The Value Proposition

Transcription

1 The 9th Annual New England NASPP Regional Conference co-hosted by the Boston and Connecticut NASPP Chapters July 14 th, 2017 Which Value is This Again? Sandra Pace, Steven Hall & Partners Ted Manley, Dunkin Brands Group, Inc. Kristin Johnson, Quintiles IMS Holdings, Inc. CJ Van Ostenbridge, Aon plc

2 CPE Credits Continuing Professional Education (CPE) Credits are Available! You will receive one (1) CPE credit after attending this session You must attend the entire session to be eligible In order to earn the available credit(s) for this session, you must see the room monitor at the end of the session to receive your stamp to be officially signed out. Electronic certificates will be ed to you a few weeks after the conference with the cumulative number of credits earned The National Association of Stock Plan Professionals (NASPP) is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. Web site: 2

3 Agenda The Many Types of Value Award Sizing Award Design vs. Value RSUs Options PSUs (Non-Market Based) PSUs (Market Based) Questions 3

4 The Many Types of Value - Target Target Value Target The intended value of the grant Realized Accounting Fair Value Often equal to a percentage of base salary Target Value must be converted to target number of award using a divisor Perceived Value Compensation Expense Stock price at grant Average stock price over the month prior to grant Accounting fair value Realizable Disclosed 4

5 The Many Types of Value Accounting Fair Value Accounting Fair Value Perceived Realized Target Value Accounting Fair Value Compensation Expense Dictates the amount of compensation expense recognized by the issuing company Originally estimated on the grant date, but can change throughout the life of the award in certain situations Non-employee awards Liability awards Realizable Disclosed 5

6 The Many Types of Value Compensation Expense Compensation Expense Realized Target Accounting Fair Value Equal to Fair Value x Target Awards Vested for options and market-based PSUs Equal to Fair Value x Actual Awards Vested for options and non market-based PSUs Value Impacts company s income statement Perceived Compensation Expense Realizable Disclosed 6

7 The Many Types of Value - Disclosed Disclosed Value Realized Target Accounting Fair Value Displayed in the Summary Compensation Table of a company s proxy statement Equal to the Accounting Fair Value x Awards Probable to Vest as of the grant date Value Receives scrutiny from shareholders and governance firms Perceived Compensation Expense Realizable Disclosed 7

8 The Many Types of Value - Realizable Realizable Value Realized Target Accounting Fair Value Displayed in the Grants of Plan-Based Awards Table of a company s proxy statement Threshold Value Target Value Maximum value Perceived Value Compensation Expense Can also be expressed as threshold, target, and maximum number of awards Specific to performance awards Realizable Disclosed 8

9 The Many Types of Value - Perceived Realized Target Accounting Fair Value Perceived Value The value that an award holder believes an award has Hard to quantify Closely related to motivation and/or retentive value Perceived Value Compensation Expense Realizable Disclosed 9

10 The Many Types of Value Realized Realized Target Accounting Fair Value Realized Value The value that an award holder ultimately receives Hard (or impossible) to predict Closely related to motivation and/or retentive value Perceived Value Compensation Expense Realizable Disclosed 10

11 A Simple Relationship Example: A company increases a target grant of time-based RSUs from 100 shares to 150 shares Target value increases by 50% Accounting fair value does not change Compensation expense increases by 50% Disclosed value increases by 50% Perceived value increases by 50% Realized value increases by 50% This is easy! 11

12 A Complex Relationship Example: A company decides to grant cash-settled PSUs awards whereby the Target Value ($1,000,000) is converted to target shares by dividing the Target Value by Accounting Value. The company is considering a maximum payout of either 150% or 200%. 150% Max Payout 200% Max Payout Target Value $1,000,000 $1,000,000 Accounting Fair Value $11.00 $12.50 Target Awards 90,909 80,000 Compensation Expense Dependent on Performance Dependent on Performance Disclosed Value $1,000,000 $1,000,000 Realizable Shares 180, ,000 Perceived Value?????? Realized Value Dependent on Performance Dependent on Performance This is hard! 12

13 A Key Decision How Target Value is converted to target shares is a critical decision Divisor equals Accounting Value at grant: Target Value = Compensation Expense = Disclosed Value for employee equity awards Design decisions (and therefore Accounting Value at grant) affect the number of target shares granted, complicating the relationship between Target Value / Compensation Expense / Disclosed Value and Perceived / Realized Value Can result in angry employees if they get fewer awards than they expected (Accounting Fair Value > Stock Price) Divisor equals stock price at grant (or similar): Target Value only equal to Compensation Expense and Disclosed Value if Accounting Fair Value equals divisor Design decisions flow more directly to award holders and issuing company 13

14 RSUs Dividend Equivalents Simplest value relationships because often Accounting Value = Stock Price Exception when company does not provide dividend equivalents Grant Size Based on Accounting Fair Value Dividend Equivalents No Dividend Equivalents Target Value $1,000,000 $1,000,000 Accounting Fair Value $10.00 $9.40 Target Awards 100, ,383 Compensation $1,000,000 $1,000,000 Expense Disclosed Value $1,000,000 $1,000,000 Perceived Value?????? Realized Value Higher at lower future stock prices Higher at higher future stock prices Would award holder rather have more awards or dividend equivalents? Grant Size Based on Stock Price Dividend Equivalents No Dividend Equivalents Target Value $1,000,000 $1,000,000 Accounting Fair Value $10.00 $9.40 Target Awards 100, ,000 Compensation $1,000,000 $940,000 Expense Disclosed Value $1,000,000 $940,000 Perceived Value Higher Lower Realized Value Higher Lower Is perceived value of a dividend equivalents worth $60,000 in additional compensation expense and disclosed value? 14

15 Options Divisor is Fair Value When award size is based on Accounting Fair Value there is a trade-off between design features and number of awards granted Contractual Term: Longer contractual term means higher Accounting Fair Value, fewer awards granted Would employee rather have 1, year options or 1,200 7-year options? Vesting Schedule: Longer vesting schedules mean higher Accounting Fair Value, fewer awards granted Employee would prefer more options that vest over a shorter time period Company must balance retentive value with perceived value Realized Value dependent on future stock price path and individual exercise behavior 15

16 Options Target is Fixed When award size is fixed there is a trade-off between Perceived Value and Compensation Expense to company Contractual Term: Longer contractual term means higher Perceived Value, but also higher Accounting Fair Value, Compensation Expense, and Disclosed Value Sometimes, but not always, results in higher Realized Value Vesting Schedule: Longer vesting schedules mean higher Accounting Fair Value, Compensation Expense, and Disclosed Value but lower Perceived value Company must balance retentive value of longer vesting schedule with other consequences Realized Value dependent on future stock price path and individual exercise behavior 16

17 Options Contractual Term Options vest annually over 3-years, strike price equal to stock price Grant Size Based on Accounting Fair Value 7-year Term 10-year Term Grant Size Fixed 7-year Term 10-year Term Target Value $1,000,000 $1,000,000 Accounting Fair Value $4.00 $5.00 Target Awards 250, ,000 Compensation $1,000,000 $1,000,000 Expense Disclosed Value $1,000,000 $1,000,000 Perceived Value?????? Realized Value?????? Would award holder rather have more awards or longer to exercise? Target Value $1,000,000 $1,000,000 Accounting Fair Value $4.00 $5.00 Target Awards 250, ,000 Compensation $1,000,000 $1,250,000 Expense Disclosed Value $1,000,000 $1,250,000 Perceived Value Lower Higher Realized Value?????? Is perceived value of a 10-year term worth $250,000 in expense to the company? 17

18 Options Considerations Value Cap Limit gain on option to a certain level (i.e., 600% of exercise price) Lower Accounting Fair Value, magnitude of discount will depend on volatility Impact on Perceived Value may be low Could lower Realized Value Indexed Options Tie exercise price to Index return Lower Accounting Fair Value, magnitude will depend on volatility and correlation to Index High impact on Perceived Value, will affect Realized Value Can result in adverse tax consequences (exercise price may be lower than stock price at grant) Valuation Lower expected life and/or volatility assumption will lower Accounting Fair Value with no impact on Perceived or Realized Value, but must stay within accounting guidance Same with exploring a different valuation model (i.e., Lattice Model instead of Black- Scholes) 18

19 PSUs Not Market Based Accounting Fair Value = Stock Price at Grant Disclosed Value depends on most probable level of performance at grant Compensation Expense based on number of awards that actually payout Perceived value dependent on the performance goals set and buy-in from award holders Realized value dependent on actual performance, as well as stock price movement, and can vary widely 19

20 PSUs Not Market Based PSUs pay out 0% to 200% depending upon EPS over a 3-year performance period PSUs Target Value $1,000,000 Stock Price at Grant $10.00 Accounting Fair Value $10.00 Target Awards 100,000 Most Probable Performance at Grant 100% Disclosed Value $1,000,000 Realizable Awards 200,000 Low Performance High Performance Stock Price at Vest $5.00 $20.00 Payout Percentage 50% 200% Compensation Expense $500,000 $2,000,000 Perceived Value Equal at Grant Equal at Grant Realized Value $250,000 $4,000,000 20

21 PSUs Not Market Based $4,500,000 Realized Value vs. Payout Percentage $4,000,000 $3,500,000 Realized Value $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $0 Payout Percentage $5 Ending Stock Price $10 Ending Stock Price (Compensation Expense) $15 Ending Stock Price $20 Ending Stock Price 21

22 PSUs Not Market Based Considerations Setting performance goals that are probable to be achieved at a target level as of the grant date will ensure that disclosed value equals target value After grant, many of the types of value diverge Perceived value will be impacted by performance Compensation expense will ultimately equal fair value x actual shares earned Realized value will depend on performance and stock price movement 22

23 PSUs Market Based Accounting Fair Value determined using Lattice or Monte Carlo model and incorporate probability of possible payout scenarios Disclosed Value equals target shares x Accounting Fair Value Equal to Target Value if Accounting Fair Value used to determine target shares Often greater than Target Value if stock price used to determine target shares, as Accounting Fair Value is often greater than stock price Compensation Expense equal to Disclosed Value and fixed at grant Perceived value dependent on the performance goals set and buy-in from award holders, can be very different from Target / Disclosed Value and Compensation Expense Realized value dependent on actual performance, as well as stock price movement, and can vary widely 23

24 PSUs Market Based 3-year relative TSR award with maximum payout of either 150% or 200% Grant Size Based on Accounting Fair Value 150% Max Payout 200% Max Payout Target Value $1,000,000 $1,000,000 Accounting Fair Value $10.50 $12.50 Target Awards 95,238 80,000 Compensation $1,000,000 $1,000,000 Expense Disclosed Value $1,000,000 $1,000,000 Realizable Shares 142, ,000 Perceived Value?????? Realized Value Higher at performance close to or below target Higher at performance near maximum Grant Size Based on Stock Price 150% Max Payout 200% Max Payout Target Value $1,000,000 $1,000,000 Accounting Fair Value $10.50 $12.50 Target Awards 100, ,000 Compensation $1,050,000 $1,250,000 Expense Disclosed Value $1,050,000 $1,250,000 Realizable Shares 150, ,000 Perceived Value Lower Higher Realized Value Lower Higher 24

25 PSUs Market Based Percent Rank Payout 1 Payout 2 75 th and Above 150% 200% 50 th 100% 100% 25 th 50% 50% Below 25 th 0% 0% Fair Value $10.50 $12.50 Target Awards 95,238 80,000 $160,000 Value to Award Holder $130,000 $100,000 $70,000 Assumes flat stock price over performance period* $40, % 30.0% 35.0% 40.0% 45.0% 50.0% 55.0% 60.0% 65.0% 70.0% 75.0% 80.0% 85.0% 90.0% 95.0% 100.0% Percent Rank 150% Max Payout 200% Max Payout 25

26 PSUs Market Based Percent Rank Payout 1 Payout 2 75 th and Above 150% 200% 50 th 100% 100% 25 th 50% 50% Below 25 th 0% 0% Fair Value $10.50 $12.50 Target Awards 100, ,000 Expense $1,050,000 $1,250,000 Value to Award Holder $220,000 $200,000 $180,000 $160,000 $140,000 $120,000 $100,000 $80,000 $60,000 Assumes flat stock price over performance period* $40, % 30.0% 35.0% 40.0% 45.0% 50.0% 55.0% 60.0% 65.0% 70.0% 75.0% 80.0% 85.0% 90.0% 95.0% 100.0% Percent Rank 150% Max Payout 200% Max Payout 26

27 PSUs Market Based $4,500,000 Realized Value vs. Percent Rank $4,000,000 $3,500,000 Realized Value $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $0 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% 90.00% % Percent Rank Compensation Expense $5 Ending Stock Price $10 Ending Stock Price (Compensation Expense) $15 Ending Stock Price $20 Ending Stock Price 27

28 PSUs Market Based Considerations Value Cap Limit gain to a certain level (i.e., 6x stock price at grant) Lower Accounting Fair Value, magnitude of discount will depend on volatility Impact on Perceived Value may be low Could lower Realized Value TSR Cap Cap payout if absolute TSR falls below a threshold Lower Accounting Fair Value, magnitude will depend on volatility and correlation to peers Likely low impact Perceived Value, may affect Realized Value Shareholders love it (Governance Value?) Other Adjustments to Plan Design Lowering maximum payout will have large impact on Accounting Fair Value, Disclosed Value, and Compensation Value, but also lowers Perceived Value and often Realized Value Same with increasing performance necessary to reach payout levels Finding more correlated peers can lower Accounting / Disclosed / Compensation Expense without impacting (or even improving) Perceived Value 28

29 Post-Vest Hold Periods An award with a post-vest hold period cannot be sold or transferred for a certain period of time after vesting Executives often hold their awards after vesting regardless, so formalizing the requirement often has low impact on Perceived Value Can have large impact on perceived value for broader employee populations Governance Value - Creates defined pathway to meet ownership guidelines and enforce claw-backs while further aligning executives with long-term shareholder interests Provides discount to Accounting Fair Value Magnitude of discount depends on company volatility and length of holding period Holding Period Length 30% Volatility 50% Volatility 70% Volatility 1-year 5% - 8% 6% - 13% 7% - 15% 2-years 7% - 11% 10% - 18% 14% - 23% 3-years 8% - 13% 13% - 20% 16% - 27% 29

30 Wheel of Take-Aways How Target Value is converted to Target Shares is a critical decision, with many downstream consequences Hard to predict, and heavily dependent on award design Realized Target Accounting Fair Value Can affect number of target shares granted, and is often higher than expected for marketbased awards Very nuanced engage with your award holders! Perceived Value Compensation Expense Fixed for timebased awards and market-based PSUs, variable for non-market-based PSUs Possible value/shares delivered Realizable Disclosed Dependent on Accounting Fair Value and expected level of performance at grant (for non-market PSUs) 30

31 Contact Us CJ Van Ostenbridge, CEP Senior Consultant Aon plc Sandra Pace Managing Director Steven Hall & Partners Phone: Kristin Johnson, CEP Director, Equity Programs QuintilesIMS Ted Manley VP, Total Rewards & HR Operations Dunkin Brands, Inc. Phone: