Performance Shares: The Future of Executive Compensation
Creating stock grants that base payouts for executive employees on more than just their continued employment has become the new norm for a growing number of companies. These special stock grants are known as performance shares, and nowadays tech workers who reach executive status are more likely to receive grants of performance share units (PSUs) as opposed to stock options.
While stock options may still be included in the mix of grants received by top level employees of private companies and startups, PSUs and restricted stock units (RSUs) have overtaken stock options in popularity at public companies due in part to their simplicity. However, performance shares are typically granted in conjunction with RSUs rather than in place of them.
Performance share units are often issued as grants of shares that pay out only if specific performance goals are met, hence the term performance shares. These types of performance-based equity awards are highly customizable to match a company’s intended outcomes and overall behaviors they’re looking to incentivize. Not only do PSUs provide a direct link between your pay and the company's performance, they also offer an opportunity to earn a larger payout compared to stock options or RSUs if the company performs well.
Grants of performance shares tend to include multipliers that can yield a bigger payout for meeting or exceeding a goal while reducing or eliminating its payout altogether if you fall short. The goals can be financial (i.e., increasing earnings per share or shareholder value) or non-financial (i.e., customer satisfaction or employee retention). In recent years, it has become common for performance share grants to have multiple triggers, with each one unlocking only a portion of its potential value.
Let’s say, for example, you receive a grant of performance shares where 50% will only be issued if you increase employee retention while the other 50% is tied to your internal feedback score. Missing one won't eliminate your ability to earn the other; you may still receive a partial payout. However, you will not receive the full grant unless you satisfy the criteria of both categories.
The most popular metric used is the company’s total shareholder return (TSR). This is a measure of your company’s performance rank relative to the performance of other companies in the same industry or sector. Your company’s TSR will increase if its stock price goes up and/or pays dividends and will decrease if its stock price goes down. While companies have always been interested in how their executives' compensation packages compare to those of their peers, the recent focus on pay-for-performance has made TSR a popular metric for measuring whether an executive's pay is "fair.”
While the terminology and features of these special grants vary from company to company, they almost always pay out as shares of stock rather than cash. That means that if you receive a grant of performance shares and your company’s stock price goes up, your payout will be worth more than it would have been if you had received the same number of shares as a regular RSU. Similarly, if the company’s stock price goes down, your payout will be worth less. This can create a powerful incentive for executives to do whatever they can to increase shareholder value.
In addition to increasing revenue by a certain percentage or reaching sales targets within an agreed upon timeline, the prospective recipient must remain employed by the company through the vesting period to receive the payout. If you are considering a job offer that includes performance shares, be sure to ask questions about the performance goals and how they will be measured. You should also inquire about the vesting schedule and whether the shares will be subject to a clawback if you leave the company before they vest.
It is important to read and gain a full understanding of the terms of your performance shares and any circumstances that would prevent you from receiving them. It is a common procedure that switching companies during the vesting period will end your rights to any payout. However, the provisions for retirement, death, or disability under your plan likely differ. Some companies choose to allow pro rata distribution at the end of the performance period, while others base their decision on your tenure.
Many recipients of this newer form of long-term incentive compensation prefer it over others due to its simplicity. Though PSUs do not offer the same sort of optionality and tax favorability offered by stock options, their simplicity and predictability may make up for it.
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Malcolm Ethridge, CFP® is the Managing Partner of Capital Area Planning Group based in Washington, DC. He is also the Managing Partner of Capital Area Tax Consultants.
Malcolm’s areas of expertise include retirement planning, investment portfolio development, tax planning, insurance, equity compensation and other executive benefits.
Disclosures:
The information provided is for educational and informational purposes only, does not constitute investment advice, and should not be relied upon as such. Be sure to consult with your legal advisors before taking any action that could have tax and legal consequences.
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