All too often the myriad types of truly performance-based equity get muddled together into a stew. Like other great equity compensation ingredients (RSS, RSU, ISO, NQSO) each type of performance equity should first be tried as an independent ingredient before being thrown into your LTI pot and hoping for the best. Performance Earned Units (PEUs) are a fairly pure form of Pay for Performance (P4P), so I figure we should start with them. Let’s start with a definition. Since there is not yet a standardized formula for performance equity nomenclature or acronyms, compensation professionals must understand the specifics of each type of performance award.
PEUs are Restricted Stock Units where the payout is determined as a percentage of the shares awarded, as related to the achievement of a threshold or modifying goal. Nothing vests unless performance is met.
The Key Performance Indicators (KPIs) for these programs can be anything that fits within a S.M.A.R.T. goal structure. For public companies, the overwhelming belle of the ball is Total Shareholder Return (TSR). Other common metrics include revenue, EBITDA, customer service and profit margin. However, your goals should be whatever can be measurably aligned to your success. The first thing you will notice is that we are already drowning in acronyms. If you choose to utilize a plan like this, spend the time to spell out as much as possible. Then take a little additional effort to truly communicate the meaning of every term.
Even as P4P becomes the mantra for executive compensation, PEUs remain a small sector of this family of compensation instruments. For at least three decades, nearly all equity compensation had time-based triggers for vesting. Often time was used to vest only a portion of awards, usually to ensure vesting regardless of performance. This paradigm has made it difficult for compensation professionals and executives to accept the all-risk profile of PEUs.
Nearly all PEUs include a time element. Most awards use the same performance metric for annual or quarterly intervals, with different goal levels linked to each measurement date. Some awards have multiple metrics, each with their own goal levels and time elements. Less common are awards with a simple cliff-based expiration with metrics and goals that can trigger vesting at anytime prior to expiration. The truth is, PEUs come in enough varieties to be an interesting meal all by themselves.
As both compensation professionals and P4P programs become more sophisticated, they are beginning to utilize different types of goal payout measurements. When I refer to different types of goal payout measurements, I am not referring to the behavior or result that is being measured. I am instead referring to HOW things are measured. Goal payout measurements include thresholds (also called gates or hurdles) and modifiers. A threshold is a goal that works like an on/off switch. Make it and you’re in. Miss it and you’re out. Modifiers change payout amounts by dictating the percentage or multiplier of units to be earned based on a range of potential outcomes. Combining these two types of goals can create an award that ensures a minimum level of performance in one area, while motivating strong performance in another.
PEUs are one of many performance equity ingredients I will be covering in this series over the next several months. If you would like to get started on your performance equity stew now, feel free to access the matrix you can find here. As always, you can reach out to me directly if you have specific questions.