Editor's Note (Jan. 2012): While this FAQ was written after the stock market downturn of 2008 and 2009, renewed financial and economic uncertainty may continue or even amplify the stock compensation trends discussed here. When information starts to emerge about the impact of events in 2012 on company practices, we will update this FAQ accordingly.
Changes in executive compensation and equity pay practices stemming from the downturn of 2008 and 2009 were predicted to be far more extensive and vigorous than those caused by the 2000–2002 market drop. More companies were affected in 2008–2009, the drop in the markets was accompanied by a steep rise in unemployment, and stricter rules on disclosure and shareholder approval were already in place.
In general, during the recovery since 2008 the focus in stock compensation has shifted from adjusting grant practices for mandatory expensing to questioning how stock grants, particularly performance-based grants, should be used. In some cases, the downturn provided new lessons for employees with equity compensation. Quoted in The Wall Street Journal (Firms Rethink Compensation Plans, Feb. 17, 2009), one CEO said: "We built a performance-based system and there was a lot of risk in there, which I don't think we'd fully recognized because we'd never seen markets like this. To the management team, it was a very swift kick in the behind."
Beyond Underwater Options: Major Issues
Underwater stock options were initially a high-profile issue, though the impact of underwater options has faded somewhat as stock prices have recovered since their nadir in March 2009. Companies have been taking various approaches to underwater options, as another FAQ explains.
Beyond the question of underwater options, companies continue to shift toward more restricted stock/RSUs and cash, new goals for performance share grants, and the advantages offered by ESPPs. Some companies reconsidered the valuation approach they use to determine the size of new stock grants.
Many companies base grant sizes on either a target amount of compensation or a target number of shares (see related FAQs on these grant guidelines for stock options and restricted stock). In down markets, the problem for many companies involves whether to adjust the target dollar value of stock grants (converted into a specified number of shares/options/units) or to adjust grants that are usually a fixed target number of shares. Under the target value method, lower stock prices means companies need to grant many more options or shares to reach a target value. This, in turn, uses up shares much faster (i.e. increases the burn rate), raises dilution concerns, and creates too large a gain for executives if the price rises quickly. However, the target size approach, without an adjustment in the size, results in a grant with a much lower value.
What Companies Have Been Doing: Research And Analysis From Consulting Firms
Experts at consulting and research firms have been busily analyzing corporate stock plan practices since the economy changed in 2008.
 Towers Watson
In its Executive Compensation Bulletin (Dec. 2010), Towers Watson used data in the firm's Long-Term Incentive (LTI) Database to uncover trends that emerged during 2010. The authors found that since the market rebound the value of LTI grants had increased by 15% in total over the levels of 2009. The study found the following about stock compensation:
- There has been a move away from a prevalence of stock options in the LTI mix to a more balanced LTI portfolio. In 2010, 73% of companies granted at least two forms of equity (up 10% from 2009). The average senior executive (base salary over $300,000) at a large company received an LTI portfolio of 35% restricted shares/units, 33% performance shares, and 32% stock options.
- Restricted stock and RSUs were granted by 71% of the companies. Three quarters of them used time vesting. There was no increase in the number of companies that granted performance-vested restricted stock.
- Almost 20% more companies used performance shares in 2010 than in 2009: 35% of these companies granted performance shares in 2010, while 23% used performance cash awards. The most common metric in these plans was revenue, followed by TSR and earnings per share.
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Pearl Meyer & Partners
Surveys by Pearl Meyer & Partners in 2010 and 2011 offer a glimpse of the way companies may structure their executive pay practices and programs in uncertain economic and regulatory environments. (See also the firm's survey of 2009, discussed below.) The surveys included a variety of companies, from those in the Fortune 50 to nonprofits and high-growth companies. In general, the studies found that the economic and financial strife of the past few years is "dissipating" but that stock markets and the overall economy are not yet "back to normal." They also noted the growing "perceived importance" of setting goals and choosing metrics for incentive plans, resulting in a "more rigorous review process." Among the findings of interest for equity compensation:
- The trend away from plain-vanilla stock options and SARs continues, with restricted stock staying about the same, while there is a continued increase in stock awards with some type of performance measure. Large companies are allocating more LTI value to performance share plans, whereas smaller companies continue to emphasize stock options.
- Slight changes have arisen in year-over-year long-term incentive programs, with a decrease in company burn rates, an increase in the number of shares for executives, and a bigger increase in the economic value to executives.
- The percentage of companies providing full acceleration of all outstanding stock grants with a change in control (single trigger) has "fallen slowly but steadily," along with the percentage providing a full tax gross-up.
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PricewaterhouseCoopers
According to the 2011 Global Equity Incentives Survey by PricewaterhouseCoopers, "restricted share units were offered more commonly than stock options in 2009 and 2011 but restricted shares for the first time became more commonly used in 2011."
PwC's 2009 Global Equity Incentives Survey found that the downturn prompted numerous changes beyond just actions to remedy underwater stock options. PwC noted that the most frequently mentioned change was the replacement of service-based grants with grants based on performance conditions. The surveyed companies were asked what changes they would make to grant practices according to current market conditions.
| Outlook for changes |
Percent of companies |
| Changes are ahead, but still exploring alternatives |
45% |
| More performance-based restricted stock/RSUs |
27% |
| More service-based restricted stock/RSUs |
15% |
| Relaunch of ESPP (with or without redesign) |
12% |
| Cash or nonequity benefit instead of options |
12% |
| More performance-based than service-based restricted stock/RSUs |
8% |
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James F. Reda Associates
A study published by James F. Reda Associates in August 2009 reviewed proxy statements from almost 200 of the largest companies (by market capitalization) in the S&P 500, looking for changes in executive compensation practices. The firm reviewed proxy statements in the first half of 2009 for changes in response to the economic downturn and increased shareholder scrutiny. It found that 70% of 191 companies reported alterations. A majority of them made what the study deems a "major change." The greater the drop in stock price, the more likely it was that a company had modified its program. The study found that, in general, the equity compensation parts of incentive plans, at least for senior executives, were altered as follows:
- A shift from long-term to short-term incentive plans.
- Performance measures in long-term incentive plans shifted to capital efficiency (e.g. return on equity), cash flow, and total shareholder return.
- Companies increased emphasis on time-vested restricted stock and restricted stock units; the surveyed companies changed their LTI mix as shown below:
| Type of plan |
No. of reported increases |
No. of reported decreases |
Net changes |
| Restricted shares and units |
13 |
9 |
4 |
| Performance shares and units |
13 |
14 |
–1 |
| Stock options and SARs |
6 |
16 |
–10 |
| Total |
32 |
39 |
–7 |
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Buck Consulting
A March 2009 survey by Buck Consulting found changes in grants ("Taking The Pulse Of Equity Compensation," summarized briefly at the website Talent Management). It reported that decreasing stock prices at that time meant most companies would not make grants with the same equity values as before. Among its results:
- 31% of the surveyed companies expected to somewhat increase the number of options or shares in 2009. Very few intended to fully restore the prior year's value.
- At companies issuing equity compensation based on a number of shares, 60% anticipated no change in awards. At companies making grants on a dollar-value basis, only 30% expected no changes in awards.
- 45% of the surveyed companies were considering a change in the equity compensation mix.
- 29% said they would increase their use of shares and decrease their use of options.
- 16% said they would increase their use of options and decrease their use of shares. Buck Consulting noted that this creates the "possibility of delivering more future value from the increased number of options granted."
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Hewitt
Hewitt reviewed Form 4 filings made by S&P 500 companies in December 2008 through February 2009. The firm compared them with the prior year's grants to individuals in the same roles at the same companies, trying to measure how the downturn affected grants (Trends In Long-Term Incentive Design Practices And Award Sizes 2009, March 2009). Among the highlights of its results:
- The median decline in total median present value of stock options was 23%, and for restricted stock 25%, compared with a median stock price decline of 44%.
- The mix of stock options and restricted stock (not performance plans) stayed about the same, at 54% restricted stock and 46% stock options.
- Companies seem to lower the value of their LTI awards significantly after the stock price has declined by about 50%; the greater the fall in stock price, the greater the decline in LTI value. For example, companies with a fall in stock price of more than 50% had a 31% decrease in the economic value of their grants. However, those whose stock price declined by less than 30% saw their grant values fall by only 4%.
- To offset the substantial stock price declines, share use increased significantly for new grants even though they had a lower value than in 2008.
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Mercer
Among the suggestions that Mercer made to companies:
- Analyze the value of unvested awards under various stock price changes over the next two to four years. This is important in evaluating the role new grants need to play to retain talent. Unvested gains should equal two to four times base pay to counteract hire offers from competitors.
- Compare stock price changes relative to peers. If they have dropped more, companies need to use "proportionally more shares than your peers for this year, and vice versa." This analysis can also indicate what the share usage of your company's peers will look like this year and whether it needs to adjust grant levels for competitive reasons.
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Stock Grants Instead Of Cash?
In a throwback to the 1990s, some consultants have even suggested the use of stock options or restricted stock to replace portions of cash pay. This is the approach that Vail Resorts took, according to a report in the local newspaper Summit Daily (Summit County, Colorado), which included the open letter by its CEO that outlined the cutbacks. The company implemented a wage-reduction plan to keep jobs and save the company $10 million annually. To balance the lowering of wages, it issued restricted stock units (vesting a third of the grant per year) to all full-time year-round employees:
- full-time employees Grade 25: wage reduction of 4% but grant of RSUs worth 1.5% of pre-reduction salary
- full-time employees Grades 26 and 27: wage reduction of 5% but grant of RSUs worth 3% of pre-reduction salary
- full-time employees Grades 28, 29, and 30: wage reduction of 6.5% but grant of RSUs worth 4.5% of pre-reduction salary
- all executives: wage reduction of 10% along with grants of stock appreciation rights worth 7.5% of their pre-reduction salary
Executive Compensation: Initial Response To Market Fall
In 2009, the consulting firm Pearl Meyer & Partners surveyed corporate changes in plan design for executive compensation. Some of the key findings on stock compensation occurred in public companies' responses about implemented or contemplated changes to long-term incentive programs for executives. The table below indicates the percentage of companies that have made or are considering each change.
| Change |
Implemented |
Contemplated |
| Request more shares |
20.5% |
18.3% |
| Change perf. measures |
15.2% |
18.3% |
| New ownership guidelines |
9.7% |
15.2% |
| Change existing ownership guidelines |
4.1% |
15.2% |
| Switch from absolute to relative metrics |
7.4% |
8.8% |
| Lengthen perf. measurement period |
3.1% |
8.7% |
| Increase vesting period |
4.2% |
6.4% |
| Decrease vesting period |
6.3% |
3.3% |
| Reprice options |
3.6% |
5.8% |
| New "hold to retirement" provision |
0.4% |
7.5% |
| Switch from relative to absolute metrics |
3.4% |
3.0% |
| Shorten perf. measurement period |
2.2% |
3.9% |
| New "hold past retirement" provision |
1.3% |
2.6% |
Stock Ownership Guidelines
Given the popularity of the multiple-of-salary approach to ownership guidelines, problems arise when the stock price drops and executives find themselves out of compliance with the guidelines. Proxy disclosures in 2009 revealed that companies took a variety of actions, from revising their targets, suspending them, or giving executives additional time, to simply not making any changes at all. |
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