Option Adoption

October 11, 2017

Equity as compensation warrants a rethink.

Stock options gained popularity in the 1950’s and conventional thinking was that equity compensation aligned the interests of executives with those of shareholders (the agency theory). It also appealed to baby boomers by rewarding loyalty and gaining them entry to the shareholding classes. Vesting provisions supposedly encouraged retention but boomers were already loyal to their company pension and needed little further incentive. The biggest attraction was the preservation of cash (and beneficial tax treatment for the corporation when options were exercised).

Over the years design variations, the associated administration, and compliance requirements developed by Governments to keep pace and prevent excess led to high priced consulting help monitoring competitive practice, performance, and governance.

Younger, soon to be executive employees view work as a commodity with a shorter shelf life. To retain their engagement and motivate their behavior pay components must be perceived as valuable. Vesting payouts over several years for example will are less an “incentive to remain” than frustrate enjoyment of the fruits of their labor. Vesting distances reward from performance and adds further to this divide when payout exposed to market volatility. Would a company want to risk its engaged workforce to the leadership of someone who may feel even slightly cheated?

Studies tell us that recipients mark down the value of deferred pay more than the economic models used to develop them, partly because they assume that they will not be around to collect and partly because of the perception that these are devices used by employers who lack the wherewithal to pay the freight today.

Simpler incentives involving less extraneous risk directly aligned with objectives and values may improve ROI and engagement.

As organizations recognize the power of teams internal equity becomes as important a consideration as absolute levels of pay. “Felt Fair Pay” amongst team members improves engagement and productivity. Executive pay determination perhaps overly influenced by governance or compliance has become detached from engagement thinking and intrinsic motivators and has consequently lost some of its impact.

Notwithstanding long term aspirations short term performance defines organizational success and a CEO’s tenure. Excessive CEO compensation often caused by the future value of deferred pay, results from efforts to mitigate this risk. Perceived excessive CEO pay absolute or relative will undermine brand and engagement. Long term compensation performance is undermined by activities (cost-cutting and downsizing) in conflict with sustainability to improve short term performance.

Millennial employees have similar aspirations to their predecessors; purpose in their work, to be paid proportionately and to progress through the organization. Unlike their predecessors however, they are likely to communicate directly what they want and to expect an honest response. Long term compensation too must be subject to transparency, authenticity, and direct alignment.

Compensation models linked predominantly to compliance and deferrals other than for companies that have yet to reach maturity may have diminishing motivational impact. Shareholders however, will continue to want to see a portion of executive net worth in the company and stock purchase plans may yet have a bigger role to play. 

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