What is the Accumulated Gains and Carried Interest Table?
As discussed in the September-October 2005 issue of The Corporate Counsel,
the third essential tool for every compensation committee is the "Accumulated
Gains & Carried Interest Table." As Fred Cook so ably
recounted in his speech, stock options were not originally intended to be
part of current compensation, but rather an ownership incentive. Over time,
executives would accumulate a "carried interest" that would motivate them to
increase the value of the company over the long term. Unfortunately, because so
many consulting firms
included one-time mega grants in their surveys and smoothed them out to look
like annual grants, over time the numbers became so inflated that today's
average annual grant is higher than what used to be a huge one-time mega grant.
chart prepared by one of our Task Force members that dramatically shows that
the median annual CEO grant is now 2.2 times larger than a one-time mega grant
in 1988.) To
quote from Fred's talk, "it is my belief that currently high stock option
grant values for executives have gone beyond any rational motivational value and
are sustained only by compensation surveys."
Because so many CEOs now have accumulated so much equity, the motivational
value of additional, incremental grants has been lost for those CEOs. Indeed,
there is the temptation to cash out and take the money and run (a perverse,
reverse incentive). Again to quote from Fred Cook, "What can be the possible
purpose served in granting a CEO who already has an equity carried interest of
150-200 times salary, another option whose ‘face value' is 20 times salary? The
CEO is likely to be already so motivated by stock price performance that new
grants add no incremental motivational value. They only add cost. It is only
done because the surveys say that, without the new grant, the CEO's total
compensation will not be competitive. No survey, to my knowledge, considers what
executives have already received in options."
An Accumulated Gains & Carried Interest Table enables a compensation
committee to see in one place the total value of all the options and other
equity delivered to the executive to date. Too often, directors do not have that
information in front of them when they consider making new grants (or when
reviewing other aspects of the CEO's compensation). As Fred Cook has pointed
setting as a target a net future gain from equity grants of 6 to 15 times
current salary "should be sufficient to optimize a leader's alignment with
shareholders and motivation for a share price appreciation." We have posted an
example of a table that illustrates how to set forth both the cumulative
realized and unrealized gains for top executives at a company, as well as a
chart to demonstrate what the values of equity holdings will be as the stock
What Can a Responsible Compensation Committee Do Here?
After a compensation committee has an accumulated gains table in front of it
and sees how much wealth has already been delivered, there are two obvious
courses that responsible boards and CEOs should take.
Turn Off the Hose (It Has Flooded the Field and is Damaging Roots).
First is to recognize that the purpose of the equity grants has been met. This
means that boards must bite the bullet and put on the table that the CEO has
received so much already that there is no reason for more. (For this to happen,
some responsible CEOs are going to need to speak out—as some CEOs already
have—by, e.g., asking their compensation committees to put their grants back in
the pool for other employees. See these and other important examples set forth
in the new "CEOs That Have Set an Example" section on CompensationStandards.com.)
This also carries over to retirement and severance arrangements. Boards must
recognize that the purpose of their option grants was to provide (a) incentive
for the long term and (b) a healthy nest egg should all things work out. At
those companies where the amounts from accumulated equity grants have now
exceeded what were beyond the wildest dreams just a decade ago, boards must
consider what is now already out there for the executive's retirement years and
cut back on (and, in some cases, eliminate) the retirement and severance
provisions that were intended to provide for the future. Now that some
executives have amassed several lifetimes' worth of wealth as a result of past
grants, it is time for responsible boards and CEOs to act here to restore (both
internally and externally) trust and loyalty in the company's leadership.