Though once a critical component of competitive compensation, in the not too distant future it could be a rare thing to hear folks talking about options packages.
Options grants are going out of style while performance-based full-value shares are becoming the norm. According to recent analysis of 1,345 S&P companies performed by Equilar, since 2012 the median number of options granted has fallen from 250,000 to 181,000 as the median number of restricted shares or restricted stock units has risen from 433,000 to 440,000. Furthermore, since 2009, the share of companies granting performance-based equity has risen from 46 percent to 69 percent. This trend exists across all major sectors of the economy.
The reasons for the decline of options as an equity compensation vehicle are subject to intense debate, but we see two key reasons: first, during the recession many employees saw the value of their options decline and/or disappear. This is a cut that still stings today. Second, performance-based shares allow companies to tie awards to individual performance creating a tighter link between performance and compensation.
A Cut That Still Stings
We have all heard anecdotes about junior employees who became millionaires because of stock options granted by rapid-growth firms. The allure of this potential windfall continues to attract some employees to companies that offer sizable stock option grants in lieu of competitive salaries. But just as lottery sales skyrocket as the jackpot increases, the demand for options is highest in an up market. In the market downturn of 2008-2009, many outstanding options lost much or all of their value, compromising their ability to serve as a meaningful incentive for employees.
Furthermore, the market collapse changed employee attitudes toward stock options. To be sure, today the market is healthier than ever, if we take record highs as our guidepost. But many employees do not easily forget 2008 even in the face of strong and significant growth. Employees came to realize that options dont automatically drive wealth. And the loss of 2008 hurts more than the gain of 2013 through today.
Tying Awards to Performance
Corporate governance of compensation has increased significantly over the past ten years as a result of legislation like Dodd-Frank, which is driving more companies to link executive compensation to performance. Performance awards provide companies with flexibility to establish this link while creating vesting metrics specific to their unique company goals. Third-Party Administrators have responded in kind by providing more robust solutions to accommodate performance awards programs. This empowers companies to create plans that are tied to more diverse performance metrics and to grant performance awards more deeply into the employee base.
Growth in the use of performance equity has been steady. The trend from options to performance equity brings with it a wealth of new possibilities for benefits and compensation professionals, as well as new structures for implementing, administrating and awarding. Equity compensation models can help steer and drive the business. But we are now in a far more complex space. In short, the need for thoughtful and deliberate planning before, during and after rolling out a new equity comp structure is more important than ever.
Adam Colon is vice president at E*TRADE Financial Corporate Services
