May 16, 2016
Compensation programs are particularly challenging to manage during sensitive scenarios such as M&As, spin-outs, financial restatements or terminations. These situations cause concern among companies, since there are a number of elements to be considered that may affect how well a transition will be processed.
Equilar recently hosted a webinar with Nathan O’Connor, Managing Director of Valuation Services at equity methods and Damien Yu, Principal at Hugessen Consulting, to highlight relevant economic and governance considerations that companies should take into account when making policy decisions related to these sensitive transition scenarios. The panel highlighted four unique transition periods that influence executive compensation, detailed below.
New Hire Grants
A complete review of all contract provisions is required whenever a new employee is hired. Essentially, companies must impose a balance between keeping the executive content with his or her new compensation plan and managing the overall expense of the package. Oftentimes, this comes down to awarding executives with either fixed-value or fixed-share packages. In fixed-value, the total cash value of the award is set, and the number of shares granted are backed into based on grant-date fair value. In fixed-share, the total number of shares awarded is set based on internal metrics or calculations, but the accounting value can change.
“We’ve seen a lot of companies to take a fixed-value approach to manage risks, then manage the incoming executive’s expectations actively up front,” explained O’Connor.
Change-in-Control (CIC) benefits give executives protection to focus on a pursuing transaction that is in the best interest of shareholders. Triggers, typically tied to severance payment or favorable treatment of equity, define when a CIC provision will kick in. Overall, institutional shareholders want to see the definition of a CIC to be tight, in that there is an actual CIC event taking place and not perceived to be occurring, such as an announced transaction that never comes to fruition. When an executive resigns or is terminated for cause, whatever outstanding awards that has not been vested would be forfeited. However, under CIC, when the triggers have been met, unvested equity could be subject to a range of treatment. In general, fully accelerated vesting is the most commonly used approach in stock options, restricted stock and performance awards.
“Shareholders believe acceleration has the effect of waiving the time requirement on options and the performance requirements on PSUs, so what they really would like to see is a rollover,” said Yu.
A clawback policy is triggered if a restatement is required due to the material noncompliance of an issuer with any financial reporting requirements. In anticipation of the final SEC release on the rule, clawbacks will need to go beyond fraud and include any restatement, even if fraud was not involved. Determining clawbacks on the accounting side are relatively simple to deal with; however, clawbacks on market prices pose a challenge. Stock prices will move up or down over time due to a wide range of market, industry and company specific factors, and it’s difficult to tell what the stock price would have been had the numbers been correctly stated originally.
“We need to be able to understand how the misstatement impacted the stock price, as separate from the other market, industry, and company-specific factors that were in effect at the time to help understand the impact of these kinds of events,” explained O’Connor.
Among the many types of terminations, termination without cause is the most unique transition a company may face. Many criticize the fact that CEOs are paid very generously in severance and argue that it is contrary to the notion of pay for performance. While shareholders understand this is a traditional part of the corporate structure, it is also essential that companies not pay a terminated executive in excess. Overall, companies have to make sure their lawyers and accountants agree on what would happen to grants without a modification and also look for ways to be strategic about what particular kind of modification to implement, given the company’s unique circumstances and the structure of its awards.
To request to view the replay of the webinar, click here.
For more information on Equilar’s research and data analysis, please contact Dan Marcec, Director of Content & Marketing Communications at firstname.lastname@example.org. Amit Batish contributed to this post.