American companies are curbing both the frequency and size of equity compensation given to executives employed outside the United States, an effort to hold the line on compensation costs and share dilution that abandons the once-common practice of exporting U.S.-sized option awards around the globe.
Historically, American companies routinely granted overseas employees the same equity awards as their U.S. counterparts. Now, according to compensation consultants, domestic companies are awarding less equity to fewer overseas executives than they were even just a few years ago.
Matthews
“Companies are focusing on the cost of equity and being more careful about how much they distribute,” says James Matthews, a principal at the consulting firm Towers Perrin and head of the compensation unit in its global consulting group.
To that end, experts say companies are either reducing the level of awards provided to international participants in long-term incentive programs, reducing the number of international employees eligible to receive “LTI” awards, or doing both.
Indeed, a recent Towers Perrin survey of 61 U.S. multinational companies found that only 24 percent expect to grant the same number of shares to both U.S. and non-U.S. employees at the same level in the organization in the near future.
Further, according to Towers Perrin’s “2007 Global Long-Term Incentive Policies Survey,” more than one-quarter of companies have reduced long-term incentive program participation levels, and more than one-third plan to reduce future participation levels.
Observers say the shift in U.S. companies’ use of long-term incentive programs worldwide is largely the result of a change in the accounting rules that requires companies to treat employee stock options as an expense. Pressure from shareholders to lower compensation expenses and share dilution has also played a part, although to a lesser extent.
Richard Alpern, a principal at compensation consulting firm Frederic Cook & Co., says those findings are in line with what he sees among the firm’s multinational clients. He cites some forces driving the trend: pressure from U.S. investors to constrain costs and share dilution and pressure from investors in other countries to moderate pay levels. The latter, he adds, decreases pressure to use a U.S. standard of compensation beyond American shores.
Indeed, says Steve Van Putten, an executive compensation consultant at Watson Wyatt Worldwide, in the late 1990s, “Companies were aggressive in terms of taking equity beyond U.S. borders to spread a culture of participation and share ownership.”
That attitude changed in 2005, when Financial Accounting Standard No. 123R, Accounting for Stock-Based Compensation, took effect. With stock options carrying the same expense as any other form of equity compensation, companies began reassessing all of their pay programs to make sure they were getting the most compensation bang for their expense buck.
Same Total, Different Parts
By giving international employees the same equity awards, Van Putten says, many companies actually overpaid international employees relative to their U.S. counterparts, because those employees get other fixed benefits, such as larger car allowances and greater vacation benefits, that U.S. employees do not.
As a result, many companies shifted the structure of their compensation programs with an eye toward retaining the components of their plans that have the highest perceived value to employees, while scaling back or eliminating others to curb overall compensation levels and expense.
Van Putten
While equity incentives “are an ingrained part of the compensation culture in the U.S.,” Van Putten says, that is not true internationally. “Outside of the U.S., equity doesn’t have the high perceived value relative to other compensation and benefit elements,” he says. “International employees favor certain benefits and cash compensation more than they do equity participation.”
Matt Turner, of compensation consulting firm Pearl Meyer & Partners, also notes that equity compensation—particularly stock options—“can be an inefficient pay vehicle in some countries” due to tax rules.
Turner
“Using equity in some places becomes so burdensome from a tax standpoint that it doesn’t make sense,” Turner says. “With cost pressures, companies are seeking more efficient vehicles. Often times, a cash long-term plan or some other ‘equity-like’ vehicle makes more sense than true equity.”
So when companies look to cut their compensation expenses outside of the United States, equity awards are the first to be trimmed.
As a result, equity “isn’t being spread like peanut butter any more,” says Turner. Instead, companies are developing long-term incentive plans matched to what drives value in an industry or giving country; for example, Turner says, many companies have increased their use of performance shares and performance-based equity.
“Outside of the U.S., equity doesn’t have the high perceived value relative to other compensation and benefit elements.”
— Steve Van Putten,
Compensation Consultant,
Watson Wyatt Worldwide
According to the Towers Perrin study, more companies are organizing long-term incentive award sizes by geography and tying awards more closely to local-country practices. Roughly 42 percent of the companies surveyed differentiate awards by geography, up from 39 percent in 2005 and only 5 percent in 2001.
Among those companies that customize awards geographically, most separate countries into regions or “tiers” by clustering countries with similar competitive values, and then provide common LTI award levels for that group. Only 13 percent of companies surveyed say they have award-size guidelines for each country individually.
In addition, companies often set award sizes to non-U.S. employees as a percentage of the U.S. award size. According to Towers Perrin, the current median policy award in Europe is 80 percent of the U.S. award size, while the median for the remainder of the world is 60 percent of the U.S. award size.
The global trend mirrors what’s happening in the United States, Turner says. “Nationally, we’ve seen companies reducing their use of equity in terms of the percentage of shares issued each year and who’s eligible for grants,” he says. While the overall value of long-term incentives isn’t necessarily falling, he says, “The portion that’s attributable to equity may be declining.”
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