Equity Compensation Program Design: “How It Works”

Fred WhittleseyPay and Performance: The Compensation Blog0 Comments

Webinar this week:  Behavioral Economics and Equity Compensation, Part ISteve Jobs said that “It’s not just what it looks like and feels like.  Design is how it works.” He of course was talking about things like Macs and iPods (and, later, iPhones), but the same applies to equity compensation program design.

The current governance environment has drawn excessive attention to how equity compensation programs “look” and “feel.”  And the ever-increasing number of professionals labeling themselves as plan “designers” often focus on the look and feel of plan design.

The “look” part is features like types of award vehicles used, methods for allocating grants to employees, determining and reporting accounting expense, and dilution to shareholders. Increasingly, companies want their plans to look not too different from other companies’ plans.  Many would say that these characteristics, and the process of mimicking other companies’ programs, comprise “plan design” and the work that goes into this must then be the result of the efforts of plan designers.

The “feel” part is the arbitrary standards imposed by various proxy advisors, institutional investors, and other external parties:  overhang of 10% “feels” OK but overhang of “15%” “feels” too high. RSUs feel OK for non-executive employees but do not feel OK for executives.  These external forces have become significant factors influencing the design of compensation programs, becoming indirect plan designers.

It’s time to return our focus to “how it works” not just how it “looks and feels.” That requires a focus on strategy and behavior, not survey data, run rates, and accounting expense.

Since I introduced the concept of behavioral economics to equity compensation professionals during the 2008-2009 financial crisis and as a keynote session at GEO’s 2009 Annual Conference in Paris, I’ve continued my exploration of these ideas and how they can improve the effectiveness of equity compensation programs.  My book chapter in GEOnomics 2009 spurred a global discussion on the topic and resulted in some companies redesigning their program accordingly.

While many have focused on the communication and perception aspects of the behavioral economics concepts, I believe there are proven applications for equity compensation plan design as demonstrated around the world in the design of pension plans, savings plans, and healthcare benefits.

I will be doing a two-part webinar for GEO in September and October; the first on 28-September presents the key concepts of behavioral economics in easy-to-understand ideas and discusses how these concepts have been implemented. Attendees will learn how some program design features that we take as a “given” should be questioned in light of the ongoing research in the field of behavioral economics.

This discussion will lay the groundwork for Part II of the series on 26-October in which we’ll look at specific program features and discuss both how these influence behavior and how employee behavior actually affects the value of the equity instrument – producing a direct effect on the return on investment (ROI) to the employer.

With the continued and increasing scrutiny of equity compensation as a result of concerns about executive pay, it’s time to understand what plan design is, and is not, and how to understand how to make it work. Maybe we can turn equity compensation from a perceived source of risk and abuse into something cool.  Like an iPhone.

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