Share Grants to Employees Confirm Trend Away from Stock Options

Equity awards continue shift toward time-restricted and performance-restricted shares

By Stephen Miller, CEBS Dec 22, 2011

After peaking in 2009, the proportion of a company’s outstanding common stock shares that were designated for grants to employees as incentive compensation (known as the "share utilization rate") returned to steadier levels as economic conditions improved, according to a study by HR consultancy Mercer released in December 2011.

Shares awarded to employees in the U.S. as compensation fell to 0.95 percent of outstanding shares in 2010 from 1.25 percent in 2009 and 1.02 percent in 2008. During the same period, the percentage of market capitalization used to compensate employees remained fairly constant, hovering at 0.5 percent.

Mercer’s U.S. Share Utilization Study measured the effect of equity-based grants to employees from the perspective of share usage and economic value transfer. The study was based on the most recent proxy filings and annual reports from 350 publicly traded companies in the U.S.

“With respect to share utilization, this last fiscal year can be called a ‘return to normalcy’ as the economy improves,” said Ted Jarvis, leader of Mercer’s data research and publications team. “The fact that the economic value transferred to employees during this time stayed consistent suggests that companies increased the number of shares awarded to employees during 2009 to adjust for falling share prices, then reverted to a more sustainable granting level in 2010. Of course, the highly volatile equity markets in 2011 suggest this stability may be transitory and our definition of what is ‘normal’ needs to change.”

Continued Shift to Full-value Shares

The composition of equity awards has continued to shift away from stock option awards toward full-value stock shares (and in particular time-restricted stock and performance-restricted stock) over the studied three years. In 2010, more than half of equity awards (52 percent) were granted in full-value shares, up from 44 percent in 2008.

While this trend applies to companies of various revenue sizes, Mercer’s study found a slightly greater proportion of full-value share awards among small companies—55 percent among the smallest 150 companies surveyed compared to 50 percent among the largest 50 companies in the study.

Moreover, this movement toward full-value shares was reflected in the design of equity compensation plans. Virtually all companies surveyed (99 percent) allowed full-value shares as part of their programs, and the use of caps on the number of allowed full-value share awards decreased slightly from 31 percent in 2008 to 29 percent in 2010. Companies are turning to fungible plans that allow for the use of stock options and full-value shares as compensation vehicles yet limit the use of full-value shares by depleting the reserves at a greater than one-to-one ratio. According to Mercer’s study, fungible plans have increased in prevalence, up from 20 percent of companies surveyed in 2008 to 28 percent in 2010.

“It’s not surprising that companies continue to move toward full-value shares, but at this point we don’t believe this shift can be attributed to fallout from the change in accounting protocols,” said Jarvis. “The impact of that change occurred primarily in the years immediately following mandatory expensing of stock options.

“We also don’t expect options to disappear from the compensation landscape for senior executives,” Jarvis continued. “In our study, larger organizations tended to hold on to their option-based programs and, on the whole, companies preferred to retain some flexibility in their equity plans.”

Impact on Shareholders

The dilutive impact of all outstanding options and unvested shares from employee awards dropped to previous levels, down to 5.5 percent of common shares outstanding in 2010 after peaking at 6 percent in 2009.

Potential total dilutive impact—which takes into account shares that remain available for future issuance and any requests to shareholders for additional shares—was 11.2 percent of common shares outstanding. This figure, which was slightly higher in 2008 (11.6 percent) and 2009 (11.5 percent), might be caused in part by a decrease in new share requests, down to 23 percent in 2010 from 31 percent in 2008 among the companies studied. However, new share requests as a percentage of common shares outstanding increased from 3 percent in 2009 to 4 percent in 2010.

“Companies that requested more shares in 2010 may have been making up for share depletion from the high share utilization rates in 2009,” explained Gregg Passin, leader of Mercer’s U.S. executive remuneration consulting business.

The New Normal

While 2010 patterns closely parallel those prior to 2009, it is difficult to ascertain whether they reflect a steady state. Economic conditions are by some accounts improving, but the improvement has not been consistent and has failed to secure consumer confidence.

“The ‘new normal’ is likely to be more volatile and, in the midst of more regulation and greater shareholder scrutiny, this will put more pressure on companies to manage their granting practices and equity reserves,” said Passin.

Stephen Miller, CEBS, is an online editor/manager for SHRM.

Related Articles:

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

Companies Enhancing Stock Plan Offerings to Employees at All Levels, SHRM Online Compensation Discipline, November 2009

Bringing Underwater Stock Options Back to the Surface, SHRM Online Compensation Discipline, February 2009

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