Performance Shares?

There has been a lot of buzz lately about replacing traditional stock awards with performance shares. "Performance shares" is a term of art, not a legal term. It is simply a plan that grants shares outright to an employee upon the achievement of a specified target. That can be anything—the increase in share prices (indexed or absolute), revenue, profits, or whatever other critical number or numbers are chosen. The shares can be granted with or without further restrictions. For instance, the shares might be awarded upon the achievement of a goal, but then subject to vesting before they are actually delivered. The awards are taxed as income when the restrictions lapse, or at grant if there are none. If there are further restrictions at grant, the employee could make a Section 83(b) election to pay ordinary income tax currently, but then only pay capital gains taxes if and when the shares are ultimately sold (the initial tax is not refundable if the awards never vest, however).

The argument for performance shares is that they are less dilutive than other kinds of awards and that they only get awarded if the company or individual performs well. The trick, of course, is picking the right targets and time periods for achieving them. Some companies have granted these awards only to revise the targets when things get tougher, a practice that makes them look more like straight compensation. Others have set targets that are too easy to reach. Targets that are too aggressive, however, can be demotivating. More important, perhaps, is that it is easy to pick the wrong targets. Stock price growth, for instance, seems like a good goal, but not if it encourages an executive to forego long-term (but costly) investments to make short-term numbers look better. No equity incentive is perfect, however, and performance shares have a lot to recommend them if well-crafted.