Equity Plan Design: "How It Works"

Webinar this week:  Behavioral Economics and Equity Compensation, Part I

Steve Jobs said that “It’s not just what it looks like and feels like.  Design is how it works.” He of course was talking about things like Macs and iPods (and, later, iPhones), but the same applies to equity compensation program design.

The current governance environment has drawn excessive attention to how equity compensation programs “look” and “feel.”  And the ever-increasing number of professionals labeling themselves as plan “designers” often focus on the look and feel of plan design.

The “look” part is features like types of award vehicles used, methods for allocating grants to employees, determining and reporting accounting expense, and dilution to shareholders. Increasingly, companies want their plans to look not too different from other companies’ plans.  Many would say that these characteristics, and the process of mimicking other companies’ programs, comprise “plan design” and the work that goes into this must then be the result of the efforts of plan designers.

The “feel” part is the arbitrary standards imposed by various proxy advisors, institutional investors, and other external parties:  overhang of 10% “feels” OK but overhang of “15%” “feels” too high. RSUs feel OK for non-executive employees but do not feel OK for executives.  These external forces have become significant factors influencing the design of compensation programs, becoming indirect plan designers.

It’s time to return our focus to “how it works” not just how it “looks and feels.” That requires a focus on strategy and behavior, not survey data, run rates, and accounting expense.

Since I introduced the concept of behavioral economics to equity compensation professionals during the 2008-2009 financial crisis and as a keynote session at GEO’s 2009 Annual Conference in Paris, I’ve continued my exploration of these ideas and how they can improve the effectiveness of equity compensation programs.  My book chapter in GEOnomics 2009 spurred a global discussion on the topic and resulted in some companies redesigning their program accordingly.

While many have focused on the communication and perception aspects of the behavioral economics concepts, I believe there are proven applications for equity compensation plan design as demonstrated around the world in the design of pension plans, savings plans, and healthcare benefits.

I will be doing a two-part webinar for GEO in September and October; the first on 28-September presents the key concepts of behavioral economics in easy-to-understand ideas and discusses how these concepts have been implemented. Attendees will learn how some program design features that we take as a “given” should be questioned in light of the ongoing research in the field of behavioral economics.  

This discussion will lay the groundwork for Part II of the series on 26-October in which we’ll look at specific program features and discuss both how these influence behavior and how employee behavior actually affects the value of the equity instrument - producing a direct effect on the return on investment (ROI) to the employer.

With the continued and increasing scrutiny of equity compensation as a result of concerns about executive pay, it’s time to understand what plan design is, and is not, and how to understand how to make it work. Maybe we can turn equity compensation from a perceived source of risk and abuse into something cool.  Like an iPhone.

Music Lessons

Fred Whittlesey

Compensation Venture Group

Every Labor Day weekend in Seattle is the Bumbershoot festival.  The format varies year to year, but it’s generally 3 days and more than 100 bands.  There are a lot of other artistic activities as well, but I focus on the bands.  It draws a couple hundred thousand people each year. 

You are guaranteed to see (1) a band you’d loved forever and always wanted to  see (Bob Dylan, 2010) (2) a band you’d heard about but never listened to (Band of Horses, 2008) and (3) a band you’d never heard of and now is your new favorite after seeing them (Thee Oh Sees, 2011).  This has been going on for 11 years for me.

I love Bumbershoot because I can really escape into several days of music festival culture and not think much about work.  Ah, but I do.  There are great lessons about – you guessed it – compensation at Bumbershoot.  Here are a few from this year.

1 – Imagine if you could assemble a team of 50 or so superstar talented people and get them to perform under rigorous conditions, week in and week out.  They are so good at what they do that tens of thousands of people applaud for them every few minutes or so.  (When was the last time that happened with your work?)  As they later mingle they talk about the passion they have for their work, the great people they work with, and so on.  In casual conversation, they also volunteer information about their pay for this demanding role, just as a side comment but also as a part of the passion they have for their role:  Minimum wage.

2 – An individual begins to speak and perform and a crowd gathers.  Dozens of people watch his talents for about 15 minutes.  As he introduces his final task, he explains why the observers should pay, suggests how much they should pay, and why it is reasonable for them to pay for what they have just enjoyed.  His hat is passed and it overflows with cash.  I estimate that he’s made the equivalent of about $200 per hour.  Much better than minimum wage, even in the state of WA with the highest minimum wage in the US.

3 – Another performer quietly displays his world-class talent (he has won multiple international competitions) standing on the side of the path.  Saying nothing to the passing potential audience, and answering questions in a single phrase, he continues with his amazing work.  His hat lies on the ground with no sign or other indications.  His hat overflows with cash.   I sensed that while he surely liked the cash he was there for the adoration of his quirky talent.

4 – A well-known performer finishes up her set on one of the major stages and notes that she will be at the tent adjacent to the stage after the show, inviting the audience to come by and say hello.  The tent also has CDs, t-shirts, and other items for this artist.  People line up, shake hands, and spend.

I spoke directly with at least one person of each of the four examples above, in detail, about compensation.  (OK, I’m a hopeless compensation geek at a music festival.)  In all cases, I didn’t have to ask, the information was volunteered or obvious.  They are all extremely satisfied with their compensation model and results.

Noticeably absent from this year’s Bumbershoot lineup were the mega-acts that are making a lot of money just to play, before t-shirts and CDs, and no hat is necessary  (though Bob Dylan wore a really stupid looking hat last year). 

Much of the compensation delivered this year, like every year at Bumbershoot, was through a voluntary process, or didn’t involve cash at all. 

Pay and Performance.   Compensation plan designers:  Look into it.

#bumbershoot