Equity Compensation Probably Doesn’t Save You Much
About a million years ago when I began my journey in this industry equity compensation was an entirely different beast. Over time it has evolved, in some ways for the better in some ways for the worse. The perceptions of and expectations for equity have not always kept up with the reality. An understanding of how equity works now gives us a better understanding of how we may be able to improve it for the future.
I began my compensation career in 1994. People still typed things (on typewriters). Email was a new thing used by only a limited few. Equity compensation was the wild west. It cost companies nothing. It was used as liberally as salt at a corner burger joint. Few companies knew all the rules and fewer followed them. Gains were expected and repricings were performed without much thought. Importantly, equity was used to fill sometimes massive gaps between cash compensation expectations and cash compensation realities. Stock options were a secret weapon of startups and IPOs to asymmetrically compete for talent against the tech titans and other big companies of the day.
Over the next couple of decades, equity compensation was forced to clean up its act. The Dot.com boom and bust made people reevaluate its impact. Similar cycles followed. Lawyers and investors became better versed in the details. FASB finalized its accounting rules and equity was no longer “free.” But, during all this, something else was happening. Base pay and cash compensation was rising in tech while equity was being used more deeply by larger companies.
Early stage startups and companies who were unsure of a potential IPO were still underfunded, and their base pay reflected this. Equity and its upside were still sold as the great differentiator, and sometimes that lottery ticket paid off. Very few companies went public with thousands and thousands of employees, most had only several hundred so equity was not spread as thin. None of them went public with a valuation in the multiple billions of dollars. The cash – equity gap narrowed, but cash remained king at big companies and equity was the ruler at smaller, high-growth companies.
Over the past ten years, we have seen a change that is not fully respected. No longer is equity used to fill a deficiency in cash compensation. In fact, most of the regions and industries that use equity the most generously also have the highest base pay levels. Companies save little or nothing by using equity, but in the same breath, most cannot succeed without it. Added to this reality is a growing transition from high risk, long-term (four to ten years) stock options to lower risk, mid-term (two to four years) restricted stock units (RSUs.) Equity is no longer a secret ingredient that makes up for smaller portions, it is an important part of every wholesome meal.
And now we are experiencing a historic talent shortage. It will not improve unless the markets crash around us. We have also stagnated our base pay growth and reduced the specialness of equity at most companies. Often we find startups compete more heavily on culture and mission than ever before. The gamble of enormous equity upside is still there, but its softened by base pay that often exceeds that at the most mature companies.
It would not surprise me to see those big companies flip the tables by offering outsized cash incentives over the next few years. The companies who are making a profit can spend that additional cash and toss their ineffective equity compensation aside. This move may be accelerated by the loss of the 162(m) tax deduction for executives that was a foregone conclusion with equity awards. If the executives see their pay moved to cash, it will take about a year (or less) to see a pullback in equity for non-executives. Equity no longer saves most companies any money, and fixing that will require new ideas and tactics that perhaps we can discuss in a future post.