A Creative Answer to Implementing Executive Stock Ownership Guidelines

There is a clear trend among companies to strengthen the linkage between shareholder and executive interests.  Many companies are responding to this trend by evaluating the effectiveness of having stock ownership and/or stock retention guidelines for their executive officers.

We observe that implementing such guidelines in the current economic environment can be challenging for these executives.  Since executive cash compensation is flat or increasing only slightly, achieving stock ownership requirements can represent a greater burden than in the past.

However, these difficult times also present a partial solution.  Many companies decided not to give salary increases to key executives for 2009 and, some cases, 2010 as well.  Hopefully, those companies are having better financial results this year, are concerned that executive salaries may trail the market, and are considering giving an additional salary increase beginning in 2011 – say five percent on top of whatever a regular raise might be.  Herein lies the opportunity to address some of the challenge of increasing executive stock ownership.

Instead of granting the additional raise, consider an equivalent value in Restricted Stock Units (RSU’s) with a reasonably short restriction period (e.g., two years).  Since the salary increase is an annuity as long as the executive is employed, then the company would grant the same dollar value in RSU’s every year.   RSU’s also offer an interesting feature that is not available with Restricted Stock grants – RSU’s can be voluntarily deferred beyond the restriction period as long as the executive complies with IRS Code Section 409A requirements related to the deferral.

This approach offers several benefits both to the company and to the recipient:

  • The executive defers income taxes until actual shares are finally received at the end of the restriction period, including the voluntary deferral period.  Thus, the executive accrues more shares than if the additional salary were used, on an after-tax basis, to buy stock.
  • The company’s stock ownership guidelines would give credit for RSU’s that have been granted and not yet converted into actual shares.  By using the voluntary deferral procedure, the executive can count all RSU’s towards meeting stock ownership guidelines as well as postpone income tax.
  • There is also the option to take cash in lieu of shares (or a portion in cash to pay income tax and the remainder in shares) at the end of the deferral period, or to defer the cash payout as long as the executive complies with IRS Code Section 409A rules.
  • The company does not have to issue actual shares until the end of the voluntary deferral period.
  • Since this will be an ongoing program of annual grants and increasing stock ownership among executives, there is also a pretty nice story to tell shareholders.

These are challenging times for addressing executive compensation issues.  But maybe this is one of those instances of being handed “lots of lemons”, but using the opportunity to “make some lemonade”.

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