VideoSuch low thresholds typically don't require any active buy-in from executives, who generally have up to five years after joining a company to meet the requirements. Some companies also allow executives to count a broad array of stock instruments toward their ownership quota, such as unexercised stock options, shares held in their 401(k) plans, shares held by spouses or children, and restricted shares that will vest months after the proxy filing.
One way to help mitigate the possibility of an executive selling and running is to add a requirement that executives hold a certain percentage of restricted shares and options as they vest, rather than liquidate them. Such "stock-retention guidelines" complement the salary multiples, says RiskMetrics's McGurn, because "if executives have been with a company for a long period of time, they've met the base [salary multiple] requirements, so that's not motivating for them." About 35 percent of companies have such holding ratios or required time horizons for holding the stock in addition to target salary multiples or shares, according to the Cook study.
Consultants Set the Bar
CFOs who have recently helped their companies craft guidelines say they simply follow consultants' advice and available benchmarks. At Landauer Inc., an $84 million maker of radiation-detection monitors, the compensation committee decided last fall to require executives to hold twice their base salary in company stock. "That seemed to be a reasonable requirement" based on advice from Hay Group, says CFO Jonathon Singer. The fairly low multiple is due in part to the fact that executives now receive restricted shares rather than stock options, which means fewer shares overall are available through compensation.
With a base salary of $236,716 last year, Singer is required to hold just under $475,000 worth of stock, the equivalent of 9,442 shares at the February 4 trading price. Thanks in part to a grant of 2,350 restricted shares when he joined in October 2006, which will count even though all haven't vested yet, Singer will likely fulfill his requirement this year, after less than two years at the company. However, he will still have to earn it, he says. Seventy percent of annual equity grants are awarded based on performance. "You have to look at it in the overall context of the compensation philosophy," says Singer. "The trade-off is how much compensation is performance-driven versus retention-driven, how much is for short-term performance versus long-term."
The Trade-Off
The biggest argument against making executives hold more stock, of course, is that in principle they, like all investors, should diversify their portfolios. "Any investor will tell you it's smart to diversify," says Jeffrey Jones, CFO of $828 million Vail Resorts Inc. "Managers should be able to do that without feeling they are hurting the company's future prospects." Pitney Bowes says explicitly in its proxy that it doesn't want executives overly invested in the company. "While [an executive] is not discouraged from increasing the absolute level of holdings of Pitney Bowes stock, the company does not want its stock to comprise a disproportionate percentage of the executive's net worth," it reads.
What are the perils of overinvested executives? One is that they might become more risk-averse and more afraid to spend money as they strive to preserve value, says Kay. Asking for too much stock ownership can also subvert the retention aspect of the shares. A policy that says executives must hold a high percentage of their vested shares until they leave the company "could create an incentive for executives to leave a company in order to cash out shares, which you don't want to do," says McGurn. In the extreme, high executive share ownership may create an incentive for fraud — or at least irrational behavior. Conseco, for one, went bankrupt even as its executives were borrowing on the margin to buy its stock, as CFO reported in April 2000 (see "A Good Deal Too Much").
In fact, some executives see the new guidelines as a desirable way to set boundaries on investor expectations. Having a preset expected level should "allow executives to sell and diversify at times" without the "angst" and "stigma" that can be attached to such sales, says Jones at Vail Resorts, which just last year implemented salary-multiple guidelines ranging from one to five times salary to conform to what its compensation consultant, Hewitt, said were best practices. As of last October, Jones held 88,801 shares (including vested options), about three times his requirement based on share prices at press time.
For the moment, investors don't seem to be using level of stock ownership as a key litmus test for the quality of corporate governance. Many think the guidelines are a step in the right direction and don't want to quibble about the numbers just yet. "It's important, but we don't necessarily maintain specific standard levels. You want to look at it on a company-by-company basis, and consider the tenure of executives," says McGurn. Other big investors and investor advisers, including TIAA-CREF and The Corporate Library, say the same. After unsuccessfully mounting a proxy proposal to make Dell executives and directors hold 75 percent of the stock granted to them, the American Federation of State County and Municipal Employees has moved on to other aspects of executive compensation, namely lobbying for bans on tax gross-ups and proposing limits on insider sales during company stock buy-backs.
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