December 19, 2000
Professionals
on the Use of
Compensation professionals who use surveys to
determine competitive stock options/long-term incentive grant guidelines for 2001
need to be aware that such surveys may reflect an extraordinary level of grant
activity in 2000 caused by the market decline in equity values since April.
Many companies that made their normal stock
option grants earlier in 2000 saw their stock prices decline significantly in
the subsequent market correction that affected both new and old economy
companies. Thus, their 2000 (and in
many cases earlier) stock options went "underwater," wiping out vested
and unvested option values. Because
this was a market correction, not an economic recession, demand for talented
employees and competitive pay opportunities remained high.
This combination of depressed market values
and strong demand for good people caused grave retention concerns among
established and emerging companies alike.
Fortunately, new accounting rules and responsible corporate governance
discouraged the cancellation and repricing of options. However, many companies quite reasonably
responded to this threat to their key employee population by other means. These actions took various forms, including
acceleration of year 2001 option grants, "extra" on-top option
grants, and/or selective restricted stock grants. None of these extraordinary actions signaled a permanent change
in their anticipated equity usage but rather were in response to the exigencies
of the situation.
The risk is that these special actions will
be included in compensation surveys indiscriminately and become part of
"normal" competitive practice, thereby contributing to an unwarranted
escalation of equity grant values, compensation costs and equity dilution.
What should responsible companies and
compensation professionals do in response to this situation? We have five suggestions.
For Companies That Made Extraordinary Grants
in 2000
1. Clearly explain and distinguish the
extraordinary grants in 2001 proxy statement grant tables, in the compensation
committee report, and in the 2000 annual report equity footnotes.
2. When submitting grant data in third-party
survey questionnaires, provide only the normal annual grant amounts for 2000
and exclude any extraordinary or accelerated grants.
For
All Companies Using 2000 Survey Data For Their 2001 Grant Guidelines
3. Advise top management and board
compensation committees that 2000 survey data may reflect an extraordinary level of equity grant activity that
need not be recognized in new grant guidelines.
4. Ask third-party survey firms to provide
either (1) "normal" grant values only, or (2) to estimate the amount
by which the survey data may be distorted by the extraordinary grant activity.
5. If unable to get "normal" data
for 2000, continue with existing 2000 grant guidelines in 2001.
For most companies, continuation of their
normal grant guidelines provides reasonable and justifiable grant values,
motivation, retention, and equity dilution without the artificial and
unwarranted inflation of grant values and costs that would result from
including year 2000 extraordinary grants as "normal."
Frederic
W. Cook