In my February 25, 2011 posting “Stock Option Moving Sale”, I suggested that rather than end up with the compensation equivalent of acid washed jeans or a teal mock-turtle neck, perhaps a better shopper could find deals that were a bit less trendy or even tenuous. Equity compensation may be better utilized like a list of 401K investments. Imagine different tools balancing at the same time to create a more effective compensation package. People using a single instrument, like stock options, for the majority of the equity portion of total rewards, often end up decrying its flaws just a few years later. Others rejoice because they guessed correctly and things are paying off handsomely. Some people say the glass is half-full. Some people call the glass half-empty. I often think that maybe you just have the wrong size of glass.
Glass half full: Stock Options are the tool for the ultimate optimist. Consider them the “Growth” selection in your program. They provide the unbridled hope of tomorrow in the form of virtually limitless value based on stock price performance and leveragability. Unfortunately, hope is seldom a strategy. Stock Options granted at the wrong time or for the wrong reason, end up with little or no monetary value. They can also end up with significantly negative political value in the eyes of shareholders and employees.
Glass half empty: Restricted stock is the tool for people looking for safety and guarantees. They are the equivalent to a “Bond” in your program. They provide a link to tomorrow’s growth without requiring a complete bet. You may not be able to determine the odds, but there is very little chance of losing all of your money. Conversely, awarded at the wrong time, people end up regretting their conservatism as they watch the big stock option bettors take home fabulous prizes.
Buy a new glass: Performance equity is a tool that allows balance to be added based on the award details rather than just the movement of the market. These awards can fit the needs of the optimist and the pragmatist. Many people believe that adding performance elements to equity compensation is the least predictable solution. I believe that when they are designed properly performance equity programs can limit the risk and temper the upside of restricted stock and stock options. Regardless of where the market is today, you can build in leveragability. No matter how high your stock price is right now, or how low it goes, you can build in a component of downside protection.
Of course, with performance equity you must work to create the right size and type of glasses for many different beverages. Just like a mug for root beer would be terrible for a fine red wine, a TSR goal may terrible for an individual working on a production line. Just like Starbucks offers several sizes of drinks (Short, Tall, Grade, Venti and the recently added Trenta), you need to offer sizes that suit both the individual’s needs and the instruments specifics. Think of these additional pieces to the increasingly complex compensation puzzle as job security for the eager compensation professional.
Every modern corporate compensation program that includes equity should offer each of the elements above. The compensation package of anyone eligible for equity should include a blend of these instruments. This is not as easy as the prior method of picking a single instrument and level. It requires thorough analysis of past effectiveness, performance and future potential. But, in the end, it provides equity compensation programs that can avoid some of the major problems we have seen multiple times since the Dotcom Crash of 2000. More importantly, we can create a new understanding of the importance and effectiveness of share-based compensation as we continue moving into this decade and beyond.