Tools of

compensation

What is it?

Why do companies use it?

Limitations of the scheme

Multi-year

performance

plan

Multi-year performance plan is a plan that measures and pays for performance over a time-frame longer than a single year.

This is used to:

 Align short term and long-term performance and compensation pay-outs.

 Reinforce long-term planning and performance management processes.

 Motivate employees to deliver sustained, long-term performance and value creation and encourage them to become shareholders.

 Provide long-term capital accumulation opportunities tied to company performance.

Greater effort is required to manage and communicate this scheme to maintain its effectiveness as a performance incentive, i.e., executives feel their bonus are less secure and are unsure about the vesting or claw back of future payments.

Performance

share

Performance share is a conditional award of a number of common shares at the beginning of a performance cycle.

In this option, the number of shares payable at the end of the cycle depends on whether the agreed performance targets have been met. Typically, the performance/vesting period is three to five years and subject to forfeiture if recipient leaves the company before vesting.

 Setting accurate long-term performance forecasts can be problematic.

 Perceived value may be lower compared to restricted shares due to uncertain payment levels, i.e., share price could increase but gains could be zero if performance targets are not met.

Stock options

Stock options are a right to purchase shares of a company stock at a fixed price for a given period of time.

This links executive and shareholder interest since pay-outs only occur when stock price appreciates. Furthermore, the granting of stock options does not require an immediate cash outlay by the company and can be important to a cash-strapped start-up enterprise trying to attract top flight talent.

 High usage of shares are needed to deliver the same value compared to other long-term incentive mechanisms, which can lead to greater shareholder dilution

 Underwater options result in no value to employees and therefore no retention effect.

Restricted stock

Restricted stock is a conditional grant of actual shares of stock with vesting contingent upon continued employment for a specified period of time.

Typically, vesting happens after two to five years and subject to forfeiture if recipient leaves the company before vesting. Dividends usually paid during vesting period. Companies use this to provide opportunities for significant stock ownership in a short period of time and can be designed to encourage stock ownership.

In addition, some companies use this to improve top executive retention and drive up the competition’s cost of recruitment.

 It can be perceived as a giveaway unless tied firmly to performance.

 Units cannot be sold and usually do not count towards stock ownership requirements.