calculation provision provided for in IRC §1273 and §1274.
Is raising capital to pay down the debt still possible?
Bringing in a partner who will provide the cash to pay down the instrument or help fund the difference between the original note and the property’s current value for refinancing purposes is an option. Many traditional sources of cash have dried up, so partners will have to be creative and look to institutional investors, pension funds, life insurance companies, and even friends and family who might want to invest. Be aware that infusing capital into an existing partnership may create a step-down in basis under new mandatory basis adjustment rules that are just now having an impact, given the recent losses in real estate values. So model your new structure and plan to protect tax attributes.
Have some owners successfully converted lenders to partners?
If you have a relationship with the lender, selling him or her the debt in exchange for an equity stake in the business is another possibility. Be aware, however, that forgiving debt or cancelling debt is usually treated as income to the partners, unless there’s an exception. The American Jobs Creation Act eliminated the exception of using partnership equity to cancel indebtedness income. Under the revision, the partnership is treated as paying off the debt in exchange for the fair market value of the interest transferred, and the excess principal is forgiven, which creates tax consequences at the partner level. Under some circumstances, where the partnership agreement requires a deficit obligation restoration or guarantee, these gains can be mitigated, but both come with onerous economic considerations. It’s not that bringing in a lender as a partner isn’t plausible; it’s just not a slam-dunk solution because of the tax implications, especially for tax-paying partners.
Should owners consider the option of fore-closure or filing for bankruptcy protection?
Both foreclosure and bankruptcy are options. However, the decision often hinges upon whether the indebtedness was secured through partners’ personal guarantees. When liabilities are reduced or are deemed to be distributions, partners can be charged with the gains, and they’ll have to come up with the cash to pay the additional tax, unless they can find an appropriate exclusion.
What’s most important is that partners consider all options and the consequences of each choice, while considering the long-term business impacts. Though short-term business survival and debt reduction may be the current focus, eventually the economy will turn and partners want to be ready to capitalize on the rebounding market.
TOM O’ROURKE is a tax partner with Haskell & White LLP. Reach him at (949) 450-6358 or TORourke@hwcpa.com.
Sales are declining and so are profits. Many CEOs react to economic downturns by cutting costs and eliminating staff, because human capital costs are often a company’s largest operating expenditure. While reductions in the company’s top line are temporary, the long-term forecasted changes in work force demographics are not. Baby boomers may delay their retirement by a few years, due to shrinking portfolio values, but soon they will be exiting the work force, followed shortly thereafter by all the other boomers who are right behind them. Unless staff reductions are made wisely, the resulting business impact may be felt long after the economy rebounds.
“Despite the economic conditions, there are still talent shortages in critical skill areas,” says Paul DeYoung, talent management practice leader for Watson Wyatt Worldwide. “If executives simply issue an edict to management to reduce personnel expenditures by a certain percentage, the long-term results can be devastating. Strategic work force planning is a vital component of any downsizing action.”
Smart Business asked DeYoung what executives should consider when designing and executing a human capital cost reduction strategy.
What should CEOs evaluate before making staff reductions?
Executives need to understand which employees are pivotal players by asking who will bring the greatest value to the company in both the short term and long term. What executives want to avoid is making staff reductions purely a financial exercise, left strictly to the discretion of line managers, who may not understand the long-term impact of releasing critical staff. Conduct a work force supply-and-demand analysis looking forward five years; inventory those who have critical skills and who are your top performers and make sure that they are taken care of, because downsizings create uncertainty, and CEOs should not assume that retained employees will be grateful to have their jobs and will stay once the economy rebounds.
How can CEOs reduce costs while avoiding long-term business impacts?
Don’t focus on cutting heads; focus on reducing total expenses. For example, eliminating contractors or temps might be a good way to reduce short-term costs, but their charges usually aren’t included in the same line item as full-time staff expenses. A strategy focused on reducing head count may miss this opportunity to save these costs while preserving key personnel. Perhaps some employees would be willing to work part time or take unpaid leave as a way to reduce expenses; both moves preserve institutional knowledge and long-term productivity. Reductions in overtime or hiring freezes can produce savings without eliminating vital employees.
Are there other ways to save on human capital expenses?
Downturns can be an opportune time to look at organizational structures or job design to achieve greater efficiencies and savings. Do you have managers reporting to managers? Are engineers spending 60 percent of their time on administrative tasks? While the analysis and realignment process doesn’t produce instant cost savings, the company will benefit in the long term from making changes that improve efficiencies and the return for every dollar spent on human capital.
What are the best practices for implementing human capital reductions?
When it comes to sensitive areas like eliminating staff, how the process is conducted and communicating with employees is vital, because employee morale and productivity hang in the balance.
- Put safeguards in place to make certain
that any head count reductions are sustained. You don’t want managers bringing
back former employees as contractors, for
instance, unless it’s part of the strategic
- Take steps to retain critical knowledge.
Offer employees outplacement services
and severance pay in exchange for training, if the company doesn’t have formal
training and mentoring programs that facilitate knowledge transfer.
- Restructure performance plans. It’s
important to re-establish priorities and
align employee performance objectives to
fit with the company’s revised structure
and head count.
- Communicate effectively and transparently. Reach out and communicate with
employees whenever possible, so they are
reassured. If the company’s priorities have
changed, communicate the new vision. To
drive engagement and productivity you
have to create line-of-sight between the
company’s mission and the role of employees at every level of the organization. When
layoffs occur, employees will have questions, and it’s critical for CEOs to address
- Manage the process well. There are
many hidden costs to conducting this
- Do not forget about taking care of the survivors.
PAUL DEYOUNG is a talent management practice leader for Watson Wyatt Worldwide. Reach him at firstname.lastname@example.org or (818) 623-4779.