SOME DESIGN GUIDELINES FOR EQUITY‐BASED PAY

Nick Hudson and Karl Pichler

Journal of Applied Corporate Finance, 2004, vol. 16, issue 2‐3, 100-110

Abstract: Almost everyone agrees that equity‐based incentive compensation can play an important role in increasing shareholder value, but there is considerable disagreement as to what that role should be and how equity pay should be packaged. What's more, there has been a backlash against equity pay that has compensation committees, investors, and corporate watchdogs on full alert. The authors of this article provide some basic guidelines for equity pay that could help to restore confidence in this useful element of compensation–guidelines that encompass the type of equity instrument, the level of equity‐based pay, the extent to which equity pay is performance based, and the structure of the equity package in terms of vesting, exercise, and expiry. They start by acknowledging that the role of equity pay is limited by the extent to which shareholder value can be affected by the manager in question. They recommend building steadily to a constant level of stock price exposure and then gradually reducing this level after retirement. For most companies, equity‐based pay should be significant only for a handful of employees; performance based cash bonuses provide better “line‐of‐sight,” especially for operating managers who are somewhat removed from corporate‐wide decisions. And disclosure–both internal and external–is perhaps the most important aspect of equity‐based pay plans.

Date: 2004
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