April 26, 2013
According to the 2012 Equilar S&P 500 CEO Pay Strategies Report, stock and option awards represent approximately 63.0% of the value of a CEO’s total compensation. Analyzing this portion of CEO pay provides insight into the long-term incentives that drive many executives’ decisions. Although equity is a significant percentage of CEO pay, executives often do not receive the full value of such awards at one time. The process by which an executive is eligible to realize value from an award is referred to as vesting.
Equilar examined time-vesting equity awards granted to S&P 1500 CEOs during 2012 as disclosed in Form 4 filings. This study revealed the most common vesting types, vesting periods, and other trends related to the vesting schedules of equity awards.
Approximately 78.0% of equity awards had a graded vesting schedule.
45.3% of options and 48.6% of stock awards were granted with three-year vesting periods.
Over 80.0% of graded stock and option awards vest in annual increments.
Equity grants are generally composed of stock and option awards. For this study, units were included as part of stock, and stock appreciation rights were included as part of options. Equity awards either vest all at once, known as cliff vesting, or in increments over time, known as graded vesting.
The figure below shows the breakdown of S&P 1500 CEO equity awards into equity and vesting types.
More stock awards were granted than option awards, comprising 55.5% of the total equity granted, as compared to 44.5% for options. This is consistent with the 2012 Equilar S&P 1500 Equity Trends Report, which noted that 96.1% of companies granted stock, but only 73.1% of companies granted options. The percent of options granted will typically be larger, since more options must be granted in order to equate a similar value of restricted shares.
Both types of awards primarily had graded vesting schedules, rather than cliff vesting schedules. For stock awards, there were about twice as many grants made with graded vesting than cliff vesting. Even more prevalent, 93.2% of option awards were granted with graded vesting. In general, 78.0% of all time-vesting equity awards had graded vesting schedules.
Vesting Across Sectors
The percentage of each vesting type across sectors is shown in the graph below.
The Financial and Utilities sectors granted the most stock to CEOs, representing 66.5% and 80.0% of each sector’s total equity granted, respectively. In the Utilities sector, the percentage of cliff stock granted was nearly twice as much as any other sector. However, the percentage of graded options was less than half that granted by almost all other sectors. In addition, the Utilities sector also had the highest percentage of cliff vesting equity at 44.0%, while the Technology sector granted the most equity with graded vesting at 87.6%. With regard to cliff options, the Consumer Goods industry led with 8.3%, which was considerably more than the second highest sector, Basic Materials, at 4.9%. Not surprisingly, executives in more stable sectors, such as Utilities and Consumer Goods, are more likely to have cliff vesting schedules. This practice promotes retention as it requires executives to stay longer to receive any value from the awards. In comparison, within more volatile sectors like Technology, graded awards are more typical. These companies provide a greater percentage of pay in equity providing opportunities for employees to realize some of the value throughout the vesting period.
Vesting Across S&P Indices
A distribution of the vesting types within the S&P 1500, LargeCap, MidCap, and SmallCap is displayed by the graph below.
Companies within the MidCap and SmallCap granted a slightly higher percentage of stock awards than those in the LargeCap. While the MidCap and SmallCap granted a similar percentage of total stock, the SmallCap granted a higher percentage of graded stock. The percentage of graded options awarded by LargeCap companies was also relatively large, nearly 10.0% greater than that awarded by SmallCap companies.
A distribution of vesting periods within the S&P 1500, LargeCap, MidCap, and SmallCap is displayed in the graph below.
A majority of stock and option awards vest three to four years after the grant date. Approximately 60.0% of cliff-vesting stock and options had vesting periods of three years, three times more than the next most prevalent cliff-vesting period. Graded stock and option awards were more balanced between three- and four-year vesting periods. For example, 43.4% of graded stock vests in three years, while 34.9% vests in four years. For graded options, the percentage of three- or four-year vesting periods differed by less than 2.0%, at 44.2% and 42.4%, respectively.
While the most prevalent vesting periods were three or four years, certain companies such as Strayer Education, Healthcare Realty Trust, and Comcast granted equity awards with longer vesting periods. The CEO of Strayer received a stock award that cliff vests after seven years. Healthcare Realty provided its CEO a stock award that vests in full after eight years. Comcast granted its CEO an option award that vests over ten years, in annual increments.
Across sectors, vesting periods are typically three to four years. However, the Healthcare sector granted cliff options with five years as the most common vesting period. Granting graded awards allows companies to give awards with longer vesting periods, since executives are able to receive a portion of the award value earlier. Granting cliff awards means that executives must stay at the company for the entire vesting period to receive the value. Consequently, companies generally grant cliff awards with shorter vesting periods.
Graded Vesting Breakdown
Graded awards were further categorized by the schedule by which they vest. Because the vesting increments varied in length, they were divided into Annually, Semi-Annually, Quarterly, and Monthly periods. In addition, situations where 1) the first increment vests more than a year after being granted and continues to vest in equal increments thereafter, or 2) a substantial portion vests in the first increment and the remainder continues to vest afterward, were classified as Cliff+Annually, Cliff+Semi-Annually, Cliff+Quarterly, or Cliff+Monthly. A category breakdown of graded vesting is displayed in the table below.
More than 80.0% of graded stocks and options vest in annual increments, and approximately 4.0% vests Cliff+Annually. Options were more likely to vest in monthly increments, as 6.8% of graded options had Monthly or Cliff+Monthly vesting, versus a combined 0.2% for graded stock. The fact that the vast majority of companies grant awards that vest annually indicates that companies desire to implement simpler vesting schedules. Infrequent vesting is more simply administered and easier for employees to understand.
Please contact Dan Marcec at email@example.com for more information. Dan Marcec is the Director of Content & Marketing Communications at Equilar. The contributing authors of this paper are Christopher Chin, Project Manager, Felicia Wong, Senior Analyst, and Ankur Prabhakar, Research Analyst.