May 16, 2019
Why Equity Mix Matters
– Liz Dunshee
I’ve blogged – last fall as well as last month – that the CEO pay mix has been shifting to include more full-value stock awards and fewer stock options. This CFO.com article – which is based on this 2017 research – says that executives who receive primarily restricted stock have incentives to deliver more predictable earnings and engage in less risk-taking. Dan Walter gives more color in his blog:
Restricted stock is mainly used as a retention tool. It is low risk with limited reward. Stock options are mainly used as an incentive tool. Options are high risk with the potential for extraordinary rewards. The research shows that the characteristics of these two vehicles seep into decision making that drives company earnings in profound ways.
Shareholders generally appreciate predictability when it comes to projecting future company performance. The research shows “the results are consistent with stock holdings aligning the interests of managers and shareholders, and managers using discretionary accruals to smooth past earnings to reveal information to investors about future performance.” In other words, restricted stock makes it easier for investors to know what they are investing in.
On the other hand, stock options were linked with excessive risk-taking and the use of awards “to mask the volatility of less predictable future earnings.” In other words, stock options may turn investors into gamblers. This is where too much of a good thing can be a bad thing.
When a company leans too heavily on either equity tool they miss out on the potential for better success.