How do we align Employee Ownership with Short Term Investing Strategies? - 16 June 2009
I don't often write my own opinion pieces for the ECE site, but I have been having quiet discussions with several people about the disconnect between investors, pundits and the government wanting executives and employee shareholders to hold stock for very long periods of time, including holding until retirement. This, people say, will align the executives and employees with external stockholders. I wonder if we have thought through all of the facts sufficiently.
The assumption is, of course, that investors buy stock and hold it for the long haul. But, do stock holders still purchase stock with a distant horizon in sight and wait for the company to perform well enough over several years to earn a healthy return? Evidence may suggest otherwise. More and more investors are buying and selling in short time frames. Holding shares for a few quarters, a few months or even a few weeks is not uncommon (and that says nothing about day traders). Companies with both low and high stock prices will tell you how their stock prices move more quickly, in both directions, than ever before.
Michael Porter, Harvard Professor and leading authority on competitive strategy said in a recent speech that the short-term trading trend by investors is negatively impacting our economy
"Players in financial markets are rewarded for trading stocks and
facilitating mergers and acquisitions, the Harvard business professor
said, not for creating any real value. That has contributed to the
business community's poor image, which has been eroded further by the
financial meltdown.
“We have a tremendous reputation problem. We
have poisoned our nest here,” he told alumni at the Rotman School of
Management at the University of Toronto. Business has a long way to go
to “rebuild the trust of communities and society,” he added.
With
so much focus on the immediate value of stocks, and the resulting costs
from short-term trading in and out of individual company shares, “the
stock market now is a tax on the real economy,” he said.
“The financial sector is extracting value from the rest of the economy [through] fees, costs and expenses.”
I wonder if perhaps there is an unrealistic expectation of what is expected from both external investors and employee shareholders (and optionees). Should we expect our executives and employees to be forced to hold stock and be subject to risk that investors to not seem to share? If yes, how to we balance that risk with appropriate reward. If not, how do we ensure that everyone is focused on the long-term success of companies, in respect for the next round(s) of external investors?
I personally believe that much of this can be corrected with a stronger tie between real corporate and individual performance, as linked to compensation. Rather than hand out shares based on time and then force people to hold them, perhaps shares and options shoud be earned based on performance and any gains made will be the result of success in support of corporate goals.
I would love to hear you thoughts on this.
www.equitycompensationexperts.groupsite.com
Dan
Dan Walter, CEP
ECE Founder
President and CEO
Performensation Consulting
917-734-4649
dwalter@performensation.com
www.performensation.com
skype: performensation
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From ECE member Robin Ferracone, RAF Capital
LLC
Hi Dan –
Regarding your question about long-term equity holds, I think:
·
Reasonable ownership guidelines make sense (e.g.,
3 to 5 x salary) for as long as the executive is employed
·
Shortening the option window period also makes
sense (right now, three year ratable vesting (2 year average) and 10 year terms
are the norm, leaving an average 8 year exercise window). I think shortening
the window period makes sense because much of the run-up and run-down in stock
price is due to secular market trends, not company performance, so a lot of “optionality”
rewards more for market movements than company performance
·
Longer term LTI periods (e.g., 3 to 4 year
performance plans, and 4 to 5 year vesting on options with a 7 to 8 year term),
and a combination of vehicles makes sense
·
Financial measures that correlate to value are
needed
·
Goals need to be set within a competitive
context and not marked to market annually based on “what we think we can
do next year”
·
Requiring that all stock be held until retirement
makes no sense at all
We can discuss further if you’d like.
R
Robin A. Ferracone
Chief Executive Officer
RAF Capital
LLC
2600 Mission Street, Suite 201
San Marino, CA 91108
Office: (626) 799-2700
Cell: (213) 399-6225
Fax: (626) 799-1102
robin.ferracone@rafcapital.com
At the National Center for Employee Ownership, we have long advocated the idea that equity should be given out based on meeting periodic critical corporate numbers, then subject to vesting over time based on long-term trends not year-to-year data (such as profit growth relative to market over the trailing three years or total return on equity relative to market over trailing years). That way, additional awards are always possible, but only gain value over time. Equity becomes less an entitlement or, when given infrequently in large blocks, a lottery favoring those who get it when prices are low. I use the concept critical number purposely. It should be based on meeting long-term objectives. Once exercised, executives should be limited in their ability to sell beyond what is needed for taxes until retirement. All of this gets the focus to be on the long-term, not short-term, a focus that has helped truly devastate the economy. How many executives in finance knew that loading up on CDOs was a very risky long-term strategy-but if they didn't, they'd lose out in the short-run and all the tons of options they can get?
But I also think the focus just on executives is harmful. The data clearly show that broad-based awards work better. The "80-20" rule that dominates today's discussions of incentive pay is a myth, not a research-based result. More than ever, companies need employees also to focus on the long-term and finding ways to improve performance. If people really are the most important asset, why not treat them that way?
Corey Rosen
National Center for Employee Ownership
1736 Franklin, 8th Fl
Oakland, CA 94612
www.nceo.org
I have a concern with the intense push to use performance based metrics for long-term plans these days. I don't think that shareholders are getting the right bang for their buck. Particularly when the economy is as volatile or as recessionary as it is, it's extremely difficult to set performance goals that reward the right behavior. I've seen it happen both ways.
A company has tried really hard to set realistic goals (both external and internal), the market falls out and the goals are dead in year one of a three-year plan, but at the same time a company has actually grown in a downturn, which should actually be recognized - wrong message. Conversely, when the company's not doing all that great compared to peer groups, awards are paying at maximum because the market or industry is going through the roof, but again goals were set before that happened and the wrong behavior is being rewarded. If a company is improving revenues, but losing market share, I'm not saying they shouldn't get compensated, but I do think that they've set themselves up to really do poorly in an economic downturn which shouldn't be compensated at maximum levels which is what I think this push is going to cause because the result is over and over again not correlated to true shareholder value.
I think longer term pure share plans with retention requirements and partial performance accelerators can accomplish similar goals without compromising the integrity of the goals or sending the wrong message.
Jessica Carbullido
Director Compensation, Con-way Inc.
Thanks Jessica.
I think your concerns are fairly common through most industries. Setting long-term goals when stock prices and corporate performance are fairly unpredictable can be a difficult thing.
I think we need to continue to remind people that there is no silver bullet solution to executive compensation. I truly believe that the key to success is taking the time to look at the evidence and design fact-based programs that support the goals and culture of each unique company.
I hope others will provide their input on this issue.
Dan
If the objective of equity compensation is to motivate and retain employees, companies need to be mindful of provisions that may have an opposite affect. Take share ownership requirements for example. On paper they appear to align company objectives with those of shareholders by mandating "ownership", but these requirements might also incent employees to leave the company it that is the only way they can sell a desired number of shares. This may also result in a decrease in employee motivation because it ties people's hands and doesn't allow them to take appropriate action as personally needed.
There is a lot to consider when designing or modifying an equity compensation program especially when stock prices are down. However, all proposed changes should be tested in terms of employee motivation and retention. Shareholder goals will generally be addressed by a stock plan that motivates and retains the best employees (not just the officers).
Bill Dillhoefer
Net Worth Strategies, Inc.
www.stockopter.com