Stock Ownership Guidelines in a Turbulent Market
By: Chris Crawford & Brent Longnecker
A stock ownership guideline is a policy created by a company’s compensation and/or governance committee that establishes the level of stock ownership executives and outside directors should hold.
Over the past 10 years, stock ownership guidelines for public companies in the U.S. have risen dramatically. Now, more than 85% of Fortune 500 companies publicly state having a stock ownership and/or retention ratio policy. Companies have continually adopted these policies because:
• They can assist in creating better alignment between the executive, the long-term performance of the company and shareholder wealth creation.
• They can potentially help to mitigate excessive risk taking, particularly in the short-term.
• They satisfy institutional advisors and institutions’ desires for executives and directors to own more shares.
When stock ownership guidelines first came on the scene, they were typically defined as a multiple of base salary for executives or multiple of the cash retainer for board members. While a number of approaches have been employed by companies to encourage executive stock ownership, the most common practice to date is a multiple of salary approach. It’s common practice for a company to set stock ownership guidelines for a CEO at 5-6x base salary, an EVP at 3x base salary and other executive officers at 1-2x base salary. Many governance experts deem these levels sufficient to balance the incentive for short-term risk-taking versus long-term shareholder wealth creation.
Ownership In a Turbulent Environment
While the multiple approach serves an effective way to encourage stock ownership in a rising or even flat market, it can fall short in a volatile or depressed market. One week, an executive could safely comply with the stock ownership guideline. The next week, the market could retreat significantly, and the executive could find him- or herself significantly out of compliance, leaving the compensation committee wondering how to deal with compliance.
Given this boardroom dilemma, below are several alternatives a compensation committee could consider to accomplish the spirit of stock ownership guidelines:
• Do Nothing. The committee simply explains compliance has not been met due to stock price decreases, but it will continue to monitor stock ownership levels to ensure the executives have sufficient ownership to balance short- and long-term incentives and risk-taking.
• Extend the Compliance Window. The committee may extend the compliance period with a specific deadline date for the executives to be compliant. The intention of this alternative is to take action so that executives can continue to hold shares, but it will allow the stock price to return to previous levels.
• Utilize an Average Share Price. The committee may utilize a 90-, 180- or 360-day share price average to reduce market and stock price volatility in calculating share ownership.
• Utilized Fixed Number of Shares. The committee may establish an either/or scenario where the executive has to own a certain minimum number of shares or own the minimum multiple of salary.
• Utilize a Retention Ratio. The committee may establish an either/or scenario where the executive has to either hold a certain percentage of vested shares for a specified time period (e.g. 50% of vested shares for 3 years) or own the required multiple of salary.
• Hold Until Met. The committee may implement a policy saying the executives must hold vested shares until the ownership guidelines are met.
Market turbulence creates a number of concerns and decision points for company executives and directors. Compliance with stock ownership guidelines should not garner a significant amount of time and attention away from the core operational and financial objectives of the company. This list of alternatives provided above should allow the key decision makers of the company to efficiently navigate stock ownership compliance during turbulent times.