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Is it time for employers to rethink stock-based compensation for broad groups of employees? The answer depends on what the company wants to accomplish and whether stock-based pay is the best way to spur the employee performance to achieve those goals.
In the past, companies did not necessarily consider the link between their goals and their use of stock-based pay. In the boom years, it seemed that everyone was offering broad-based stock plans to keep up with peers. In other cases, startups offered employees stock because they were short on cash. As a result, some organizations “were using stock for the wrong reasons,” said Juan Gonzalez, a partner with Axiom Consulting Partners in Reston, Va. “There are situations where broad-based stock-based plans make a lot of sense, but there are a lot of occasions where they do not.”
Prevalence of Stock-Based Plans
Stock-based compensation takes several forms. Overall, “about one-third of the employees who work for a company that issues public or private stock own that stock in one way or another,” said Corey Rosen, senior staff member of the National Center for Employee Ownership in Oakland, Calif.
Perhaps the oldest way to provide stock-based compensation is through an employee stock ownership plan (ESOP). Generally, ESOPs are used to transfer ownership to the employees of a company. These plans tend to be limited to specific situations, such as when the owner of a private company retires and wants to liquidate his or her stake in the company by selling it to an ESOP.
During the dot.com bubble, offering broad-based stock options became the thing to do for many companies. However, Rosen noted that stock options peaked with 12 million U.S. participants in 2001 and declined to 9 million in 2006; since then participation has remained relatively steady. “Stock options became kind of a fad, and a lot of companies made one-time grants and then didn't do it again, so those programs never had much impact,” said Rosen. “However, companies like Whole Foods, Starbucks, Southwest Airlines, Google and many other technology companies offer stock options for reasons that are closely aligned with their philosophical and organizational approach.”
Employee stock purchase plans (ESPPs) that allow employees to buy stock at a discount cover approximately 11 million U.S. employees. Many companies maintain stock option and employee stock purchase plans with employee-participation rates of about 30 percent, said Rosen. Although these plans do not have much of a motivational effect, it is a benefit that companies can offer at low cost, he noted.
Finally, stock-based compensation can come through a 401(k) plan when a company matches or contributes to employee contributions in company stock. However, concerns about asset diversification in employees’ 401(k) accounts have caused many companies to scale back or eliminate this practice. Rosen noted that 401(k) plan assets invested in company stock and bonds peaked at about 19 percent around 2000 and stood at about 10 percent in 2012.
The Society for Human Resource Management's
Employee Benefits research report shows different numbers, with 10 percent of SHRM members reporting that their companies offered an
employee stock purchase plan while 9 percent offered incentive stock options, 8 percent offered restricted stock options and 7 percent offered nonqualified stock options.
No matter what type of stock-based compensation a company chooses, there are some ways to maximize the upside of these plans while minimizing the downside. Some suggestions follow.
Make sure that the company is offering the plan for the right reasons.
Competitive concerns for talent, the desire to offer broader ownership opportunities and keeping pace with industry norms are reasons to offer employees stock-based compensation. However, the key question is whether offering this compensation in cash or stock is the better choice.
For example, Gonzalez recalled a CEO who focused on stock-based compensation because he was a firm believer in wealth creation through stock-based rewards. As a result, he wanted to implement below-market base-salary compensation with higher stock-based incentive rewards. However, the talent the company was targeting had plenty of job opportunities that offered much higher levels of cash compensation. As a result, the CEO’s chosen solution was not appropriate for the target employee base.
To avoid this kind of misalignment, companies should start by developing a reward strategy to define the type of compensation that will attract and retain the talent that company needs. In addition, companies need to consider how that reward strategy will support desired business results. What impact will these rewards have on the business and employees? Companies can go astray when they decide on a reward solution without doing enough research to make sure that it represents the best vehicle to achieve their goals.
Make sure that employees understand the plan.
Stock-based plans can be complicated and confusing to some employees who might not understand fully how they work and, as a result, undervalue what these plans deliver. The stock plan should not be so complex that employees focus more on how the plan works than on how the business works and how employees can help the company achieve its goals. “You want them to focus on how they can impact long-term value creation and the fact that they will be well compensated for those results,” said Gonzalez.
Make sure that employees can impact performance.
Equity alone will not change employee behavior. By providing education and business literacy training to employees, companies stand a better chance of having stock-based rewards that drive better employee performance. Better yet, companies can “combine an equity plan with a high-involvement management program, self-managing teams and ad hoc employee committees, and open-book management,” said Rosen. “The key is to get employees more involved in decision making.” And to highlight the linkage between employee performance in support of corporate goals and equity incentives.
Added Gonzalez, a growing number of companies are taking a back-to-basics approach by restricting eligibility for stock-based compensation to individuals in positions that have true line of sight to the creation of value for the company and have an impact on company performance.
Joanne Sammer is a New Jersey-based business and financial writer.
Share Grants to Employees Confirm Trend Away from Stock Options,
SHRM Online Compensation Discipline, December 2011
Equity Incentive? How Perceptions of Employee Stock Options Affect Job Performance,
SHRM Online Compensation Discipline, April 2011
Study: Stock Options Improved Executive Performance, Had Minimal Effect on Rank and File Employees,
SHRM Online Compensation Discipline, August 2010
New Rules for Employee Stock Purchase Plans and Incentive Stock Options,
SHRM Online Compensation Discipline, February 2010
Companies Enhancing Stock Plan Offerings to Employees at All Levels,
SHRM Online Compensation Discipline, November 2009
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