Published on Wednesday, May 07, 2008
Employee stock ownership is becoming increasingly popular, what with a vast majority of companies offering stock options frequently as incentive compensation.
Under this scheme, the management awards the right to buy a specific number of shares of the company stock during a certain time and at a specified price which is usually discounted. The awardees can elect to exercise the option and convert it into st ock on maturity (after a particular vesting period or phased vesting) by paying the strike price. They can then reap handsome profits by selling the stock at a higher price then or later.
What’s more, equity-linked compensation is no longer limited to the executive suite – CEOs, key executives, senior directors or top-performing managers. Stock options are trickling down to not just mid-level employees but even the rank-and-file.
The endemic usage rides on the rationale that stock rights will both attract and retain top workers by binding them to the company and making them feel like partners in the business. Having invested their personal wealth in the organisation, employees will be motivated to work harder and attain peak levels. Not only does the equity-based element align executive interest with those of shareholders, but also serves as a handy means of rewarding performance that goes beyond salaries, especially for start-ups that are not yet profitable or have limited amounts of disposable cash. But, the feeling of ownership as an incentive is not without its fallout. The promise of big payoff has made many millionaires out of ordinary (read: undeserving) executives and employees.
Stock options have perpetrated a series of headline-making scandals and frauds. Top executives are increasingly attempting to temporarily manipulate stock price and accounting, by say, dressing up the short-term numbers. They distort company earnings and even increase share price volatility in a bid to encourage stock performance irrespective of actual operating performance and income. It also encourages manoeuvres to manipulate value of options (pre- and post-exercising) so as to maximise personal rewards all at the expense of genuine investors.
Employees have also been known to indulge in financial shenanigans and other improper behaviour even to the extent of acquiring and/or exercising options based on insider information like an imminent announcement, deal or acquisition.
Apart from this, compensation specialists argue that stock options greatly dilute stock value, not to mention the fact that stock price is significantly influenced by future expectations and external considerations that have no bearing on actual profitability or growth. In fact, Warren Buffet has publicly blasted stock options because as he says, ‘The practice of repricing options for top executives unfairly rewards them at the expense of shareholders!’
Re-examining compensation programmes
The growing abuse of employee stock options is necessitating a long, hard look at compensation plans. So much so that, some employers have even totally scrapped their option-based incentives to return to more traditional ways of rewarding performance.
But, this knee-jerk response is quite uncalled for as the situation does not warrant total elimination. Stock ownership is still a viable form of compensation incentive for attracting, rewarding and retaining employees.
So, instead of abandoning it, organisations should invest time and effort in designing better compensation packages that balance base salary, annual bonus and other perks with stock options as each offers a different form of motivation.
Top companies have developed a smarter way to compensate employees by tweaking stock options. Restricted stock or deferred stock grants emerge as a more preferable strategy where securities are granted subject to certain safeguards like voting rules, time constraints and transfer limitations.
Another option is a performance vested restricted stock that is based on meeting certain objective performance criteria. In a similar vein, stock grants can also be linked to other key drivers like customer satisfaction, client loyalty, return on investment or even new product development.
Some organisations simply offer stock without any options, while others are actually opting for premium-priced options (priced higher than current market valuations) that spur employees to pursue growth as a means of jacking up stock prices.
Such measures shift the emphasis to long-term value creation as the workforce starts concentrating on turning in meaningful performance. As one finance professor observes, ‘Stock grants reward managers no matter what happens to stock price because the stock is worth something. Options, if they are indexed properly, reward managers only for value’.
However, such incentives should not be awarded left, right and centre just to control turnover, but structured and utilised appropriately to develop a shrewd succession plan!
Under this scheme, the management awards the right to buy a specific number of shares of the company stock during a certain time and at a specified price which is usually discounted. The awardees can elect to exercise the option and convert it into st ock on maturity (after a particular vesting period or phased vesting) by paying the strike price. They can then reap handsome profits by selling the stock at a higher price then or later.
What’s more, equity-linked compensation is no longer limited to the executive suite – CEOs, key executives, senior directors or top-performing managers. Stock options are trickling down to not just mid-level employees but even the rank-and-file.
The endemic usage rides on the rationale that stock rights will both attract and retain top workers by binding them to the company and making them feel like partners in the business. Having invested their personal wealth in the organisation, employees will be motivated to work harder and attain peak levels. Not only does the equity-based element align executive interest with those of shareholders, but also serves as a handy means of rewarding performance that goes beyond salaries, especially for start-ups that are not yet profitable or have limited amounts of disposable cash. But, the feeling of ownership as an incentive is not without its fallout. The promise of big payoff has made many millionaires out of ordinary (read: undeserving) executives and employees.
Stock options have perpetrated a series of headline-making scandals and frauds. Top executives are increasingly attempting to temporarily manipulate stock price and accounting, by say, dressing up the short-term numbers. They distort company earnings and even increase share price volatility in a bid to encourage stock performance irrespective of actual operating performance and income. It also encourages manoeuvres to manipulate value of options (pre- and post-exercising) so as to maximise personal rewards all at the expense of genuine investors.
Employees have also been known to indulge in financial shenanigans and other improper behaviour even to the extent of acquiring and/or exercising options based on insider information like an imminent announcement, deal or acquisition.
Apart from this, compensation specialists argue that stock options greatly dilute stock value, not to mention the fact that stock price is significantly influenced by future expectations and external considerations that have no bearing on actual profitability or growth. In fact, Warren Buffet has publicly blasted stock options because as he says, ‘The practice of repricing options for top executives unfairly rewards them at the expense of shareholders!’
Re-examining compensation programmes
The growing abuse of employee stock options is necessitating a long, hard look at compensation plans. So much so that, some employers have even totally scrapped their option-based incentives to return to more traditional ways of rewarding performance.
But, this knee-jerk response is quite uncalled for as the situation does not warrant total elimination. Stock ownership is still a viable form of compensation incentive for attracting, rewarding and retaining employees.
So, instead of abandoning it, organisations should invest time and effort in designing better compensation packages that balance base salary, annual bonus and other perks with stock options as each offers a different form of motivation.
Top companies have developed a smarter way to compensate employees by tweaking stock options. Restricted stock or deferred stock grants emerge as a more preferable strategy where securities are granted subject to certain safeguards like voting rules, time constraints and transfer limitations.
Another option is a performance vested restricted stock that is based on meeting certain objective performance criteria. In a similar vein, stock grants can also be linked to other key drivers like customer satisfaction, client loyalty, return on investment or even new product development.
Some organisations simply offer stock without any options, while others are actually opting for premium-priced options (priced higher than current market valuations) that spur employees to pursue growth as a means of jacking up stock prices.
Such measures shift the emphasis to long-term value creation as the workforce starts concentrating on turning in meaningful performance. As one finance professor observes, ‘Stock grants reward managers no matter what happens to stock price because the stock is worth something. Options, if they are indexed properly, reward managers only for value’.
However, such incentives should not be awarded left, right and centre just to control turnover, but structured and utilised appropriately to develop a shrewd succession plan!
PAYAL CHANANIA
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