With compensation committees continuing to struggle to find the magic mix of incentives to motivate their companies’ executives, restricted stock has emerged as the most popular form of long-term pay.
For the first time last year, a greater percentage of S&P 500 chief executive officers got restricted stock (78 percent) than stock options (71 percent), according to Equilar, an executive-compensation research firm based in Redwood Shores, California. Further, the value of those restricted-stock grants increased by more than 10 percent.
Indeed, some companies are making radical changes in their long-term compensation portfolios in an attempt to tie pay more tightly to performance. Hewlett-Packard, for example, jettisoned options and cash from its long-term incentive plans and moved to performance-based restricted stock as the sole long-term incentive for all its top executives, according to its most-recent proxy.
Rewards for HP finance chief Cathie Lesjak and others will hang on whether cash flow from operations hits a certain percentage of revenue, and how well the company performs according to “a metric based on total shareholder return relative to the S&P 500 over the three-year performance period.” The change “represents a further step being taken to drive a high-performance culture,” the proxy says.
Unisys, which switched from options last year, this year made all of its executive stock grants contingent on performance, up from 75 percent last year. The stock all vests in 2010, contingent on the company’s hitting certain goals related to cumulative revenue-growth rate and cumulative pretax profit (exclusive of retirement expenses, gain or loss on divestitures, and restructuring charges). That could mean significant risk for CFO Janet Haugen, who, along with other Unisys executives, will receive none of the performance-based payout for last year after the company missed certain targets.
The move from length-of-service-based stock to performance-based stock has evolved gradually at most companies that have made the switch. “A lot of the big companies I work with that used time-based restricted stock did it as kind of a default,” says George Paulin, chairman and chief executive officer of Frederic W. Cook, an executive-compensation consultancy. “They didn’t want to grant all options because of the expense, but they felt uncomfortable about setting multiyear performance goals when they hadn’t done that in the past.”
Now, as companies refine their methods of goal-setting — including such tactics as refreshing earnings-per-share goals each year and rewarding executives based on returns relative to an index or peer group rather than absolute measures, says Steve van Putten, east region practice leader for Watson Wyatt’s executive-compensation practice — they’re getting more comfortable letting pay ride on those goals. Still, experts caution not to count out stock options yet. The fact that the median value of options granted to a CEO, $2.3 million, stopped declining last year for the first time in five years means “the companies that wanted to get rid of them have, so the number using them will probably hold steady going forward,” says Alexander Cwirko-Godycki, research manager with Equilar. “Options may even make a comeback as [share prices] deteriorate, because [stock options are] exactly what incentivize executives to get the stock price up.”
Some CFOs maintain that options still have a major role to play. For a given dollar amount, “you can deliver infinitely more options than restricted stock” since Black-Scholes values are so much lower than the trading price of a stock, notes Mike Pappagallo, CFO of Kimco Realty Corp. The publicly traded real estate investment trust just began offering its executives the choice of options or restricted stock (with dividends that are payable immediately) last year, when the growth of real estate share-prices slowed. But restricted stock isn’t making any quantum leaps among the choosers. Since “shareholder growth may not be as robust in the past, we’ve gravitated toward restricted stock as a component of equity — but it’s not the only one,” he says.
A few companies in the troubled financial-services sector are combining preset performance targets with stock options for new hires and special grants, using options that vest only if the company hits certain targets. “It’s almost like a reemergence of old megagrants but with very high performance risk and leverage,” says Paulin. American Express, JP Morgan Chase, Citigroup, and Merrill Lynch are among those using this tool for their CEOs. Most compensation experts don’t expect it to become widespread, however, since “options are viewed as being inherently performance-based,” says van Putten.
One trend that no one disputes: CFOs are becoming more essential participants in the design of compensation packages, often identifying which performance measures are most relevant and what the goals for them should be. “We need their help to do this,” says Paulin. Some companies even acknowledge this formally. Aruba Networks CFO Steffan Tomlinson is one of several top executives designated to attend the board’s compensation-committee meetings throughout the year to provide “assistance and advice,” notes Aruba’s proxy.
“For my clients, I insist on at least one good conversation with the CFO, if not more,” says Myrna Hellerman, a senior vice president at Sibson Consulting who recently gave a presentation on the new collaboration she’s seen between CFOs and human-resources chiefs. “In short order, that will be common sense.”