When it comes to executive-level pay or compensation, financial compensation comes in a number of forms, including salary, bonuses, and other forms of compensation, such as equity compensation. This type of compensation is often used as a way to reward performance as well as entice talented professionals into executive levels in a corporation.1
While equity compensation might be the ideal way to entice sought-after talent, the process comes with both risks and rewards for employers, and employees, which should be taken into consideration before a decision is made. Most forms of equity compensation involve pay-for-performance. This is beneficial for employers as they will not have to pay compensation unless they reap the benefits. It could be a hindrance to CEOs as they are risking part of their compensation on how the company performs, which may see a downturn that is out of their control. On the flip side, equity compensation might significantly increase a CEO’s wealth if they are able to grow the company and increase the performance of the company stock.2 The more equity they own, the more they earn when stock prices rise.
Types of Executive Equity Compensation
There are multiple ways in which a company may provide executive-level employees with equity compensation through the distribution of stock or shares in the company. The most common forms of equity utilized include:
Stock options are one of the most popular forms of equity compensation and provide executives with the options to purchase shares of the company over a designated period of time for a set price.3 The set price is most often the price of the stock at the time that the option is offered. If the company performs well, the value of the stock will rise, allowing the CEO to profit as the company grows.
Another way equity may be awarded, is by awarding stock that cannot be sold until a vesting schedule is complete. This is referred to as restricted stock. During the vesting schedule, they will have voting rights and receive dividends that come with the ownership, but if they leave before the stock vests, they will forfeit the compensation. This provides an employer with some security as to how long the executive will need to stay to receive their compensation.
Restricted Stock Units
Another form of equity compensation similar to Restricted Stock is Restricted Stock Units (RSUs.) With this form of compensation, the CEO will be paid a specified number of shares when a vesting schedule is complete.3 They differ from Restricted Stock as it is issued without diluting the share base, they have lower administrative costs, and they are easier to defer taxes on because the issuance of the share is delayed. But since it is only a promise to pay future shares and not actual immediate ownership of the shares, it will come with no dividend earnings or voting rights.
Performance shares are a form of compensation that is based on performance markers that will need to be obtained for the compensation to be awarded. Two types of performance measures may be used, including market conditions and performance conditions. Performance conditions will be determined by financial goals, while market conditions will be determined by how the company performs on the market. Equity will be granted based on performance periods, which typically run about three years though grants may be made annually.
Equity compensation comes with the benefits of rewarding CEOs for their performance and providing them with a reason to stay invested in the company’s future.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
Stock investing includes risks, including fluctuating prices and loss of principal.
The information provided is not intended to be a substitute for specific individualized tax planning or legal advice. We suggest that you consult with a qualified tax or legal advisor.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by WriterAccess.
LPL Tracking #1-05318617.