Executive compensation continues to evolve, but the goals remain the same: align the incentives of the shareholders with the executives. Financial engineering will progress in all areas, and executive compensation is not immune. We have seen complex incentive structures created to reward executives for specific performance or market-based achievements. While these structures remain relevant and can be used to tailor an executive’s compensation, we have also observed an increase of standard equity awards with post-vesting restrictions. In general, equity compensation is intended to align the objectives of shareholders and executives. The addition of post-vesting restrictions promotes executive retention and incentivizes stable long-term growth.
The following benefits have encouraged the use of post-vesting holding requirements in restricted shares:
- Improved corporate governance
- Reduced compensation expense
The benefits achieved are dependent on the restrictions and rights issued with shares. We will discuss the corporate governance benefits that are achieved with lower compensation expense. The lower compensation expense is due to the discounts in the valuation for the post-vesting restrictions. Corporate governance is enhanced, the company has reduced expenses and the employee receives equity compensation, making restricted shares a benefit for all.
Improved Corporate Governance
Executive compensation (as a percentage of corporate earnings) is at an all-time high and has been targeted both politically and socially. Public companies are required to disclose executive compensation, allowing shareholders and the general public to scrutinize executive rewards relative to performance. The pay-for-performance idea is not novel, yet it is challenging to implement. The issue is that value and performance are difficult to quantify and can also be fleeting. In order to adjust for misaligned compensation and discourage the pursuit of short-term economic policies, companies have implemented time restrictions and clawback provisions for executive compensation. In the event of poor corporate governance, compensation adjustments can be executed to preserve an equitable arrangement.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was established to protect investors. Final Securities and Exchange Commission (SEC) rules associated with the requirement for recovery mechanisms have not been finalized. Upon adoption, all listed companies will be required to incorporate effective compensation clawback policies.
The intent of corporate governance is to align shareholders, Boards of Directors and executives toward common goals. Issuing restricted shares with time-based post-vesting restrictions and clawback provisions supports strong corporate governance.