Executive Compensation

Transcription

1 Executive Compensation Bulletin Research Reveals Equity Award Practices at Companies Completing Private Equity-Backed IPOs Jacob O Neill, Scott Oberstaedt and Todd Lippincott, Towers Watson August 5, 2014 A strong stock market has fueled a very active market for initial public offerings (IPOs) on U.S. stock exchanges over the past 18 months, with 219 offerings completed in 2013 and 145 companies completing an IPO through July of this year. This level of activity represents a significant increase over , when a total of 97 companies completed IPOs in the two years combined. Much of the general buzz in the market often surrounds high-growth IPOs that are founder- and/or venture capital- (VC) sponsored. However, there s been a significant volume of recent private equity- (PE) sponsored IPOs. At these companies, the executive compensation programs especially the equity and long-term incentive (LTI) plans often look quite different from those of other IPO organizations. Towers Watson s Executive Compensation Resources unit conducts ongoing research on the disclosed pay programs of companies going public and maintains an extensive database of IPOs, offering a detailed look at trends in equity plan design and grant practices at newly public companies, including both PE-sponsored and founder-/vc-sponsored IPOs. To gain insights into typical equity incentive practices among companies completing an IPO with a large PE shareholder, we examined the IPO-year equity awards at 163 PE-backed companies that have gone public since This article shares highlights from our IPO database and offers insights into the latest trends in executive compensation design among these organizations. Share Pools for IPO Awards Our analysis revealed that 80% of companies reserved new shares at the time of the IPO to fund future equity grants, either under an equity plan already in place or, more often, under a new plan created to fund awards as a public company. The average number of shares reserved under these plans accounted for 7.9% of the total common shares outstanding (CSOs) immediately following the IPO on an undiluted basis. Evergreen provisions, or automatic annual increases in the share reserve, were prevalent in only 10% of equity plans in 2013, which is down from 46% of IPOs in (Note, however, that the prevalence of evergreen provisions is considerably higher among high-growth/early-stage company IPOs, such as pre-commercial pharmaceutical firms.) Our analysis revealed that 80% of companies reserved new shares at the time of the IPO to fund future equity grants, either under an equity plan already in place or, more often, under a new plan created to fund awards as a public company.

2 Stock grants in the IPO year are very common, with 99% of companies reporting some form of equity grant (stock options and/or full-share grants) in the fiscal year that the IPO takes place. Approximately 32% of the companies we examined made their primary equity grant on or close to the date of the IPO. Interestingly, this means that the majority of these companies rely on pre-ipo LTI awards to motivate and retain executives through and immediately after the IPO, often transitioning to a normal LTI award cycle the following year. At the median, the stock awards granted to employees in the year of the IPO amounted to 2.3% of the total shares outstanding at the time of the IPO on an undiluted basis. At the upper quartile, the corresponding figure was 5.6%. The total fair value of these awards was equivalent to 1.1% of the IPO market capitalization at the median and 3.3% at the upper quartile. It s worth noting that IPO award practices vary widely across industries and company sizes. The figure below provides a snapshot of the range of market practices. Equity incentive plan allocations and grant rates at PE-backed IPOs, New shares reserved post-ipo CSOs)* Total equity grants in year of IPO post-ipo CSOs)* Fair value of LTI awards in year of IPO IPO market cap)** As a % of all IPOyear grants CEO Executive IPO-year equity awards Value IPO market cap)** Other named executive officers (NEOs) CEO Other NEOs 25th percentile 5.4% 0.9% 0.5% 10% 13% 0.12% 0.13% 50th percentile 7.9% 2.3% 1.1% 18% 23% 0.24% 0.29% 75th percentile 10.3% 5.6% 3.3% 28% 34% 0.54% 0.57% *Undiluted **Market cap based on IPO offer price Based on number of shares granted Equity Award Composition In the market today, most mature companies offer a portfolio of LTIs, including options, restricted stock and some form of long-term performance plan. In contrast, PE-backed IPO companies predominantly use a mix of stock options and full-value shares when making grants to employees at the time of the IPO. Performance plans are an exception among these companies. In 2013, for example, less than one-fifth of these companies attached explicit performance criteria to their equity awards. While generally not using performance plans in their IPO-year awards, a majority of companies (56%) still employed a mix of equity in grants, while 27% of companies made equity awards solely in the form of stock options. Not surprisingly, high-tech companies were the most likely to use only stock options. Conversely, companies in the consumer discretionary industry were the most likely to make awards solely in the form of full-value shares. While it s common to provide some mix of equity awards at IPO, stock options still remain dominant. While it s common to provide some mix of equity awards at IPO, stock options still remain dominant. Ninety percent of the shares granted and 78% of the LTI fair value granted in the IPO year were in the form of stock options for companies awarding a mix of equity vehicles. This contrasts sharply with practices at Fortune 500 companies, where only 15% to 20% of LTI fair value is typically awarded as stock options. Research Reveals Equity Award Practices at Companies Completing Private Equity-Backed IPOs I 2 Practices I 2

3 Executive Equity Grants Eighty-three percent of the companies in our sample granted some form of equity to their NEOs in the year of the IPO, and 67% of CEOs received an IPO-year award. Among the companies that made grants to NEOs, 18% of the total equity granted was awarded to the CEO at the median, with 23% going to other NEOs. Together, 40% of the aggregate IPO-year equity awards were made to NEOs. CEOs generally received the largest share of the equity value granted in the year of the IPO. Based on the grant-date fair value, CEOs were awarded equity incentives equal to 0.24% of the market cap at IPO, while other NEOs as a group received 0.29%. For NEOs, stock options dominate the IPO-year grants. Thirty-nine percent of companies made their equity grants to NEOs as options only, while 25% used a mix of options and full-value shares. At the median, 66% of the equity value awarded to NEOs in the year of the IPO was made in the form of options, and 34% was in the form of full-value shares. CEOs generally received the largest share of the equity value granted in the year of the IPO. Broader Considerations in Executive Compensation Design While our analysis focuses on equity usage among PE-sponsored organizations, there are a range of other executive compensation considerations that are often tackled at the time of the IPO. These include: Peer group selection and targeted pay positioning appropriate for a publicly traded company. Many private companies have a cash compensation positioning above the market median prior to the IPO because they maintain more aggressive bonus plans as a privately held company and/or have acquired senior talent at a premium to the market. As a public company, these above-median cash compensation philosophies need to be reevaluated in light of equity compensation and shareholder expectations regarding pay positioning. They may still be appropriate, but will need to be balanced against stretching performance expectations and, potentially, more leverage and performance variance in the pay package. Conversion and transition of pre-ipo compensation plans. Pre-IPO companies that were part of a PE firm s portfolio during the recent recession may have experienced significant swings in valuation and profitability that affected their ability to earn long-term awards under the PE s preferred compensation structure. Since the valuation and payment of such awards is often tied (at least partially) to the IPO event, executives may be reluctant to forfeit or cancel those pre-ipo awards. In other instances, executives may have benefited from adjustments approved by the PE sponsor to awards outstanding prior to the IPO and/or from participation in earlier distribution or recapitalization events. In such instances, transition planning becomes especially important. In some cases, there may be a reason to convert pre-ipo LTI awards into post-ipo awards, thus improving shareholder alignment and enhancing retention. In other instances, it may make sense to consider a phased approach to achieving the post-ipo targeted LTI and pay positioning. Award timing and design. While performance share awards are not commonly adopted by companies in their IPO year, institutional shareholders are increasingly looking at award designs to ensure executive pay is properly tied to performance. This may result in compensation committees wanting to wait until the beginning of the first post-ipo fiscal year to make initial equity grants. However, shareholders also prefer to see a high degree of alignment with executives at the time of IPO through stock ownership. As a result, committees need to strike a Research Reveals Equity Award Practices at Companies Completing Private Equity-Backed IPOs I 3 Practices I 3

4 balance between their equity decisions and grants immediately following the IPO, and their longer-term equity compensation strategy. It s often helpful for companies to consider their longer-term approach to incentive and equity compensation in tandem with their immediate plans for the year of IPO. S-1 disclosures. The executive compensation section of the S-1 statement is the first time that many PE-backed companies disclose the pre-ipo compensation programs for their NEOs. Even with the passage of the JOBS Act (see SEC Burdens for Executive Compensation Reduced, Executive Compensation Bulletin, April 2012, for details) and the ability for so-called emerginggrowth companies to file more limited executive compensation disclosures, companies that expect to have a diverse set of shareholders post-ipo increasingly see the S-1 disclosure as a way to talk to those future shareholders directly about post-ipo pay programs and how they align with shareholder interests. Finally, while IPO companies have to disclose their programs like other organizations, we note that many enjoy an effective window during which they can avoid the glare and impact of say-on-pay votes (as sponsors often maintain a majority ownership level), requirements for broad-based shareholder approval of equity plans and the often-doctrinaire perspectives of proxy advisors. Companies should take advantage of this window to ensure their programs are truly tailored to their unique business and circumstances, even if the approaches taken may not perfectly align with market norms or other third-party perspectives. Ideally, once say on pay and broader shareholder engagement is required, companies will be able to demonstrate a strong track record of company performance aligned to pay. The executive compensation section of the S-1 statement is the first time that many PE-backed companies disclose the pre-ipo compensation programs for their NEOs. Research Reveals Equity Award Practices at Companies Completing Private Equity-Backed IPOs I 4 Practices I 4

5 About Towers Watson Towers Watson is a leading global professional services company that helps organizations improve performance through effective people, risk and financial management. With more than 14,000 associates around the world, we offer consulting, technology and solutions in the areas of benefits, talent management, rewards, and risk and capital management. Information in this publication should not be used as a substitute for legal, accounting or other professional advice. Research Reveals Equity Award Practices at Companies Completing Private Equity-Backed IPOs I 5 Practices I 5