– Eric Marquardt, Towers Perrin

As companies look for better ways to manage costs and retain key staff in our current turbulent economy, executive choice in long-term incentives (LTI) is emerging as one potential option. Among larger U.S. companies, such as Procter & Gamble, Herman Miller and Lincoln Electric, we have seen increased disclosure of executives being offered a limited choice among different types of LTI vehicles of equal value. For example, at P&G senior managers may choose to take 50% of the annual LTI grant value in stock options, restricted stock or a split of equal value between the two. In this specific case, the options vest in 3 years, while the restricted shares take 5 years to vest.

Why offer choice? Why take on the administrative and communications tasks required for execution? The answers appear similar among those offering choice. For participants, choice can enhance the perceived value of LTI awards of otherwise equal accounting value and:

– Aid in retention of key talent, especially if there is significant diversity in the age and tenure of the management team
– Take the sting out of actual cutbacks in LTI grant value
– Allow executives to decide how to address change in their LTI in the face of uncertain company and/or stock price performance

Choice is not, however, an abdication of a company’s pay philosophy. Participation in performance contingent plans, for example, is rarely, if ever, a choice. Choice is usually between various types of service based awards. A core LTI plan continues to cover all participants, with choice rarely involving more than 50% of total LTI value. If a company has ownership guidelines, offering covered executives choice does not excuse them from compliance with the guidelines.

In the face of Internal Revenue Code Section 409A, some caution in structuring the choice is necessary. Options and restricted stock in a choice program are generally exempt from 409A, so long as the grant date of the award is not changed by the choice. Generally, choice involving restricted stock units (RSU’s) can work as well. However, choice regarding RSU’s will be considered deferred compensation. If so, a choice should be made before the year of grant, and vesting not guaranteed on certain types of terminations, such as retirement.