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Value of Stock-Based Incentives Overlooked

As with other rewards, employees won't appreciate what they don't understand

April 7, 2014 | Joanne Sammer

Financial advisor Timothy R. Golas recalls how an employee left one company to accept a job with another firm offering a $20,000 pay increase. In doing so, that individual left behind unvested stock options his employer had awarded him as part of a stock-based incentive plan. The value of those options was more than $200,000.

There is a simple reason why this happened: The employee did not have a clear understanding of his stock options, their value or how they work.

If he had realized what he was leaving on the table, “he would have stayed with his current employer and likely would have felt more valued and motivated in the process,” said Golas, a partner with Spurstone Executive Wealth Solutions in Avon, Conn. “In the end, however, the company lost talent and the employee lost a substantial asset.”

Although stock-based "equity" compensation has become a mainstay in pay packages for certain levels of employees, the understanding of these rewards, their value and how they work has not necessarily kept pace. As a result, employers risk losing or diluting the incentive and motivation these pay vehicles are designed to create.

“You can design the most brilliant stock-based compensation program in the world,” said Gregg Passin, U.S. leader of the executive rewards practice at Mercer in New York. “But if the people who are in the plan do not understand it, that plan is probably going to be ineffective.”

Recognize Knowledge Gaps

Two recent studies show that employees receiving stock-based compensation often lack the necessary understanding and information to manage this reward effectively. Moreover, employees recognize this, want more information about stock-based pay plans and are relying on their employers to provide it.

One study, conducted in 2013 by Morgan Stanley Global Stock Plan Services and Matthew Greenwald & Associates Inc. with 750 stock plan participants, found that while 89 percent of respondents felt employers should play an important role in providing education and guidance on how a stock plan works, only half said their employers had done an “excellent” or “very good” job of doing so.

Another 2013 study, conducted by UBS Wealth Management Americas with 579 stock plan participants, found that:

26 percent of participants perceived high or considerable value from their equity-based pay, while 43 percent perceived minimal or no value from these rewards.
47 percent viewed their equity awards as a way to build wealth.
36 percent saw them as a supplement to their normal paycheck.
17 percent considered them a “lottery ticket” that may or may not pay out.

Clearly, lack of knowledge about stock-based pay hinders not only employee use and management of these rewards, but also how effective these rewards can be in motivating performance.

Educate Proactively

To address these awareness gaps, employers need to customize their approaches. Educating participants through a one-size-fits-all model is “not enough, and in some instances it could be downright ineffective or irrelevant to certain individual participants,” said Michael Barry, head of UBS Equity Plan Advisory Services.

Barry suggested surveying employees about their stock-based rewards to identify what they do and do not understand about these plans. With that insight, the employer can develop an appropriate approach to providing relevant information.

The education required is likely to depend on the type of awards that are being granted, employees’ past experience with stock-based rewards and the level of the employees involved. After all, an employee who has not received stock-based rewards in the past is likely to require more basic education than employees who have experience receiving and cashing in these rewards.

Even if an employer offers one-on-one access to financial advisors as part of the stock-based pay program, some participants may need some baseline education just to feel confident asking an advisor questions about the role of stock-based rewards in their overall financial situation and other issues.

Executives are not exempt from the need for education. “Successful executives are very busy and often don’t have the time to evaluate, analyze and research the information they need to fully understand and maximize their benefits,” Golas said. But no matter who is involved, this education should be as customized and interactive as possible.

Although senior leaders are generally more business-savvy than most, they do not live and breathe stock-based compensation programs the way HR professionals do. “Executives and employees need to understand the objective behind the stock-based plan, what exactly the company is striving for and what they need to do to earn rewards,” Passin said. “Even operating executives do not deal with performance shares or stock options every day, so you have to explain them. It is important not to take anything for granted here.”

Foster Informed Decisions

These education programs should convey a range of information. For example, employees need to understand how their benefits are valued, what events impact or put that value at risk, the tax implications of cashing in these rewards, and what these rewards mean to their own private financial planning.

“Once they better understand how the vehicles work, they can also be informed of strategies that can aid in hedging tax exposure, reducing risk and possibly improving long-term results,” Golas said. “In order to do this, it makes sense for companies to leverage technology and talent to educate in small-group or individual formats.”

One thing HR professionals should not worry about is getting people’s attention. “You would be surprised how people make time when it comes to their compensation,” Passin laughed.

That leaves only the need to act. Given the value of stock-based rewards, it would be shortsighted to overlook this education. “If the company is investing millions of dollars into the benefits but not getting full engagement and understanding from executives, what value are all parties really achieving?” Golas asked.

Joanne Sammer is a New Jersey-based business and financial writer.

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