Equity Award Insanity
A Brave New World
A draft letter to all our shareholders, “…Considering our share prices dropping to half of last year’s value, we have been forced to punish our current employees by doubling the number of shares awarded to them and cutting the exercise prices of their option awards in half. Better luck next year!”
Most public companies develop annual equity award grant guidelines based on this year’s stock prices. If award values are fixed from year to year, the number of shares granted increase as stock prices plummet and shrink as prices increase. This counterintuitive message does not flatter your shareholders. It begs the question, ‘is there a better way?’ The answer, yes there is!
Before going any further on this, let us separate the notion of equity award expensing from award grant sizing. There are stringent rules on how equity awards must be expensed – nothing that follows is intended to change how that process is determined.
Back to Basics
To understand how we might award equity to employees in a better way, let us review the process that most of us use. In the Compensation Discussion and Analysis (CD&A) section of a company’s proxy statement, there commonly is a statement disclosing that equity award value targets are determined by a statistical analysis of a peer group of companies from last year, and these dollar values are converted to shares using the current share price (or something similar). Last year’s peer company values and the size of this year’s grants are determined by share prices on the date of grant.
Sometimes, awards within the peer group are outliers in that they vary significantly in either number or value from normal grant practices. In such cases, these peer award ‘anomalies’ are often adjusted using selective averaging to smooth out annual award patterns. This practice is especially important if the number of companies chosen as peers is of limited size.
What If?
We have a unique opportunity to use this macro-economic volatility to shore up the logic used in determining the number of shares awarded on an annual basis. What if we used, say three-year, averaged stock prices to determine peer award targets and annual corporate equity grant sizes? Accounting values would shrink in value in the lower years and increase in value for up years. Award shares would become much more stable from year to year and shareholder optics would improve dramatically.
Intrigued? Contact FutureSense and let us start the process of adding back some sanity to your equity awarding processes. Let’s talk equity today!
About FutureSense
FutureSense is a management consulting firm that provides integrated solutions to build and sustain human capital capacity. The firm can work with you by offering support and guidance to manage your workforce. To learn more about FutureSense, please visit FutureSense.com.