Who doesn't love a choice? Would you go to a restaurant with only one menu item? Shop at a store with only one pair of pants? Some plan sponsors are wondering why equity compensation plans should be any different. Empowering participants to make the most of their equity compensation plans by selecting the makeup of their long-term incentives is a growing trend, but one that generally shouldn’t be taken lightly. Check out these ABC’s if you’re considering an equity choice plan.
A – Awareness
It’s important to ground yourself in the basics of equity choice plans, especially what exactly we are talking about here, and who else is doing it.
What: Most plan sponsors use a primary vehicle, either restricted stock units (RSUs) or stock options, to deliver a target value to plan participants. While companies may use a mix of vehicles for a small subset of employees, often executives, the majority of equity awards generally take a single shape – either stock options or restricted stock. Equity choice plans allow the broad participant base, or a subset of participants, to select the composition of their equity awards – usually all stock options, all restricted stock, or a mix.
- Because the fair value of stock options is different than restricted stock, a ratio may be used to equalize the value at grant.
- Often the ratio is based on the Black-Scholes value of the stock options.
- If the Black-Scholes value of the stock option is 1/3 the value of the restricted stock, an equity choice plan might let a participant choose 3,000 stock options, OR 1,000 restricted stock units, OR, 1,500 stock options and 500 restricted stock units.
Some plans may allow for other allocations, but all combinations will generally have the same fair value at the time of grant. It is also possible to include a cash option; however, cash alternatives don’t carry the same benefits of employee ownership and stock price connection, and cash payouts impact company cash flow.
Who: There are two parts to the “Who” question: Who offers choice and who gets to make a choice. Equity choice plans play a relatively small role in the equity compensation landscape. In 2016 (the last year for which data are available), just 6% of plan sponsors offered a choice in their equity plans. It is notable, however, that the figure doubled from only 3% in 2013.* In the years since, Fidelity Stock Plan Services has seen growing interest in our client base.
Data aren’t currently available regarding who gets to make a choice, but observations of Fidelity Stock Plan Services clients include companies who extend a choice to all equity participants, companies who offer the choice only to executives, and companies who offer a choice to everyone except Section 16 officers.
B – Benefit
It’s important to understand the benefits – and the potential drawbacks – of offering equity choice.
Why: If you step back from a myopic view of equity compensation, you’ll see choices scattered across the benefits landscape. Generally employees choose to participate in their 401k, opt for a deferral amount, and select from a range of investment options. Most employees can choose from a variety of health plans, ranging from a PPO to a high-deductible plan. Your executives may choose to participate in a deferred compensation program. Why do companies offer employees these choices? Because different employees have different needs and preferences. And, it’s no different with equity compensation. At the most basic level, restricted stock may appeal more to your employees who value certainty, whereas stock options may appeal to employees with a higher risk tolerance.
Why Not: At first glance, allowing employees to choose equity awards that are aligned with their own risk tolerance may seem like a grand idea, but it’s important to consider the flip-side. In most cases, there is what turns out to be a “right” and a “wrong” choice, though the “right” choice doesn’t reveal itself until after the choice is made; the future stock price is the deciding factor.
C – Communication
The good news is that the risks of choice plans can be mitigated significantly with a robust communication and education program. The key is to help employees truly understand all of the potential future outcomes so they feel empowered to make a choice that’s aligned with their own risk tolerance, and a choice that they can “own” regardless of the stock price performance.
Because these employee choices can have a meaningful impact on future payout, it’s important that a comprehensive communication plan is in place. One key component of a successful equity choice communication plan is an easy-to-use (and -understand!) modeling tool. Allowing employees to see the outcomes of possible choice elections at different stock price targets (both appreciating and depreciating) can help cement the impact of different choices. An engaging, custom, multi-channel communication and education program, including video, print, live workshops, webinar, and targeted messaging can be a great way to build enthusiasm, increase knowledge, and help employees make confident, informed decisions.
The choice to offer choice plans lies with the plan sponsor, and the ultimate choice lies with the participant. Is your company ready to choose choice?
* 2013 and 2016 Domestic Stock Plan Design Surveys presented by The National Association of Stock Plan Professionals and Deloitte Consulting LLP
By Emily Cervino, CEP, Head of Industry Relationships and Thought Leadership at Fidelity Stock Plan Services
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