Never before has the issue of executive compensation garnered as much of the public’s interest as it has in recent years, due in large part to several highly publicized corporate scandals.The backlash from incidents involving top executives at global organizations, and recent changes in Securities and Exchange Commission proxy and accounting rules, have prompted interesting new trends related to how executives and board members within large public companies are being compensated and to what degree.
Organizations across the globe are re-evaluating their methods of compensation for both executives and board members. From base salaries and stock options to cash bonuses and perks, compensation trends have undergone a noticeable shift in the past several years. Large technology companies in particular are being a lot more careful when it comes to providing stock awards. Pressure from the shareholder groups on dilution issues, as well as the recognition of compensation for stock awards based on changes in accounting and compensation rules, are resulting in companies being more restrictive in their use of stock compensation.
While the use of stock compensation at the executive level, particularly for chief and other senior executives, is still fairly common, many large technology companies are not making this type of compensation available as far deep into their employee population as they would have previously. According to a recent research report on executive compensation for large public technology companies, those organizations that are still awarding stock compensation for employees at the chief financial officer level and below are not being as generous with their awards as they would have been before shareholder groups began placing greater focus on dilution and stock awards were considered compensatory and resulted in a charge.
From 2004 to 2006, the average stock awards to CFOs and other executives not including the CEO only increased by 1 percent and 5 percent, respectively.
RESTRICTED APPEAL
An emerging trend within executive compensation also reveals that large technology companies are making greater use of restricted stock as a compensation tool. Under the old compensation rules, restricted stock was compensatory and therefore subject to compensation charges. However, simple option awards were not considered compensatory and did not result in any charge. As a result, in the past companies often shied away from issuing restricted stock in favor of option awards. The times have changed and so have compensation rules. Under the new rules, option awards no longer hold such an advantage over restricted stock, as both option awards and restricted stock are now considered compensatory and result in compensation charges.
The enhanced appeal of restricted stock awards based on this rule change is causing organizations to increase their use of restricted stock. As of 2006, approximately 82 percent of large technology companies surveyed provided restricted stock awards to their executives, up from 35 percent two years prior. Restricted stock involves less risk for executives compared to stock option awards, and accordingly, fewer rewards are granted and that helps the dilution dilemma as well. Option awards, comparatively speaking, carry much greater risks, and as a result the size of the awards is typically larger.
To balance out the risks versus the rewards, many companies are using a combination of restricted stock and options. Why this change in philosophy? Their goal is to avoid situations where large, rapidly growing companies provide executives with stock options, only then, over the course of three to four years, the company’s growth rate slows down, as does the stock price, resulting in little if any profits for the employees. By providing executives with restricted stock as well, the employee is assured some degree of compensation.
In addition to striking a balance between restricted stock and options, large technology companies are also looking to balance the amount of cash compensation versus stock options. Historically, technology companies have been heavily concentrated on providing stock compensation only. Cash compensation has been held to a minimum at all levels, especially for board members. This trend is changing, as cash compensation for executives and board members has increased over the past several years. Board members in particular are receiving higher cash retainers, in large part because of the greater level of responsibilities they must undertake. From 2004 to 2006, the average cash retainer for board members jumped from $56,000 in 2004 to $62,300 in 2005 to $70,200 in 2006. This represents a cumulative increase of 25 percent since 2004.
In a post-Enron and WorldCom world, some may wonder how it’s possible for board members to get away with raising compensation for both executives and themselves without any oversight. The answer is that recent corporate scandals and the new SEC proxy rule that went into effect last year have created greater transparency regarding executive and board compensation. Transparency ultimately leads to better behavior.
There is clear evidence that compensation committees are much more active now than they ever were before, which is resulting in more thoughtful debates and analysis in the board rooms before compensation is awarded to either executives or board members. The enhanced independence of the compensation committee members is resulting in greater scrutiny and lengthier discussions before the compensation awards are granted.
Moving forward, large technology companies will likely move to a performance-based compensation model, even in the area of stock compensation. Stock options under the old accounting rules mostly resulted in no charge to profit and loss if the principal restriction was a time-based vesting. In other words, executives earned their stock awards as they rendered their services over time. Since organizations are now obligated to take a charge, in some respects they are not subject to those same restrictions and can structure stock awards to allow vesting only if performance goals are met.
While we are already seeing greater use of performance measures for earning stock compensation, large technology companies will likely begin a fundamental shift over the next several years and start to increase the percentage of awards for executives that are based on performance versus pure time-based vesting.
Raman Chitkara, CPA, is global managing partner of semiconductor industry services at Big Four firm PricewaterhouseCoopers. He was also a member of the American Institute of CPAs’ Task Force for the Valuation of Privately Held Company Equity Securities.
