Progressive will put the change to a vote of shareholders during this meeting season, although it's not required to do so. They're likely to approve the measure, says Forrester. "We just think options are a bad idea," he says, "because they don't align the interest of employees and shareholders. Restricted stock moves more in lockstep."
Pay for Attendance?
But many compensation experts would dispute the notion that restricted stock is superior to stock options. As far back as the 1970s, they point out, restricted-stock plans were maligned by stockholders as "pay for attendance," since executives would receive a guaranteed payout no matter what happened to the stock price.
"I remember 10 or 15 years ago we were trying to get rid of [restricted stock]," says Blair Jones, head of the leadership performance and rewards practice for compensation firm Sibson Consulting. "The last time that stock options fell out of favor was in the '70s, and we had a flat market just like we do now. People were trying to deliver a lot of dollars to executives, and the stock-options vehicle wasn't doing it anymore. So they switched to restricted stock, which was more about pay delivery than performance."
But at least one company, Sealed Air, doesn't worry about whether giving restricted stock to executives actually moves the stock price up. The Saddle Brook, New Jersey-based packing — materials maker doesn't base any employee compensation on changes in stock price. (Nor has it ever offered stock options, except for a small amount inherited from its acquisition of Cryovac in 1998.) Why? Sealed Air believes, as it stated in its 2002 and 2003 proxies, that "total return to stockholders as reflected in the performance of the Company's stock price is subject to factors...that are unrelated to the Company's performance."
CFO David Kelsey instead bases compensation on four interlocking components: cash salary, benefits, nonperformance-based restricted shares granted to employees throughout the company, and a management by objectives (MBO) program (there is also a profit-sharing program). Restricted-stock recipients pay $1 per share for the certificates to the stock, which cliff — vests after three years. There is no holding requirement, but by and large, says Kelsey, employees generally hold on to stock after it vests. "My sense is that we have a very high retention rate," he says.
The principal purpose of the restricted-stock program, says Kelsey, is "to align management and shareholder interests." Sealed Air views the stock not as a performance incentive but rather as a pure equity-delivery vehicle. The company leaves the job of incentivizing executives to its MBO and profit-sharing plans, which are usually paid in cash, and occasionally in stock. Bonuses are based on improvements in operating income and return on assets, coupled with individual objectives.
Does the lack of options put Sealed Air at a disadvantage in recruiting talent? Kelsey doesn't think so. "The company has traditionally developed a lot of its management talent internally, but the company does recruit outside," he says. "And there are a lot of positive things to be said for a company that espouses the values that Sealed Air does."
Blast from the Past
Questionable incentive power aside, the main reason restricted stock fell out of favor in the 1970s, and again in the 1980s, is that companies came to rely too heavily on it as the sole long-term incentive vehicle for executives — much as they did with stock options. And since restricted stock usually comes with a vesting date, executives could have similar incentives to inflate the company's stock price through dubious means.
As for accounting treatment, although restricted stock can be charged to earnings over the period of restriction (usually three to five years), the entire stock grant is immediately dilutive to earnings per share. And if the stock declines in value after the grant, the tax deduction when restrictions lapse is smaller than the charges to earnings.
In short, restricted stock potentially offers everything shareholders hated about stock options — and more.
At the same time, restricted stock does have its benefits. Because actual stock shares are involved, with a more secure value (at least at nontech companies), about a quarter of the total shares are needed, compared with options, to deliver equal value to executives, says Brent Longnecker, president of Resources Consulting Group, a compensation consultancy. This is because a restricted-stock payout is more certain than an options payout. And if stock appreciates, the earnings hit will be smaller than the eventual tax deduction when the stock restrictions lapse.
Meanwhile, restricted stock can also be tied to company-specific or indexed performance goals, although few companies currently do so. Such performance-based shares vest only when the goals are reached. Similarly, companies can offer performance units-awards expressed as a dollar figure that can pay out either in cash or stock.
Like restricted stock, performance units are a blast from the past. "PepsiCo was the original creator of performance- unit plans in the early '70s, and today they're coming back," comments Longnecker. "That's because stock changes aren't that dramatic anymore. Stock options are great as long as the market is moving up." Longnecker adds that many companies avoid performance shares because they're hard to budget for, since a company can't (and shouldn't be able to) reliably predict whether the shares will vest. This makes them less attractive from an accounting-simplicity standpoint than straight restricted stock.
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