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Executive Compensation Tactics for the Next Economy
By: Daniel P. Moynihan Do any of these concerns sound familiar?
Our stock price has tumbled
Our options are underwater
We are fearing a true economic slowdown
We can't find enough talent to meet our needs
What do we do with the boomerang dot-commers?
If you are facing any of these problems in your organization, the next logical thought is, "How can we continue to attract, retain, and motivate the top talent within our organization?" Let's discuss some of the unique things we can do in this Next Economy to encourage our Senior Team to right the ship and set a course for financial and organizational stability.
Stock Options
One question we hear a lot is, Are options still viable? Our answer is a resounding YES! However, we recommend that you think carefully about all of the ramifications of this equity alternative. First, we recommend that option grants be a continual and ongoing process. Option grants should be given so the executive gets the "dollar-cost averaging" effect. This allows the executive to have multiple strike prices over time, and therefore multiple opportunities for wealth accumulation.
The wealth accumulation aspect is important. I believe that the entire Human Resource and Compensation profession has fallen a little short in its efforts with regard to options. We have allowed our plan participants to believe that options are a current cash phenomenon. The reality is that we must communicate clearly the message that stock options are a long-term wealth accumulator, not a current cash vehicle. The intent of stock options is to provide long-term opportunity, not to pay for today's Porscheä or that big house.
Don't get me wrong, options are a great tool. If a higher frequency of grants is not palatable to your Board or Compensation Committee, perhaps an off-cycle grant could be used to help the executive regain a foothold toward upside potential. When you go away from your normal process and pattern of grants, and provide new grants at today's lower valuation, you provide them with some new upside potential. The Company benefit is options prices at Fair Market Value (FMV) have no current expense charge.
Repricing
One thing we fully discourage is the repricing of options. Often we get too involved in the tactical issues at hand, and forget the more important strategic issues. There are far too many negatives both from the shareholder perspective and the negative accounting treatment. Any appreciation on the on the newly repriced options will result in a charge against your corporate earnings as a compensation expense. With the intense focus on profitability, it's tough to justify these types of hits to earnings. If you were a Priceline.com shareholder who purchased stock near $100, would you want the Executives to have their options repriced at $2 when the stock tanked? I don't think you would perceive that as fair. There are far better alternatives including restricted stock, better perquisites, and current cash plans.
Restricted Stock
Our opinion is that, from an Executive Compensation perspective, Restricted Stock is a far better alternative than options in today's economy. There are numerous advantages to restricted stock including:
Great Retention Tool
2-5 Year Vesting
No executive investment required
Promotes immediate stock ownership
Charge to earnings is fixed at time of grant
Tax Advantaged for Executive
Deferral until restriction lapses
83(b) election
Normal Income Tax Now
Capital Gains later
The downside to Restricted Stock from the Company perspective is the immediate charge to earnings and the immediate dilution of EPS.
Our opinion is that the advantages far outweigh the disadvantages, and with the NASDAQ 60% off its high, and the Dow hovering at 10,000, the depressed stock prices make the 83(b) election a fantastic tool right now. Under the rules of an 83(b) election, you pay tax when you receive the stock, but not when it vests. You'll also report capital gain or loss when you sell the stock. By volunteering to pay tax in the year you received the stock, you effectively reduce your overall tax liability. The election allows an executive to pay the normal income tax now on the restricted stock grant at today's low price. When the restriction lapses, the event is non-taxable to the executive as taxes were paid early on. One key fact is that you cannot recoup any losses on tax payments if the stock goes down. However, when faced with a down market, now is the time to provide restricted stock because the timeline allow significant opportunity for upside growth in depressed stock prices.
Stock Loans
These equity offerings bring us to another trend; Stock Loans. A company-provided stock loan has several key features such as lower than market interest and potential forgiveness of a portion of the loan. These loans can be used for several purposes including:
- Payment of Taxes on Restricted Stock or Option Exercise
- Capital required to Exercise Options
- Other, such as First or Second Home purchases
Why would a company offer its working capital up to a member of senior management? The primary reason is retention. In a typical stock loan, the participant can pay back the loan over several years, the stock is used as collateral, and the company may provide forgiveness of the loan, up to 50%, over an eight-year period. Who would walk away from a less than market interest rate loan, with the potential of up to half being forgiven?
Flexible Perk Plans
Finally, we perceive a Flexible Perquisite Plan for Top Executives to be the biggest factor in compensating top talent in the Next Economy. Flexible Perks are a creative and unique solution to meet the varied needs of your executives. When you employ a diverse group of people of both sexes, typically between 30 and 70 years old, you find that there are many diverse needs and desires for perquisites. To meet these needs, we advise developing a custom perquisite plan.
According to our research, the most prevalent perks for top talent are:
SERPs (Supplemental Executive Retirement Plans)
Automobiles
Mobile Phone/Laptops
Executive Physicals
Post Retirement Medical Funding
Long Term Care Insurance
Employment and Change of Control Agreements
Club Memberships
First Class Travel
Financial, Legal & Tax Advice
As an employer, you must choose which are most appropriate for your population, and how best to implement these programs. Unfortunately, most companies use a cookie-cutter approach to Executive Perks, and miss out on an opportunity to create retention value. The cornerstone of a solid Flexible Perk program is a well-designed Non Qualified Deferred Compensation Plan. It must be flexible enough to meet all of your current and future needs.
According to our research, between 8% and 10% of companies are currently employing a Flexible Perk plan in their organizations. A strong need exists for a creative and customizable platform to deliver flexible perquisites to your executive team. No two executives are created equally. Each one has a set of unique needs that requires a custom set of solutions. Flexible Perks can provide your organization with the appropriate tools to motivate and retain your top talent.
Conclusion
As we embark on the Next Economy, attracting, retaining, and motivating top talent continue to be major issues within organizations, both large and small. To stay competitive, companies must remain aware of their workforce and create solutions that will meet their unique needs, including stock options, restricted stock, stock loans, and flexible perks. We advise sticking to tried and true, proven methodologies to ensure that the programs you develop today do not become tomorrow's problems. We believe that "compensation is a philosophy, a strategy and a solution." It is a tool that can be utilized to help you win the talent wars in the New Economy, the Next Economy, and whatever lies ahead.
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