Amid concerns over dilution, compensation expenses, and executive pay practices in general, companies continue to tighten their equity belts and to shift the mix of stock vehicles they dole out to employees, a study of the nation’s largest companies shows.
Equity usage overall, and reliance on stock options in particular, continued their downward march at Fortune 1000 companies in 2006, in keeping with a trend that started when the first companies started expensing stock options in 2002 in anticipation of an accounting rule change that required all companies to do so in 2005. That’s according to a study of 925 Fortune 1000 companies by compensation research firm Equilar Inc.
“The overall equity pie is shrinking,” says Equilar research manager Alex Cwirko-Godycki. “Because of concerns over dilution and expensing options in recent years, companies have been cutting the equity they’re providing to employees.”
While they still represent the largest piece of the equity pie for most companies, the use of stock options has plummeted steadily since the accounting change, replaced in many cases by restricted stock. Now that the dust has settled from the adoption of FAS123(R), the rule that requires options to be expensed, experts say there’s another movement afoot. Performance-based awards are becoming a larger portion of the equity pay mix.
“We aren’t seeing any decline in executive grant sizes, just that the mixes are different,” says Diane Lerner, a senior compensation consultant at Watson Wyatt.
Fewer Companies Granting Fewer Options
The prevalence of Fortune 1000 companies that reported employee stock option grants fell to 78.6 percent in 2006, down from 87.8 percent in 2004, according to the Equilar report, which was sponsored by Fidelity’s Stock Plan Services Group.
At the same time, the median number of total options granted fell at an annual rate of 23.2 percent to 881,000 shares per company in 2006. Median grant size varied widely by industry, with technology and health care companies granting a median of more than two million options in 2006, and telecommunication and financial firms granting a median of one to two million options per company. All other sectors granted a median of less than one million options, Equilar reported.
Lerner
“Most companies continue to use stock options, but not to the same degree as they used to,” says Lerner. While she says options represented about 95 percent of equity grants before 2002, today they represent about 60 percent.
Once stock option expensing took effect, many companies reduced the number of employees eligible to get option grants. While they’re awarding fewer options overall to a smaller pool of employees, companies are still giving large grants at the executive level, notes Cwirko-Godycki.
The percentage of total options granted to CEOs climbed from 5.3 percent in 2004 to 6.6 percent in 2006. The percentage of total option awards going to all other named executive officers also increased, rising to 14.7 percent of total option grants in 2006, up from 11.9 percent in 2004.
SUMMARY
Equilar Performance-Based Equity Data
Data for All Fortune 1000 Chief Executives
Among all Fortune 1000 CEOs, 46.3 percent received some type of performance-based equity award in 2006.
Among all Fortune 1000 CEOs, 31.2 percent received some type of long-term incentive plan grant in 2006. (This includes executives receiving only stock, only units, only options, or a combination of stock, units and options.)
Among all Fortune 1000 CEOs, 8.0 percent received some type of short-term (annual) incentive plan grant in 2006. (This includes executives receiving only stock, only units, only options, or a combination of stock, units and options.)
Among all Fortune 1000 CEOs, 7.7 percent received some type of fixed-share performance grant in 2006. (This includes executives receiving only stock, only units, only options, or a combination of stock, units and options.)
Data for Fortune 1000 Chief Executives Receiving Performance-Based Equity
Among Fortune 1000 CEOs who received some type of performance-based equity award, 41.7 percent received a long-term incentive plan grant denominated in stock. This includes executives who may have received other forms of performance-based equity. (This explains why the chart adds up to more than 100%.
Example of the Double Counting Effect
The CEO of First Horizon National Corp. (FHN) received a LTIP unit award, a STIP stock award and a STIP option award. This executive is counted three times in the pie chart on page 15.
Source
Equilar Web site.
Not surprisingly, more companies reported awarding restricted stock, with the vast majority of those shares being doled out to rank-and-file employees. Experts say that makes sense, since options are generally viewed as driving performance and restricted stock is geared more toward retention. In addition, restricted stock has a higher perceived value than options, and companies can replace options with fewer shares of restricted stock.
The percentage of companies reporting restricted stock grants for employees rose to 61.8 percent last year, up from 46.6 percent in 2004. Among the companies that granted restricted stock, 92.7 percent of all restricted shares granted in 2006 went to the general employee population. Meanwhile, the median number of restricted shares granted per company increased at an annual rate of 16.2 percent over the three-year period, Equilar reports.
While stock options were once the only game in town, most companies now report using a mix of equity compensation. In 2006, 50.9 percent of companies granted a mix options and restricted stock, up from 42.6 percent in 2004. Over the same period, the percentage of companies that awarded options only fell to 27.7 percent, down from 45.2 percent in 2004.
Performance-Based Equity
In 2006, the first year for which data was widely available, 43.6 percent of Fortune 1000 CEOs received a grant of performance-based equity, most commonly in long-term incentive plan grants denominated in stock.
Irv Becker, head of Hay Group’s executive compensation practice, expects that number to continue to rise. “I’d expect that number to be north of 50 percent next year,” he says.
As companies moved away from stock options over the last four years, most moved to service-vested restricted stock. “That was a good place temporarily, but there’s been a lot of pushback from institutional investors” to tie equity awards to performance, not just length of service, says Becker.
Sagolla
Don Sagolla, a principal with Mercer Human Resource Consulting, agrees that performance-based plans are becoming “a meaningful part of the equity mix.”
“The days of just hanging around and getting shares are gone,” he says. “We’re seeing more emphasis on performance metrics than we have in the past.”
Sagolla says shareholders, boards, and compensation committees “are increasingly asking, ‘How do the company’s performance measures correlate to increasing shareholder value, and how do we stack up in those performance measures against our peers?’”
Still, experts say that doesn’t mean options or restricted stock are going away. “Companies are just adding one more element to their equity portfolio,” says Becker.
While he says performance restricted share plans are “a nominal improvement [over options and restricted stock] because there’s a performance metric in place,” Paul Hodgson, senior research associate at The Corporate Library, says most companies don’t execute them properly. “Unfortunately, the way they tend to be implemented, not enough thought goes into choosing the metrics to measure value growth and the right performance period, and the hurdles are set too low,” he says.
One area where changes were expected but didn’t occur is in employee stock purchase plans. “When FAS123(R) came around, people assumed ESPPs would be on the chopping block first since the safe harbor was reduced,” says Cwirko-Godycki. “However, most of the data we’re seeing indicates ESPPs are pretty stable.”
From 2004 to 2006, additional share requests devoted to ESPPs stayed fairly consistent, dropping from 15.1 percent in 2004 to 14.4 percent in 2005, then recovering to 15.6 percent of requests in 2006. Similarly, the median size of ESPP share requests (as a percentage of a total shares outstanding) was almost unchanged, from 1 percent of shares outstanding in 2004 to 0.9 percent of shares outstanding in 2006.
Lerner says most companies that had an ESPP kept it. While some companies reduced their discount to stay within the safe harbor and avoid the accounting expense, she says “a surprisingly high number” maintained their programs despite the accounting change.
Many companies took the expense and kept their plans intact to provide employees who were cut from options eligibility another avenue for those employees to participate, she says.
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