Equity Compensation for High Performance Corporations If Restricted Stock is so common, where are...

Equity Compensation for High Performance Corporations

If Restricted Stock is so common, where are all of the best practices for

these plans?and

What about Performance-based programs?

Silicon Valley Compensation Association

June 18, 2008

Dan Walter, CEP

President and CEO, Performensation Consulting(917) 734-4649

[email protected]


Dan Walter, CEP – President and CEO Performensation Consulting

Dan is the President and CEO of Performensation Consulting. With more than 13 years of experience assisting companies with issues concerning compensation, he has experience with both management and broad-based programs, focusing on equity-based solutions. Dan provides end-to-end solutions for private and public companies based in both the United States and abroad.

Dan has worked extensively in with companies across the U.S. and abroad. His work with young entrepreneurial companies and large multinational companies provides his clients with a unique perspective on compensation issues. He creates company-specific solutions that effective and, when required, innovative. He also provides post-consultation support with communications and administrative best practices to help ensure programs are working as designed.

Dan’s expertise includes equity compensation, executive programs and talent management issues. His experience with these programs includes: issue diagnosis, solution design, communication, administration and reporting. His equity compensation expertise also includes stock options, restricted share and units, stock appreciate rights, stock purchase and performance-based programs. Executive compensation experience includes benchmarking, short and long-term incentive program design, proxy disclosure reporting and total-reward evaluations. Dan also has strong experience in the administrative and technological best practices for these programs.


Agenda• Restricted Stock

– Basic Review– Taxes– Accounting– Terminations and Retirement– Administrative Issues– Stock Splits

• Performance Programs– Creating a Strategic Vision– Program Structure

• Effective Performance Metrics• Current design trends

– Improving administration and participant satisfaction• Plan Roll-out• Communication• Administration• Reporting• Accounting and Tax overview


A Brief Restricted Stock History Lesson

• Who, What, When, Where, Why and How?• Exec level versus broad-based• Record keeping systems: Excel versus Equity

Comp Software• Elections and Executive handholding


The Basics: RSS Vs. RSU

• Restricted Stock Shares and Restricted Stock Units are not the same thing

• Design your plan with considerations for administering it

• The left hand needs to talk to the right hand


The Basics: Restricted Vs. Options

• Basic Differences• The Mythical, Magical 3:1 ratio• Event Based transactions Vs. Election Based

transactions• Leverage Vs. Stability


“Restricted Stock” Has Many Meanings

• Shares Issued prior to registration• Shares Issued to 144 Affiliates• Shares or Units that are subject to forfeiture and

time or performance-based vesting (“our” restricted stock)


Glossary

• Restricted Stock Shares• Restricted Stock Unit• Award• Release Date• Vesting Date• Tax Election• Pre-Release Period• Subject to Forfeiture• Constructive Receipt• Deferral• Employment Tax• Income Tax• Full Value Award• Partial Value Award


International Overview

• Tax Issues• Security Issues• Labor Law• Currency Issues


BEST PRACTICES TIP Avoid Vesting Events that…

• …occur during regularly scheduled blackout periods

• …occur very close to Period Ends

• …occur on dates very close together

• …Non-Market Days, unless plan is specific on how these are to be handled

• …occur without warning (especially with performance-based plans)


Dividends and Dividend Equivalents

• Accounting Issues• When to Pay Out• Funding of Dividend Equivalents• Reporting to IRS• Tax Withholding• Adjustments after the Fact


Calculating Taxes

• Statutory minimum withholding for Withhold-To-Cover (WTC) payments

• Last minute payroll updates• 83(b) Election issues• 1099-B issues for RSU


Withholding Taxes

• Taxes (withholding) are due when restricted stock vests

• Supplemental Income threshold• FICA due on RSU vesting date (as opposed to

release date)• Dealing with Expats and International

participants


Corporate Tax Deductions - 162(m)

• Time-based Vs. Performance-based vesting• Recent 162(m) concerns

– Is it really performance if you just have to be terminated to earn it?


Accounting Issues

• Expense for Retirees• Valuation Issues• Accrual for Performance-based vesting


Award Cost

• Par Value issues• Award at greater than $0.00• $0.00 cost awards


BEST PRACTICES TIPShare Issuance

• Plan ahead with your transfer agent - RSS– Quarter-end reporting considerations

• Plan ahead with your transfer agent and broker - RSU– Multiple issues


BEST PRACTICES TIPTerminations (but not retirement)

• Repurchase / Forfeiture• For Cause• Near time of release date• Accelerations and Dividend payment issues


Retirement

• Tax• RSU• Deferral

– Incremental payouts

• Vesting Acceleration• Prorated Vesting• Accounting Issues


409A Issues

• Shares Vs. Units• Dividends and dividend equivalents• Deferrals and re-deferrals


What About the Institutional Investors?

• Fungible Plan Pools• Minimum Vesting Periods• Option Exchange Programs


BEST PRACTICES TIPCommon Payment Methods

• Sell To Cover– Need trade volume

– Mismatch of FMVs used for taxes and sale

• Withhold to Cover– Corporate cash on hand

– Statutory Minimum issues

• Cash or Check


BEST PRACTICES TIPAdministration Details

• Elections dates and corresponding elections• Repurchase grace periods• Dividend dates• Deferral periods• Payment type for each release• Performance criteria


BEST PRACTICES TIPStock Splits

• Do not split long shares and units (or options) at different ratios

• Transactions between Record Date and Payment Date– New awards

– Releases

– Terminations


Variations On a Theme

• Deferred Stock• Phantom Stock• Performance Shares


Restricted Stock Conclusions

• Just as many issues, questions, concerns, risks and benefits as stock options

• Easier FAS 123R valuation and lack of preferential tax rules masks the complexity of these programs

• Not a silver bullet, but can provide balance to programs if designed, communicated and administered properly


Part 2 - Performance-based Plans

The future is here. What you should know


The Strategic Vision

• Programs must drive performance, rather than just rewarding it– Tie participant’s goals to the corporate vision

– Make achieving and missing goals a meaningful event, while not distracting from future delivery

– Design plans that communicate the company’s uniqueness while maintaining market relevance

– Oh yeah, hopefully provide effective communication and administration


The Basics of Performance Metrics

• Clearly defined goals– Must be relevant to the participant

– Must be understood by the participant

– Reflective of company goals and culture

• Simple and Flexible allowing use of some or all of the possible metrics

• Supporting an Ownership Culture– Goals. Responsibility. Accountability. Motivation.

Reward.


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Common Performance Metrics

Source: Culpepper eBulletin, May 2007

Larger companies

Smaller companies

Tech, Biotech, Life Sciences


Other Performance Measures

• Success Vs. Competition – directly or indexed– Relative TSR

• Success Vs. History – Year over Year, % increase over time

• Productivity – sales, production volume, call volume

• Innovation – new products, solutions to old problems

• Individual Growth – education achievements, project delivery


Example of Performance Unit Plan

• Measurement Period - 3 years• Metrics - Relative TSR, Revenue growth

– 50% of award based on each metric– TSR threshold must be met for any shares to be

earned

• Payout bands– Threshold 75%, Target 100%, Maximum 150%

Threshold Target Max

TSR 50th Percentile 75th percentile 90th percentile

Rev. Growth 10% 15% 25%


Example - program details

• TSR measured against a peer group index of 300+ companies.– Companies who fall out of the group during the performance period

are not replaced

• Participant must be employed on vesting date to earn shares

• Award is made in Units and payout is made in whole shares

• Measurement of TSR is made at 3 year anniversary

• Measurement of Revenue is made at close of most recent reporting period prior to 3 year anniversary

• Administrative consideration is provides that release date will occur 30 days after both metrics are confirmed


Positives of the prior example

• Can closely align participants with corporate and shareholder goals

• Controls dilution in two ways– 1) generally fewer shares than options

– 2) limited payout unless max goals are met

• Provides a communication theme for an extended period

• Payouts may be based on direct, instead of indirect performance (or a combination of both)


Drawbacks of the prior example

• Goals not in direct participant control and result in over/under reward– Severe changes in market conditions (up or down) effect

motivating impact of program

• Accurate multi-year goals can be difficult to define• Can provide recruitment ammunition for best talent

– when competitors offer guarantees to match future (as yet unattained) payout levels it may be hard to counter

• Possible expense charge even if no payout is made (market-based goal - TSR)

• Change in corporate focus or participant position can negate any direct link to performance


High Level Timeline

Design Process Exec Mgmt, Comp, Senior Bus. Leaders, BOD (Comp Committee)

6-24 months

Roll-out and Initial Awards Everyone 3-6 months

Often longer

Reporting for Finance and Accounting

Equity Admin, Accounting, Finance, (and any stakeholder or system with insight into meeting goals)

Quarterly

Beginning first quarterly close after initial award

First Measurement and Payout

Everyone 12-36 months after initial award

(possibly earlier)

KEY MISSING ELEMENT

Communication between Award and Measurement

HR, Senior and Middle Management, Equity Admin, Finance

Quarterly

or more frequently


Plan Roll-out and Implementation

• Assembling the Team– Finance / Accounting - Data source and goal setting,

planning and accruals

– HR / Comp - Plan structure and award size, Messaging and goal setting, systems and record-keeping

– Legal - Definitions and restrictions

– Equity Compensation Administration - tracking, event management


Communication Issues

• Goals– Clearly define what the goals are and WHY those specific goals have

been set– Be clear regarding how and when goals will be measured

• Mechanics– How will payouts be made?

• Timing• Income and Taxation• Caveats

• Progress– Communicate status often

• even if it is not good

– Frequently communicate what needs to be done to reach goals– Keep goals on the “dashboard” of the participant’s job


Components of Managing Performance Programs

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System Limitations

• Most plans are too specific for current systems

• Limited share and value ranges– Difficult if goals are greater than 100%

– Issues with multi-tranche vesting

• “Performance” systems are generally structured to support the employee review and management process– Generally focused on Performance Reviews for HR and general

Comp, not Driving Performance Goals

• HRIS systems are ungainly for small, nimble programs– PeopleSoft, Oracle, SAP and even smaller systems are designed

for more generic “heavy-lifting”

• Valuation can be complex and accounting requires a high-level of sophistication


System Limitations, cont.

• Disparate data sources for specific goals can be hard to manage– Finance, HR, External systems, “soft goals” may not be in any

system

• Communication often limited to high-level annual messaging, rather than goal-specific information– Lack of sophisticated system interaction

• The most sophisticated stock admin systems have limited (or no) support between award date and performance measurement date (when the goal has been met, you prompt system to “vest” the awards)– Very little interaction with FAS 123R reporting


Reporting to Shareholders

• CD&A reporting– Requirement to discuss the “what” and the “why” of

compensation

– May be difficult to discuss why without revealing strategic secrets

– May be difficult to discuss the specifics of “what” with out exposing the program to mimicry by competitors

– Must still artfully satisfy SEC and shareholder needs


Dividends, Deferrals and other Details

• Dividends and Equivalents– Tracking for the “max” payout– Handling a lesser payout than expected– The timing of dividend release

• Deferrals– Properly designed Performance-based RSUs can allow for deferral

elections within six months of the expected performance measurement date

• What if date moves or payout is different than expected?• Transfers, Corporate Actions, Terminations

– Difficult to design for all possibilities. Care must be taken to define what is possible and leave room to handle the rest.

• Errors in Payout– Restatements– Post termination status changes


Valuation and Accounting

• Probabilities of reaching goals– Measured quarterly (limited system support)

• Concerns with market-based” goals– No expense reversal is goals are missed

– “Monte Carlo” modeling for market-based goals

– Proper reporting requires tracking each possible outcome (vesting date, number of shares, accrual periods and amounts)


Conclusions

• Use of these programs will continue to grow as a component of equity programs

• Plan design has continued to evolve, while systems have focused on regulatory and compliance issues

• Performance plans can serve to drive goal achievement, rather than just reward it

• Communication must be consistent and frequent

• Current tools are limited in scope requiring additional effort to properly support these programs

• Valuation and Accounting for these programs is not supported by standard tools

• 162(m) may continue to provide concern as the recent ruling is further clarified


Questions / Discussion

Contact InformationDan Walter, CEPPresident and CEOPerformensation Consulting(917) [email protected]


IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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