April 10, 2017
Over the past few years, the executive compensation landscape has grown more complex amidst the implementation of SEC regulations such as Say on Pay and subsequent scrutiny from shareholders and proxy advisory firms. These changes have affected how companies structure their pay packages in order to both attract and retain executives, and incentivize performance while satisfying shareholder demands.
Mega-grants—which were often used in the past as one-off awards to attract new executive hires—are facing increased scrutiny from both proxy advisors and the investor community. For example, Glass Lewis formally noted in 2015 that the firm would exercise enhanced scrutiny on mega-grants.
Granting front-loaded awards can be a risky strategy for companies. For instance, while a three-year mega-grant denominated in options can be a huge incentive for any executive to increase the company’s market value, volatility can cause the stock price to dip below the exercise price, thereby making the options worthless. In cases like this, the compensation committee would then face a dilemma, which then may force the board to either grant more equity to account for the gap (which could lead to equity dilution if the company has to consistently rely on granting extra equity), or reprice the options—neither of which would likely sit well with stakeholders.
While mega-grants were much more common in the 1990s, fewer and fewer companies are offering them. A recent Equilar study found that only three S&P 500 companies routinely structure their annual equity compensation as mega-grants. As with perquisites, the prevalence of mega-grant awards declined in the face of shareholder opposition and controversy over how they incentivize executives and generate value. Consequently, these changes have prompted shifts towards performance-based pay practices, turning away from so-called “excessive” mega-grants of stocks and options.
Indeed, as Equilar examined mega-grant prevalence for CEOs in the Russell 3000 over the past five years, the analysis found that just 66 total companies offered these types of awards since the passing of Say on Pay—and the prevalence decreased each year. In 2015, just 10 companies awarded mega-grants, down from 24 in 2011.
(Editor’s Note: For this analysis, a “mega-grant” is any grant of cash or equity intended to cover an executive’s long-term variable compensation over several years in lieu of annual long-term incentive grants.)
Despite this gradual decline in companies awarding these grants, the total number of mega-grants increased in each of the past two years, meaning more companies that choose to include them in their pay design have been awarding multiple grants. Of course, these aren’t necessarily all “routine” mega grants—that is, some companies only intend to structure it is as a mega grant one time (usually for retention purposes) before returning to granting equity every year. For example, Horizon Pharma (proxy filed April 7, 2016) granted five mega-grants to its CEO in 2015—these were time-based units, time-based options and performance-based units. There were three granted on one date and two granted on another—the three representing a grant meant to cover three years of annual equity and they also granted an additional “special” mega grant because of company performance after an acquisition.
Another notable trend found in the study was the significant growth in value for the mega-grants awarded in the Russell 3000. While overall grant size has fluctuated over the years, in 2015, the median of the 20 mega-grants awarded totaled $5.5 million, 4.1 times the median $1.3 million for the 24 awards in 2011. The average size of these awards was $11.9 million in 2015 and $4.0 million in 2011.
In each year of the study, options were the most common mega-grant award vehicle, and other than in 2014, options also represented the largest award value. There also has been a spike in the value of mega-grants awarded in the form of units, reflecting the increased focus on tying performance-based metrics to these equity vehicles.
The median mega-grant for CEOs in this study was provided in lieu of three years’ worth of annual awards, aligning with the most common performance period for long-term incentive plan awards. Mega-grants that cover more years are riskier. Nearly all mega-grants fell within a two- to five-year period, with the longest mega-grant period spanning 10 years.
Given the increasingly complex executive compensation landscape, one thing is for certain: As with the decline of mega-grants, other aspects of executive compensation will continue to evolve as companies formulate the best ways to attract, retain and motivate its top executive talent.
For information regarding the studies referenced in this post and to purchase the underlying datasets, or to learn more about Equilar Research Services, please contact the Equilar research team at firstname.lastname@example.org.
For more information on Equilar research and data analysis, please contact Dan Marcec, Director of Content & Communications at email@example.com. Richie Xu, research analyst, and Jen Estomba, Project Manager, contributed to this post.
WSJ - Fewer CEOs Are Receiving 'Megagrants' as Incentives
Hay Group - What You Need to Know About Stock Options
Hay Group - Executive and Director Compensation
Forbes - Son of Mega Grant
Radfor - Glass Lewis Clarifies Its Approach to One-Off Equity Awards for Executive Officers
Law 360 - A Checklist For Proxy Season Planning: Part 1