Broad-based stock option plans take hold

The stock market has been buoyant. The labour market is hot. Companies are struggling to attract and retain key talent. It seems that you can’t open a newspaper or listen to a news report without learning about somebody becoming overnight millionaires based on the stock options that they hold. And there seems to be a growing number of people getting lucrative job offers that include stock options in the compensation package.

So are stock options becoming a more popular compensation tool for employees below the executive level? The answer is yes and no.

The Conference Board of Canada in its Compensation Planning Outlook 2000 Report indicates that the interest among Canadian organizations in extending long-term incentives (primarily in the form of stock option plans) to a broader based group of employees is growing. It reports that, of organizations with long-term incentive plans (142 companies in the survey sample), 56 per cent have extended this plan to their management group (those below the executive level) and 19 per cent have extended it to non-management employees. Of this latter group, 72 per cent indicated that all non-management employees were eligible for the plan and that about two-thirds received a payout.

The recently conducted Towers Perrin Compensation Effectiveness study, which analysed pay and related human resources practices at more than 770 major North American organizations, found that three-quarters of the surveyed companies provide stock options below the executive level. However, less than 25 per cent of employees are eligible to participate in these option programs, and less than 25 per cent of those eligible actually receive stock options. Only 16 per cent of the surveyed companies provide options to the entire organization.

Therefore, yes, it does appear that stock options are being used on a broader basis below the executive level. However, currently this broader application is more focused on the middle management and professional employees groups, rather than on the entire employee population. And while there does seem to be fairly significant interest in extending stock option plans on a broader basis, it may be some time before we actually see this extension covering all employees.

This view is supported by the findings of the Towers Perrin Broad-Based Long-Term Incentive Plan Survey (B-B Survey) conducted late last year in which 161 Canadian organizations participated. This survey found that 37 per cent of the survey participants currently have a broad-based long-term incentive plan (the most common type being a stock option plan) in place for their employees in Canada — with a further six per cent indicating they were considering implementing a plan within the next year. Non-management inclusion in the existing plans was reported as follows: salaried staff (67 per cent), hourly (19 per cent) and unionized (two per cent).

The various surveys on the subject have established that broad-based stock ownership as a compensation tool is being used more widely; and it does not appear as though interest in these programs is likely to drop off any time soon.

Organizations using broad-based option plans

The B-B Survey dispels certain preconceptions about the companies that use broad-based plans. Generally, when we think about the companies that have broad-based stock option plans, what tends to come to mind is – high-technology companies; large companies; and subsidiaries of U.S. companies. In fact, the survey results indicate that:

•more than half the companies with broad-based stock options plans were Canadian autonomous companies;

•there was an even split between small companies (defined as having revenues of less than $500 million or less than 500 employees) and large companies (defined as having revenues of more than $1 billion or more than 2,000 employees); and

•while high-technology companies led the pack, companies in other industries reported having significant levels of broad-based stock option plans.

Why use broad-based

stock option plans?

Survey participants reported the following as the top three key objectives for broad-based stock option plans:

•retain high-performing employees;

•motivate employees; and

•provide highly competitive total compensation.

In addition to rewarding high-performing employees with stocks option grants, such plans become an important retention tool insofar as they are linked to the vesting period of the option. Generally, an employee must remain with the organization for the vesting period in order to derive the reward associated with the stock option grant. Vesting periods are commonly no more than five years in length. The survey found that vesting after three years was the most common, closely followed by four years.

Stock options motivate employees by linking their compensation to the long-term success of the organization through the value of its stock pri ce. Stock options can influence employee motivation and behaviour by linking the award of stock options to individual and/or company performance.

A key survey finding that supports the objective of providing highly competitive total compensation is that 82 per cent of the survey participants indicated that the stock option plan was considered an “extra” for non-management employees that is in addition to a compensation package that is already considered to be competitive.

What’s working

The survey findings highlighted the following as some of the key benefits of having a broad-based stock option plan:

•Improved retention — survey respondents reported a noticeable improvement in the retention of key talent.

•Increased focus on share price — strong stock prices definitely had a significant positive motivational impact on employees.

•A more positive environment — employees feel that they are being recognized for their contribution to the organization’s success.

What’s not working

While there are many advantages to granting stock options more broadly within an organization, this practice does not come without its challenges as well. Some of the key challenges identified by the survey participants include:

•Dealing with the constraint of the number of options that are available for grants. Organizations with broad-based stock option programs may have increased concerns regarding the issue of “dilution,” that is, the greater the number of shares outstanding, the greater is the “dilution” of the interests of existing shareholders in terms of their share of corporate earnings and voting power.

•Plans are generally not successful at promoting share ownership. Survey respondents reported that very few shares are held after options are exercised, and that there are generally no requirements within the plan to retain shares for any specific period after vesting.

•Generally there is not enough education or communication about the objectives of the stock option plan and how it works. Employee understanding of the advantages of stock option plans is typically not very high, and grants can easily become perceived as an entitlement. Poor understanding of the plan objectives combined with poor share price performance can produce negative opinions of the plan and create a demotivating effect on employees.

A number of positive arguments can be made in favour of broad-based stock option programs, particularly if organizations are willing to invest in addressing the challenges associated with these plans. They have been getting an increasing amount of attention and, if the current tight labour market for hot skills continues, more and more organizations will have to at least consider whether such a program will assist them in achieving their business and human resources strategies.

Ingrid Huss is a rewards management consultant in Towers Perrin’s Toronto office. She can be reached at (416) 960-2719. Mairead Maclure is an associate consultant with Towers Perrin. She may be reached at (416) 960-7715.

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