8 variables about Equity Compensation
Equity compensation is not just variable compensation. It’s variable, variable, variable, variable compensation.
There’s the variable of stock price. There are variable numbers of shares, units, options or rights. There are variable types of awards, variable vesting timing, variable (for international participants) currency rates and for many recent awards, there are variable performance conditions. So, it’s not just four variables I mentioned earlier, but six or more variables that come into play. This can be tough to grasp in the compensation world where everyone would really like some level of expected consistency.
In addition to all of the variables, there are all of the rules, regulations, reporting obligations and stakeholders with a legitimate claim in the design, communication and administration of these programs. In this swirl, there are some big truths you simply ought to know.
1) It’s an “except when” set of rules.
There are an insane number of rules that must be followed. The seminal guide for just Section 16 Forms 3, 4 and 5 filings is more than 1,000 pages long! But, even worse is that it seems every rule is followed by a statement that starts…”except when” and then a bunch of arcane details. It’s hard to lock down your knowledge when everything seems a bit liquid.
2) Accounting (“compensation expense”) really matters.
You will never master every aspect of accounting. One of the most enticing benefits of equity compensation is that the company can have a fixed compensation expense while delivering variable value to the participant. This requires careful planning and execution. It also requires not changing horses, or sometimes, even paths, midstream. If you aren’t including your accounting department early, you should be prepared for some rude surprises.
3) The world is a big place and it turns out that every country has its own set of tax, security, currency and other rules.
Two decades ago, when I first started in this field, it was common to offer the same awards globally. It was also common to let your global participants figure out the consequences on their own. Nowadays, that’s just dumb. Many countries have more intricate rules than those in the U.S. The consequences for both the company and the individual can be devastating when not planned and executed perfectly. But, there are also upside opportunities to offer competitively differentiated, tax-preferred awards in some countries. You may be able to lower the cost of programs through tax chargebacks and other planning mechanisms. The most difficult aspect is that countries around the world may change their rules at any time. I receive several country updates every month.
4) Plan design cannot be done in a vacuum.
Compensation professionals are often in a hurry. They are busy and it can be frustrating to incorporate a big team in the plan diagnosis and design process. Very few successful companies succeed in a vacuum over the long run. The best practice for a minimally effective design team is to include people from Legal Accounting, Payroll, Corporate Tax, Stock Administration, an Executive stakeholder and an external expert (or two or three) who truly know their stuff about your stuff.
5) Stock administration systems are far more limited than your imagination.
Whether you use one of the “name brand” systems, outsource to a TPA, or build a system in house (please don’t build a system in excel) the limitations are met very quickly. This is especially true when you include performance criteria or international participants. Often someone on the design team will say “no” early. You might be surprised how often it’s because they know that the best-designed plan will fail if it cannot be executed or communicated effectively.
6) Taxes are hard. Really hard.
If you think the rules behind income and tax are hard for you to master, imagine being an engineer or line worker, or even an executive without any training in the topic. So many companies try and avoid the topic altogether. “We don’t want to provide tax advice.” This is the cry from Legal. Here’s the deal. If your participants don’t fully understand the what’s, how’s and why’s of your plan, they will never get good outside tax advice. You risk spending a lot of time and money creating a program that creates confusion, angst, anger and demotivation. Get professional help in learning the tax rules and communicating them to your plan participants.
7) You should join, or at least follow, these organizations.
NASPP – The National Association of Stock Plan Professionals
GEO – The Global Equity Organization
NCEO – The National Center for Employee Ownership
World at Work
ECE – Equity Compensation Experts. Free and a good place to keep up on industry events, webinars and news articles.
8) It’s still worth the effort.
After reading this, you are probably wondering why in the heck companies even have these plans. That’s like asking why someone has a really good kitchen. Either one, when used improperly, is essentially a waste of money. But, when used expertly, they can become everyone’s favorite place. They can bring surprises, joy and satisfaction to an otherwise mundane world.