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The Employee Ownership Report

NewsletterConcisely written for leaders in employee ownership companies and for service providers in the field, the NCEO's bimonthly newsletter, the Employee Ownership Report, is the most efficient way to stay informed about legal issues, current events, best practices, breaking research, management approaches, and communications ideas for employee ownership companies.

Available exclusively to NCEO members, the Employee Ownership Report is delivered in hard copy and all issues back to 1997 are available in the members-only area of the Web site.

Nonmembers are invited to read the sample article below from the current issue of the newsletter. Every time a new issue appears, the sample article on this page will be replaced by one from the new issue. Join online for only $90 to receive the Employee Ownership Report and all our other membership benefits.

You also can read a sample issue of the entire newsletter (July-August 2011).

Sample Article from the March-April 2015 Issue:

How Much Equity Should Key Executives Get Outside the ESOP?

According to the 2014 NCEO ESOP Executive Compensation Survey, about 30% of top executives in ESOP companies get some form of equity grant outside of the ESOP. Larger companies (more than 100 employees) are about 50% more likely to offer such plans. However, CEOs tend to receive equity awards at about the same rate as other executives. If one person gets equity, generally several do.

Data is useful, but it does not tell you whether your company should offer additional equity to key people or how much. Several factors might make these plans more appropriate:

Although some companies believe that additional equity is important to help focus executive attention on key drivers of corporate performance, the evidence and arguments for this are weak. Financial incentives are only weakly related to employee motivation to work harder. Motivation, in Daniel Pink's apt phrasing, comes more from autonomy, purpose, and challenge. In his book Drive, Pink argues that incentives can actually diminish people's deep intrinsic motivation to excel.

The data from our survey show that about 70% of ESOP companies do not have separate equity plans for executives. The most common reason they say they don't is that the ESOP already provides a substantial equity link for executives. Many companies also say that including everyone on the same basis is part of their culture.

If You Do Share Equity, How Much?

The right answer for your company depends, first, on what kind of equity. Many companies make the mistake of assuming a stock option or, more commonly, stock appreciation right, for x number of shares is the equivalent of a grant of that number of shares as restricted stock or phantom stock. Because the appreciation-based awards (options and SARs) only have value if the share price goes up over the current valuation, most models for assessing the present value of these awards show them to be worth about one-third of what an outright share grant is, although there is a lot of variance. You don't have to guess, however. Accounting rules require the present value of these awards to show in your income statement, so work with your accountant to make an estimate of this value before deciding how much to award.

In those cases where a grant is being used to make up the difference an executive would get if all pay were ESOP-eligible, the calculation should be straightforward, at least if restricted stock or phantom stock is granted. If you use stock appreciation rights or stock options, use the present value of the award.

The frequency of the award fundamentally changes its character. One-time grants are event or milestone focused. A grant made annually or every few years spreads the executives' attention over a broader time frame. Annual grants have a number of advantages. First, they allow the board more flexibility to adapt to new circumstances. Second, they reduce the lottery effect that can occur for stock appreciation rights or options if they happened to be granted at unusually low (good for employees) or high (not so good) prices. Third, they allow grants to be made based on that year's needs and financial circumstances. Finally, they provide an ongoing reinforcement for executives rather than one they file and may forget. Of course, annual grants should be smaller than onetime grants.

Rather than target a percentage of enterprise value, calculate how much an award should be worth as a percentage of each executive's compensation. Our survey found that the median value of equity-based pay in companies offering it was about a third of base pay for CEOs and 20% to 25% of other officers. That does not mean that is the right number for your company, of course. The goal is to come up with a number that when added to all other forms of pay totals a number that is sufficient to attract and retain people—but not more.

Finally, work with your advisors to make sure that the grant of equity in an S corporation meets the S corporation anti-abuse tests.

It may be helpful to engage a compensation consultant in this process, although be cautious that few have much ESOP experience and some may have a much more traditional model of executive pay in mind or, in some cases, see their assignment as finding ways to justify higher pay.

Our ESOP Executive Compensation Survey Results include data on how companies with ESOPs are compensating executives, and are customizable by region, industry, number of employees, revenue, pretax profits, S or C corporation status, or percentage owned by the ESOP.