Normally I like to highlight benefits that we offer to NASPP members, but today I’m writing about something we don’t have: data on grant sizes. It’s something I get asked about occasionally, just frequently enough that I think it would be nice to have blog entry I could point to that explains why we don’t have this data.
Why Doesn’t the NASPP Offer Benchmarking Data on Grant Sizes
We don’t offer this data because you can’t look at award sizes in a vacuum. You need to look at awards as part of the company’s overall compensation package and include cash-based compensation and other benefit programs in your analysis. Companies that pay heavily in cash are likely to use less stock compensation and vice versa. Thus, you don’t want to set award sizes based on peer data without also knowing how the cash compensation (including salary, commissions, bonuses, and other long-term incentives) paid by your peers compares to your own. Doing so could result in severely over-compensating or under-compensating employees.
The same consideration also should be given to other benefit programs. For example, I recently spoke with a company that was implementing a stock award program to replace the company match in their 401(k) program. Because their stock awards are designed to make up for a lack in their 401(k) benefit, I would expect them to grant larger awards to more employees than a similarly situated company that has a more robust 401(k).
Stock compensation should be a component of your overall compensation package–the goal is to figure out what your overall compensation package should be, including cash, stock, and other benefits, and then figure out how much of that overall package you want to be in stock.
While we, here at the NASPP, are the leading experts on stock compensation, I admit that we don’t know beans about cash-based compensation and other benefit programs. Because we don’t have the expertise to properly evaluate other compensation data, we have decided that it would be inappropriate–perhaps even irresponsible–for us to publish data on grant sizes.
Ultimately, determining guidelines for grant sizes isn’t a do-it-yourself project. It’s not quite as simple as just looking at some survey data. There are numerous questions as to how grants, particularly stock options, should be valued for compensation purposes (we’ll have a great session on this at this year’s NASPP Conference–stay tuned for more information when we announce the program later this month). The number of shares you have available in your plan and how amenable your shareholders will be to additional share allocations (which will in part depend on your shareholder demographics, as well as your overhang and burn rate) are additional factors to consider when deciding on grant sizes. You would not want to set guidelines that cause you to run out of shares before you’ll be able to get your shareholders to approve an additional allocation of shares to the plan. In addition, any survey data lags behind the market, sometimes considerably. This is an inherent part of the survey process; it takes time to collect the results, analyze, and publish them so that by the time the results are published, the market has already changed.
Once awards are granted, mistakes as to size aren’t easy to fix. I encourage companies to work with a compensation consultant who can provide the appropriate benchmarking from peer companies with similar compensation strategies and benefits and can suggest adjustments based on differences in your strategies and other benefits. In addition, a consultant can help you assess the value of your overall compensation package as it compares to your peers, determine the appropriate way to value your own options and awards, and provide input into how the market has shifted since the survey results you are looking at were published. Grant sizes are one of the single most important decisions you are going to make about your stock program; it’s worth the investment.
Correction In last week’s blog entry (“News on the Proxy Advisors“), I got the name of ISS’s parent company wrong. Four times (at least I was consistent). It should have been MSCI (not MCSI). But don’t bother going back to look at it now to find the mistakes–I’ve fixed it.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so we keep an ongoing “to do” list for you here in our blog.
Register for the 20th Annual NASPP Conference in New Orleans. Don’t wait, the early-bird rate is only available until May 31.
Register for the NASPP’s newly updated online Stock Plan Fundamentals program–it’s not too late to get into the course; all webcasts have been archived for you to listen to at your convenience.
Risky Behavior and Stock Options The study, which is summarized in the article “The Making of a Daredevil CEO: Why Stock Options Lead to More Risk Taking,” published by Knowledge@Wharton, looked at companies that had recently experienced an increased risk and evaluated which companies took steps to mitigate that risk based on the percentage of their managers’ compensation that is in stock options and the in-the-moneyness of the options.
The researchers found that firms where managers held more stock options took fewer mitigating actions. They felt that this is because once stock options are underwater, the value of the options can’t get any lower. When you think about it, with full value awards, there’s always upside potential but there’s also always downside potential–until the company is just about out of business, the value of the stock can always drop further. But once an option is underwater, it doesn’t matter how low the stock price drops, the option can’t be worth any less. As a result, managers in the study that held more options were less incented to take actions to keep the stock price steady.
Risk and In-the-Moneyness
Interestingly, and in line with this theory, the study also found that when managers’ had in-the-money options they took more mitigating action than when their options were underwater. If there was some spread in the options, the managers were motivated to preserve that spread and thus took action to keep the stock price from dropping. But where there was no spread, the managers were more incented to take risks (presumably in the hopes that the risks would pay off and the stock price would increase).
This is all very interesting; I’ve often wondered (probably here in this blog even) why the media and investors have a bias for full value awards over stock options–I think this is the first plausible explanation I’ve heard for that bias. But here in the NASPP Blog, we view studies like this with a healthy level of skepticism–it’s odd but I’ve never seen a study that didn’t prove the researchers’ initial hypothesis–so I wouldn’t scrap your option plan in favor of full value awards just yet (if you haven’t already done so).
A Nail in the Coffin for Premium-Price Options
I’ve never been a fan of premium-priced options because the reduction in expense is less than the premium, which, to my mind, makes them an inefficient form of compensation. I prefer discounted options, which provide a benefit that exceeds the additional expense to the company.
If this study can be believed, premium options would also discourage executives from taking steps to mitigate risk (whereas discounted options would presumably have the opposite impact). Maybe regulators and investors need to reconsider their bias against discounted options (although, in the case of the IRS, this bias may have less to do with concerns about risk taking and more to do with tax revenue–see my March 16, 2010 blog, “Discounted Stock Options: Inherently Evil or Smart Strategy“).
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
Today’s blog looks at a couple of random topics that showed up in my recent Google alerts: 1) options backdating and lawsuits against auditors and 2) yet another study on stock options and employee performance.
Are Your Auditors Going to Get Fussier? Option backdating stories are few and far between these days, but a new development showed up in my Google alert this week. A federal appeals court has ruled that investors can move forward with a lawsuit against Ernst & Young over Broadcom’s option backdating scheme. The ruling reverses a lower court decision dismissing the case.
The lawsuit alleges that Ernst & Young should have investigated deficient and missing documentation relating to Broadcom’s option grants. At this point, the lawsuit has a long way to go–the ruling just allows the suit to proceed, there has been no finding or judgment against E&Y and perhaps there won’t ever be. Nevertheless, I think it’s intriguing that the lawsuits over option backdating have now extended to auditors. I’ve talked to many a stock plan administrator who has felt a bit put upon with respect to the documentation requested by their auditors, and that was before the options backdating scandal. I imagine the documentation requests have already gotten more onerous and, if this lawsuit goes much further, I can only anticipate that auditors will tighten up the documentation requirements even further.
Stock Options=Lottery Tickets=Grateful, Hardworking Employees The debate over whether stock options incent employee performance slogs on. The latest rebuttal is the paper, “Stock Option Exercise and Gift Exchange Relationships: Evidence for a Large US Company” by management professor Peter Cappelli and Martin J. Conyon, senior fellow at Wharton’s Center for Human Resources.
The study posits that stock options motivate employees to work harder, but not in the way employers most likely hope. Instead of working harder to increase the stock price before they exercise, employees view options more like lottery tickets. But, if they get “lucky” and are able to exercise for a profit, employees will work harder in the period following their exercise–often for over a year–in gratitude to the company for the payout they received.
The study examined exercise patterns and job performance of 4,500 managers at a large U.S. public company (unnamed). While the sample size of employees certainly seems large enough, the results would be more interesting to me if the study had looked at more than one company. The authors don’t seem to acknowledge the differences that education (both in terms of the stock plan and company financials) and corporate culture might have on how employees view their stock options and how that influences their performance. It would also be interesting to know if the results translate to restricted stock or RSUs, which guarantee a payout to employees.
It’s Not Too Late for the Online Fundamentals The NASPP’s acclaimed online program, “Stock Plan Fundamentals,” began last Thursday, April 14, but it’s not too late to participate. All course webcasts have been recorded and archived for you to listen to at your convenience. This is a great program for anyone new to the industry or anyone preparing for the CEP exam. Register today.
Online Financial Reporting Course–Only Two Weeks Left for Early-Bird Rate There are only two weeks left to receive the early-bird rate for the NASPP’s newest online program, “Financial Reporting for Equity Compensation.” This multi-webcast course will help you become literate in all aspects of stock plan accounting, including the practical considerations and technical aspects of the underlying principles. Register by April 29 for the early-bird rate.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
Register for 19th Annual NASPP Conference (November 1-4 in San Francisco). Don’t wait; the early-bird rate is only available until May 13.
Register for the NASPP’s online Stock Plan Fundamentals program. Don’t wait–the course started last Thursday, but all webcasts are archived for you to listen to at your convenience.
It looks like hope of being the next Randall Heron and Erik Lie (of the options backdating study fame) remains alive in the world of academia. Three studies relating to stock compensation have recently been published.
This study looks for patterns in decisions to exclude stock compensation expense from non-GAAP earnings and earnings forecasts.
Somewhat predictably, the study finds that companies exclude stock compensation expense from non-GAAP earnings when doing so presents a more positive financial picture of the company to investors (e.g., increases or smoothes earnings, or helps the company achieve earnings benchmarks). Financial analysts, however, exclude stock compensation expense from earnings forecasts when doing so helps them to better predict future earnings performance. Hmmm, now that I’ve written this, it seems hard to believe a 52-page study was needed to figure this out.
In a nice counterpoint to the study “Employee Stock Options and Future Firm Performance: Evidence from Option Repricings,” that I blogged about in August (“Repricing and Company Performance,” August 31, 2010), this study finds that companies with broad-based options programs have better operating performance (based on return on assets), at least in smaller companies and in companies with higher growth opportunities per employee. The authors believe that options encourage cooperation and mutual monitoring among employees and may also serve to attract and retain higher quality employees.
This study looks at whether executives that exercise their stock options on the vesting date are motivated to do so by confidential information they have about the company. The study concludes that vesting date exercises are more likely motivated by the executive’s need to diversify his/her portfolio.
Time Has Run Out! All NASPP memberships expire on a calendar-year basis–if you haven’t already, renew your membership for 2011 today.
Got Questions on Section 16? Alan Dye has the answers. Email your burning Section 16 questions to adye@section16.net and Alan will answer them during his popular, annual Q&A webcast on Section 16. This year’s webcast will be held on January 25; this is your one chance all year to get answers from one of the nation’s foremost authorities on Section 16–don’t miss it!
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
The Boston NASPP chapter wins the race to have the first chapter meeting of the year! If you are in the Boston area, don’t miss the meeting on January 14.
Repricing and option exchange programs have long been a controversial practice. A study released earlier this year looks at whether repricings boost company performance.
The Repricing Controversy In the NASPP’s 2010 Stock Plan Design Survey, although 61% of respondents indicated that more than 50% of their options had been underwater in the past two years, only 7% had repriced (another 4% exchanged underwater options for full value awards, cash, or a combination of stock and options). Critics argue that repricing underwater options rewards employees for poor performance while proponents counter that repricing is necessary to retain employees and motivate future performance.
Repricing and Company Performance Studied
The study, “Employee Stock Options and Future Firm Performance: Evidence from Option Repricings,” co-authored by Ron Kasznik of Stanford University’s Graduate School of Business, Nicole Bastian Johnson of the Haas School of Business at UC Berkeley, and David Aboody of UCLA’s Anderson School of Management, looked at over 1,300 companies whose stock had declined by 30% or more annually from 1990 to 1996. Approximately 22% of those companies repriced; the study compared the performance of companies that repriced to those that didn’t.
Overall, the study found that the companies that repriced performed better over one, three, and five years. More specifically, the study found that companies that repriced only options held by executives outperformed the companies that did not reprice. On the other hand, companies that repriced only options held by non-executives did not outperform the companies that did not reprice.
Broad Implications for Stock Options
The authors hypothesize that this indicates that granting options to rank-and-file employees doesn’t enhance company performance. I haven’t read the whole study (not because I’m lazy–although that’s certainly a contributing factor–but because I can’t seem to access a copy of it for a nominal cost and, given how inscrutable the last study I blogged about turned out to be–see my August 18 entry, “Section 6039 and the Recession,” I’m not willing to make much of an investment here), but, according to the abstract, the authors assumed that once the options were underwater, any incentive effect they were having disappeared and that repricing the options would restore this incentive. If company performance didn’t improve after the repricing, I guess (emphasis on “guess,” as the reasoning that led to the conclusion isn’t clear from the abstract) the authors assumed that the options weren’t creating any incentive to begin with.
I Have Some Doubts
I’m not sure I’d make that leap–granted, I know next to nothing about conducting studies like this, but it seems to me that if you’re going to argue a point about the incentive effect of stock options, you ought to include some companies that don’t grant options as a control in the study.
It also seems like there are any number of other reasons why the repricings might not have improved company performance. For example, the rank-and-file employees could have lost faith in the options as a result of their being underwater and, while the repricing may have fixed the immediate tangible problem of the options being underwater, it may not have done anything to address the larger intangible issue of employees no longer believing in the company’s future growth potential. While this would impact the incentive effect of the repriced options, it doesn’t necessarily mean the options weren’t having an incentive effect before they were underwater. Or employees could be anticipating future repricings if the stock price declines further. Or, an even simpler explanation could be that the repriced options didn’t remain in-the-money–it isn’t clear from the survey abstract that the authors considered this.
The study also doesn’t say anything about retention–one of the primary reasons companies cite for undertaking repricings and option exchange programs. Valuation specialists have told me that in-the-moneyness is an important factor in estimating expected forfeitures, which leads me to believe that repricings could have their intended impact when it comes to retention.
Moreover, I’ve got to believe that the number of companies that repriced options held by executives only is a pretty small sample. Seriously, who does this? So I wonder how meaningful that data is.
Finally, what about the companies that repriced both executive and non-executive options? How did they perform?
Just 20 Days Until the 18th Annual NASPP Conference The 18th Annual NASPP Conference is less than three weeks away (and the hotel is already sold out)! Register today for the Conference, which will be held from September 20-23 in Chicago. I hope to see you there!
Last Chance for NASPP New Member Referral Program The NASPP’s New Member Referral Program ends this Friday, September 3. Any members you refer that join by this Friday receive 50% off their NASPP membership and you get $150 off your NASPP Conference registration (and an entry in our raffle for an iPad). Don’t wait–all memberships have to be completed by this Friday to qualify.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.