(dated October 31, 2005)
Talking Points - Comments on Restricted Stock
George Paulin is President of Frederic W. Cook & Co.
My reference is to time-based restricted stock (i.e., company shares earned outright for continued employment). |
- No one should be concerned about the reasonable
use of restricted stock to:
- Recognize, reward, and retain high-performing individuals.
- Recruit senior executives.
- Provide a form of payment in lieu of cash.
- Buyout SERPs and other forms of guarantees.
- However, there should be concern about the recent mega-trend to substitute restricted stock for options as a form of long-term
incentive compensation, which is different from any of the uses listed above.
- There are two primary reasons for this concern:
- First, trade-off ratios of restricted stock for options are often too favorable because options are being overvalued in pay surveys, and there is no discount for the relative difference in performance risk. (An analogy is paying executives junk-bond interest on Treasury bills.)
- Second, there is a potential disconnect between pay delivery and
shareholder-value creation, recognizing that (short of company insolvency)
restricted stock will always be worth something.
- I suggest two program-design-related actions if companies shift to restricted stock from options in a significant way:
- Correspondingly reduce the competitive market position of grant values for performance risk (i.e., all else equal, a company granting restricted stock should grant less value than a company granting options, as a risk-discount).
- Correspondingly increase ownership guidelines, including retention of
after-tax vested restricted shares until the guidelines are met. The rationale
is to replace compensation risk with ownership risk.
- On the regulatory side, there should be required disclosure of the dividends being paid or credited on unvested restricted shares.
- For example, Exxon shifted from options to restricted stock as its principal form of long-term incentive compensation in 2002.
- The CEO currently has about 2.7 million unvested restricted shares with annual dividends of approximately $3.2 million, which is more than his annual salary.