Equity effectiveness: creating alignment and value with your equity compensation plans

Transcription

1 Equity effectiveness: creating alignment and value with your equity compensation plans Jim Sillery and Sandra Sussman October 25, 2012

2 Seeking equilibrium Equity effectiveness is the point of equilibrium in share utilization: Effectiveness refers to both: Grant efficiency (tax/accounting/dilution) Motivational value Optimum utilization occurs when the return (motivational effect) outweighs the cost (dilution, expense and administration) Equilibrium point is where strongest correlation between share utilization and total shareholder return occurs 2

3 Achieving equity effectiveness During the 1990s, achieving equilibrium was easy, with little or no concerns about: Run rates Overhang Expense Allocation Motivation 3

4 Achieving equity effectiveness In the years following the recession, optimization was more difficult: Economic pressure drove increased diversification in the use of equity plans Changes felt across many participation levels and geographies For a long time, the solutions were simple 4

5 But no one expected The recession was unprecedented in: The depth of its decline The duration of its decline Its global economic impact And had a profound impact on equity compensation programs 5

6 Real S&P 500 Index Compensation practice Why was this a surprise? Are the foundations of global equity programs built on an anomaly? $1,000,000 $100,000 Growth of $10 invested in the Total S&P500 Index starting in 1900 $10,000 $1,000 Long-Term "Equilibrium" Total Return Index: 9.30%/Yr Total Price Index (Dividends Reinvested) The birth of global equity $100 $10 $ Year 6

7 Potential disconnects of today s reality with conventional wisdom Accountants vs. entrepreneurs Data vs. facts Option in March 2009 with strike of $4.00 < option in March 2012 with strike of $20.00 Surveys are reliable source of information for compensation comparison and planning Reciprocity vs. incentive Timing is everything Equity grants are powerful motivators, especially when based on performance Stocks for the Long Run 7

8 Current state 8

9 Understanding the disconnect: right-brain vs. left-brain In design and delivery of equity programs: Left is dominant: Tax Accounting Compliance Right is dormant: Perceptions Behaviors Culture 9

10 Left-brain: determines what an equity grant is worth We use complex models to calculate stock option value But restricted stock is the face value at grant Performance shares are the possible delivered value What about long-term cash? So, what is the total value delivered at grant? 10

11 So at the date of grant, what is the perceived value? Value of Stock Options vs. Restricted Stock $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 Grant Stock Options Restricted Stock Assumes ratio of 3 stock options for exery 1 restricted share Value of Stock Options vs. Restricted Stock $120,000 The answer is simple it depends $100,000 $80,000 $60,000 $40,000 $20,000 $0 Grant Stock Options Restricted Stock Assumes ratio of 3 stock options for exery 1 restricted share 11

12 But what does perceived value depend on? Work culture Personal biases and experiences Generational differences Global cultures 12

13 Work culture Alignment of equity compensation practices with both business strategies and work culture is critical for successful change and work force commitment to the change. 13

14 Perceptions and behavioral economics The three main themes in behavioral economics are: People often make decisions based on rules of thumb, not rational analysis The way a problem is presented will affect the decision a person makes on how to act There are behavioral explanations for observed market outcomes that are contrary to rational expectations and market efficiency 14

15 Behavior and behavioral economics Behavioral economics provides us with insight into employee perceptions: Mental accounting -- What is this grant worth now? Loss aversion -- What if it goes underwater? Hyperbolic Discounting -- But, when do they become mine? Decision paralysis -- What if I don t know how to decide? Regret aversion -- What if I make the wrong decision? Overconfidence -- This should be easy!!!! Following the herd -- But it s a best practice 15

16 Behavior and generational differences Generational differences manifest themselves in several ways, including how individuals view their compensation There is variation in the nature of intrinsic rewards each generation considers The generations also relate to their organizations differently 16

17 Implications on perceived equity values Baby Boomer: Optimistic + Involved + High Risk/High Rewards = Preference for highly leveraged grants like stock options Generation X: Cautious + Conservative + Distrustful = Preference for low leverage grants like service-based restricted stock Generation Y: Realistic + Confident + Career Focused = Preference for moderate leverage grants like performance shares 17

18 Behavior and global culture Culture is the underlying value framework that guides an individual s behavior Small Power Distance Hofstede Cultural Dimensions Big Power Distance Culture reflects perceptions, social interactions and business interactions Culture guides the selection of appropriate responses in social and business situations Individualism Masculinity Strong Uncertainty Avoidance Collectivism Femininity Comfort with Uncertainty Long-Term Orientation Short-Term Orientation 18

19 One company, one plan? European Countries 70 World Average PDI IDV MAS UAI Latin American Countries PDI IDV MAS UAI LTO United States PDI IDV M AS UAI Asian Countries PDI IDV MAS UAI LTO Source: Geert Hofstede Cultural Dimensions 10 0 PDI IDV MAS UAI LTO 19

20 Achieving equity effectiveness If this is what an understanding of employee behavior tells us, then how should we act today? By left-brain: Accounting Tax Compliance And right-brain: Perceptions Behaviors Culture 20

21 Looking ahead at equity effectiveness 21

22 But, how do we make this work? First, ask five simple questions: What does our participant group look like? Is our plan aligned with our work culture? How should/does the plan work? What behaviors and outcomes do we want to drive? Are we meeting the needs of all constituencies? 22

23 % of Target Payment Received Compensation practice But, how do we make this work? Creating Line of Sight Pay for Performance Workforce Analysis 300% 250% Wealth Creating Alignment 200% 150% 100% ROI Analysis TSR 50% Work Culture Diagnostic 0% 70% 80% 90% 100% 110% 120% 130% % of Goal Achieved Retention Design Outcome Analysis Creating Value 23

24 Workforce analysis An analysis of workforce demographics can provide insights into who your employees are, how their perceptions are formed and how you can manage those perceptions 24

25 Work culture diagnostic A company s work culture defines How it is organized How roles are defined Who succeeds How performance is managed How people are rewarded Using a series of diagnostic tools to assess the current, and desired, work culture to ensure that equity grants are creating alignment with those attributes that have the greatest impact on performance 25

26 Pay for performance analysis There is a range of metrics associated with value creation. Some like Free Cash Flow are drivers of future value while others like TSR measure the value created 26

27 Pay for performance analysis A pay for performance analysis looks for the cause and effect relationship between the plan design and desired/final performance outcomes This analysis ensure that there is a direct correlation between key financial, economic and behavioral factors and desired/realized outcomes 27

28 Design outcome analysis TSR Distribution Performance-based incentives can and often do have unintended consequences The design outcome analysis allows a company to look at the inner working of a plan before it is implemented 0.5% 0.4% 0.4% 0.3% 0.3% 0.2% 0.2% 0.1% 0.1% Simulation Theoretical 0.0% -200% -100% 0% 100% 200% 300% 400% 28

29 Design outcome analysis By running multiple scenarios of potential outcomes, this analysis can quickly pinpoint if and where plan design may deviate from plan intent so that it can be recalibrated Rank Distribution Vol 50% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% 90.00% % Rank 29

30 ROI analysis The ROI Analysis looks at the end-of-plan return to all stakeholders: - Shareholders - Company - Participants This provides a key look at the effectiveness of the equity plan was there equilibrium between the return to shareholder and the company (left brain) and the return to the participants (right-brain) It also provides valuable feedback to enhancing future plan effectiveness 30

31 ROI analysis The success factors considered in this analysis can and will vary across organizations and their constituencies - Companies may define success in terms of a combination of cost, retention, recruitment, commitment, market position and/or other factors - Shareholders may define success in in terms of increased share price relative to dilution, dividends and/or other factors - Participants may define success based on delivered value compared to date of grant value, stock ownership, long-term capital accumulation, financial security and/or other factors These success factors should be identified at the onset, checked on an ongoing basis to confirm their continued relevance and then measured at the end of the period 31

32 Parting thoughts Technical aspects of equity are important, but not enough To understand perceived value, a better understanding of the global workforce is needed Value is perceived, not calculated Classical rational decision-making is not the model for actual employee decision-making Triangulate to get answers rather than focusing on the single best base of information Design simplicity should be an imperative More intuition, less conventional wisdom 32

33 Questions Jim Sillery Principal Sandra Sussman Director