Compensation Isn’t Jeopardy. Using Loss Aversion to Your Benefit
A recent Inc.com article analyzed what makes the three grand champions of the game show Jeopardy so special. The article boils down the things that make these champions the best. The quick list includes: Physical Skills (you’ve gotta push that button fast.) Strategy. Mental Approach. Success. All of these are hallmarks of great executives and leaders, but the details on the mental approach caught my eye.
The author suggests that the top players have figured out how to avoid or ignore, the effects of loss aversion. Loss aversion is the human tendency to apply higher value to things they have than things they might have. Basically it is the reason a bird in the hand is better than two in the bush. It’s also why many people will give up a chance for equity upside for immediate cash payment. That’s great if your company has a pile of cash lying around, but what if you don’t?
Restricted Stock is the OG* of equity compensation. It is a fairly simple tool, with incredible power to deliver results when other forms of equity may fail you. It is fundamentally different than its full-value cousin RSU. It is nearly the opposite of a stock option. With restricted stock you become an owner on day one. The company keeps the right to force the return of your shares until some type of time or performance-based vesting.
The key is real and immediate ownership.
For many people, real ownership that must vest has the same value as units that must vest. Economically the tools are very similar at a base level. They both have a big role in total rewards strategy, and one should not be completely shunned in lieu of the other.
Restricted stock is a great tool when you are looking for people to make smart, compliant decisions. They own real shares and those shares have a real value. If the company pays a dividend, they will almost always get paid a dividend. If the company’s stock is bought by an acquiring company, they almost always get to participate. Most importantly is it can lead to loss aversion.
Loss aversion is something you probably want to be careful about when you are an early-stage company looking for extreme growth. Alternately, it can be a safe haven for companies with a more conservative outlook, or those going through troubled times. The palpable feeling of having something you “own” taken away by the company you are leaving can be far different than the annoying “forfeiture” of a virtual unit or an underwater stock option.
Restricted also has other unique benefits. It is exempt from 409A. It allows for tax planning via an 83(B) election. It is something that you can sell, at full value or a discount. It generally has less esoteric features than other kinds of equity compensation. It may be time to refamiliarize yourself with this old school tool.
If you are looking for something to get executives focused on the bottom line (rather than always focusing on the top line) throwing a bit of restricted stock into your pay mix may be just the loss aversion strategy you need.
*OG – Original Gangster for those of you not as cool as me.
Dan Walter is a CECP, CEP, and Fellow of Global Equity (FGE). He works as Managing Consultant for FutureSense. He has three metaphors for every occasion and is a leading expert on incentive plan and equity compensation issues. He has written several industry resources including the only resource dedicated to Performance-Based Equity Compensation. He has co-authored ”Everything You Do In Compensation is Communication”, , “Equity Alternatives” and other books. Connect with Dan on LinkedIn. Or, follow him on Twitter at @DanFutureSense.