Equity Compensation in a volatile market
Get direct guidance from our advisory services practice on recent industry developments, best practices, and more. In this special edition dedicated to equity compensation in a volatile market, we cover:
- Addressing Equity in an Unstable Market
- Primer on Cash-based Awards
- ESPP Focused Communications Campaign
- ESPP Share Reserve Depletion
- Resources to Support Employee Participants
- Establishing an EBP trust in Canada
Mark your calendars!
Please join Computershare for a special webcast on April 22nd to hear the very best ways to manage equity compensation in an unstable market. Speakers will share key ways that you can fine tune to improve your programs now and into the future. We'll be sending invites out soon. We'll also post it to www.computershare.com/allthingsequityplans for you to register.
Addressing Equity in an Unstable Market
Like most companies, the sudden and extreme volatility of the stock market in recent weeks has significantly impacted our stock price and disrupted our grant practices. Do you have any recommendations for addressing the economic and equity compensation-related implications during this unstable market?
Making decisions in a time when the stock price has declined significantly can be tricky, and while there is no one-size fits all approach, there are things you can do to address stock price fluctuations as it relates to your equity compensation programs. Below are a few suggestions.
An Employee Stock Purchase Plan (ESPP) is a great tool to insulate employees from macroeconomic disruptions for many reasons, such as:
- Lower stock price = more shares purchased
- More shares owned at a potentially low price = greater upside potential if the stock price rises
- Encourages dollar cost averaging—purchasing smaller amounts of stock over a longer period spreads the cost basis out over several years, providing insulation against changes in market price and encourages regular investing of a specific amount of money
- ESPP’s don't ever go underwater—where participants purchase at a discount on the price at the end of the offering period, even if the stock price has fallen sharply over the time employees have been putting away money to buy shares, they are still buying shares at a discount
If you haven’t given a lot of attention to your ESPP in the past or you don’t yet have a plan, now is a perfect time to think about promoting the plan (see below for more on what to promote about your plan) or starting one.
Other suggestions include, shifting to full value awards, like restricted stock, which are much more stable than traditional long-term incentive programs. Full-value awards are also a simple and equitable way of aligning executives / employees with shareholders given the current difficulty in setting robust performance targets several years out. Alternatively, if there is an appetite to do so, there is no better time to grant stock options than when stock prices are down as stock options are most motivating during difficult economic times since their upside potential is that much higher. And finally, where conserving shares and reducing burn rate are a concern, consider using cash-based awards. Please see below for more on cash-based awards and be sure to review our response in our last issue of this newsletter for additional ideas for planning for an economic slowdown.
Computershare can help with your plan design, communication, and administration needs. For more information visit us at computershare.com/employeeplans or contact us to speak to one of our equity plan experts.
Primer on Cash-based Awards
I’m looking for a quick primer on cash-based awards. What are some reasons a company might use cash-based incentive awards in lieu of (or in addition to) other forms of equity at this time?
Companies often use cash-based awards to retain or provide liquidity to employees to help insulate them from market volatility, which might otherwise affect their stock-based pay. Cash-based awards work very similarly to equity-based awards, primarily driven by internal performance metrics. “Pure cash” awards are where the cash amount is set at the time of grant and simply paid out over a period. They can also be driven by stock price with the option of having the cash distributed in a lump sum payment.
By and large, most companies use cash-based awards to extend the life of their share plan reserve. When companies experience a severe and sustained decline in stock price, awards paid in cash can help conserve shares as they do not hit the share reserve (provided the award is not based on stock price). Cash-based awards are also not factored into burn rate calculations, which can also be a common concern in periods of significant stock price volatility. Another obvious reason and advantage to using cash is that it’s just easier for participants to understand.
ESPP Focused Communications Campaign
As the economy has slowed, we are looking to do a communications campaign featuring our ESPP. What are some non-traditional things we might consider communicating about the program?
It’s times like these where companies fully begin to understand the real value that an ESPP can have for productivity and talent retention. So much so, they are going beyond standardized participant communications and getting even more creative around program messaging. Some interesting messaging ideas that I have seen work well for companies include:
- Comparing your program to industry peers to highlight the benefits your plan offers that your peers do not. Where they don’t offer a plan, be sure to highlight that!
- Charting past performance of your company stock price, which can give employees an idea of what they might be missing by not participating in plan
- Communicating the purpose of the plan
- Sharing why the company thinks the plan is important enough to spend money on it
- Providing participant testimonials
Companies that can maintain employee engagement during times of uncertainty are much more likely to flourish, in part because engaged employees are more likely to come up with innovative ideas for saving money and generating new products.
Computershare’s Communication Services can help with your communications through our new solution called Engage. Engage is a new way to talk to your employees about share plans. You can promote your ESPP using ready-made communications created by our marketing and share plan experts. In as little as six weeks, we’ll deliver all the communications you need to boost the performance of your share plan. Simply select a theme that echoes your brand and we’ll look after the rest!
Our cost-effective solution suits all budgets and includes templates that are easy to configure to your guidelines. You’ll save time tailoring communications to fit your brand and improve take-up rates utilizing award-winning share plan communications with a proven track record.
ESPP Share Reserve Depletion
What are the impacts of a significant decline in stock price to our ESPP? We offer a tax qualified program with a six-month offering period, one purchase period at the end of the offering and no lookback.
As share values decline, authorized share reserves may deplete dramatically because grant sizes will likely increase consequently. This can be particularly disruptive to existing ESPP programs because participants may have put aside far more money than the company has available in the reserve for share purchases—essentially wiping out an ESPP share reserve, and may a) force the company to refund cash to significantly more participants than it would if the stock price was rising and b) result in the total number of shares purchased by all participants being much higher than initially projected. When there are not enough shares to cover all contributed funds, each participant is delivered a pro rata number of shares that weights their contributions relative to the overall amount contributed by all plan participants. Each participant then receives the same relative number of shares from those available for purchase and any unused contributions must be refunded to participants.
With careful plan design, e.g., including maximum limits on the number of shares that can be purchased by any one individual or by all participants during any single purchase period, communication, and administration, e.g., processing a “mock purchase” midway through a purchase period to help forecast share usage to plan for shareholder approval of a share reserve increase sooner rather than later, are good ESPP plan management practices to employ.
Resources to Support Employee Participants
How can we best help our employees from making bad financial decisions regarding their equity compensation during these unsettling times?
Your employees are likely feeling anxious about the future and need reassurance and guidance about their stock compensation during these unsettling times. There are a variety of approaches companies can try to help keep employees from making bad financial decisions. For example, provide employees with access to a financial wellness program with the goal of shifting employee behavior as it relates to their finances, e.g., keeping employees from making bad financial decisions, like selling their awards at the market bottom, or making good decisions, like contributing to their ESPP or saving for retirement.
Computershare offers your plan participants a full suite of education materials thru the participant education section of Employee Online. Links to it are found on the main menu of the site. There participants have access to articles, webinars, podcasts, videos, quizzes and more on all types of equity plans, including in-depth information on how taxes work for each plan type.
In addition, Computershare has partnered with HighTower Advisors, LLC to offer financial advisory services to your plan participants. You can learn more about the services they offer at hightoweradvisors.com. If you'd like to offer HighTower's services to your participants, talk to your relationship manager about how to get started.
Volatile markets don’t last forever. Don’t allow your employees to make major decisions about their stock compensation during a down market without consulting an advisor first.
Establishing an EBP trust in Canada
Special thanks to Sean Davis, Computershare Senior Solutions Specialist, for his contribution to the response to this question.
My company has various award plans, including Restricted Share Unit Plans and Performance Share Unit Plans; the RSU / PSU awards are structured to settle in three years with shares acquired on the market at vesting. With my company’s share price being suddenly lower and expected to increase again over time, is there a way my company can potentially minimize future share acquisition costs related to settling these awards?
Where a company expects that its share price will increase over the lifespan of the stock-settled RSU / PSU awards it is granting (typically 3 years), one option is to establish an Employee Benefit Plan (EBP), trusteed by a recognized trust company in Canada, to facilitate the purchase of shares at the time of the awards are granted (noting that the trustee does not need to be the award plan’s administrative agent). This will crystalize the cost of the shares and protect the company against future share price increases. The trustee holds the shares in the EBP trust until required to distribute the shares at redemption.
Of course, for this alternative to be viable, your company must have enough funds available and that it can afford to lock up until the awards redeem. As well, this alternative does not guarantee cost savings as your company’s share price will not necessarily be higher at award redemption.
It is important to note that there are detailed rules as to when the plan sponsor can expense the employer contributions for purposes of income tax; however in general, the plan sponsor can expense the employer contributions only when the shares are distributed from the trust and at their original cost. As well, the participant has taxable employment income only when the shares are distributed from the EBP trust (with taxes being withheld / collected by the trustee), based on the fair market value (FMV) of the shares on the vesting/distribution date (and not the original cost).
There are several additional decisions that will need to be made, including the following:
- As some of the awards will likely be forfeited, your company will need to determine its approach to purchasing the shares. In our experience, clients typically purchase enough shares to bring the trust to a certain coverage percentage, being 100% or a lesser percentage factoring in estimated forfeitures. This approach factors in actual forfeitures on an ongoing basis which minimizes purchases to achieve the desired coverage percentage.
- If your company pays dividends and the dividends will not be paid out of the trust in the same year as received, the dividend income becomes taxable to the trust, resulting in the trust, to the extent the trust does not have offsetting expenses, being liable to pay taxes. To avoid this (not all companies do), some clients have elected to have the dividends distributed from the trust back to the plan sponsor (client) as income to the plan sponsor, where such funds are either retained (typically where awards do not attract notional dividend equivalents), or contributed back to the trust as an employer contribution (typically where awards do attract notional dividend equivalents). Other clients, typically where awards do not attract notional dividend equivalents, have instructed the trustee to hold the shares as a registered shareholder with a dividend waiver in place.
Any company interested in considering this option is encouraged to speak with their legal and tax advisors to determine feasibility, applicable tax implications, timing, amending their plan texts, etc.
Computershare Trust Company of Canada can assist you in establishing an EBP trust, including providing a template EBP trust agreement. For more information please contact us.
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About the Author
Robyn Shutak leads our equity advisory consulting services to help our clients get the most value out of their plans. She is available to discuss trends in plan design, enhancing your employee communications, outsourcing opportunities, and a whole lot more. Use the form at the bottom of the page to contact Robyn and find out how she can help improve the value of your plans.