December 13, 2023 Executive Compensation Executive & Director Pay Design Articles

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Newly Public Companies and Stock Ownership Guidelines

Most large, public U.S. companies have stock ownership guidelines, as they help ensure key executives have enough “skin in the game” to align their decisions with long-term shareholder interests. These policies require key executives to achieve and maintain certain equity ownership levels (often expressed as a multiple of base salary) within a specified timeframe.

Newly public companies usually wait until they are more mature before implementing these guidelines. Typically, that means three to five years following an IPO, or when a company loses emerging growth company (EGC) or small reporting company (SRC) status and becomes subject to more rigorous public disclosure and governance requirements, including Say on Pay.

The companies that adopt these guidelines sooner are considered ahead of the curve, as evidenced by Semler Brossy’s analysis of Russell 3000 companies, which indicates that only 36% of companies that have been public for less than five years have implemented stock ownership guidelines for executives. In comparison, more than three quarters (78%) of companies that have been public for more than five years have stock ownership guidelines for executives.

Many companies that went public during the 2020-2021 IPO boom are now reaching the point where investors may expect stronger governance practices, including adopting stock ownership guidelines. However, current market volatility and downward pressure on valuations for many of these same companies require a thoughtful board-level discussion about when and how to consider share ownership guidelines.

Questions to Consider When Contemplating Stock Ownership Guidelines for the First Time

Companies should not rush into the adoption of stock ownership guidelines because doing so could create guidelines that are unnecessarily onerous for executives. To avoid this situation, important questions to ask include:

What is the company’s philosophy on governance practices generally? 

Is your company a follower or a leader in compensation and governance best practices? Followers look at what key competitors are doing to inform whether they should start evolving their governance practices. Leaders consider best-in-class governance as core to their business and may adopt stock ownership guidelines ahead of their peers.

Do you need to build a stronger ethic of long-term stock ownership? 

Stock ownership guidelines help reinforce the importance of “skin in the game,” particularly if executives are habitually selling their shares upon vesting events. However, many newly public companies grapple with challenged valuations and protracted market volatility. In these cases, boards should be attentive to both the investor and employee experience. Although it may be prudent to adopt ownership policies to bolster alignment with shareholders, the board should also be mindful that such policies do not become overly burdensome for the employees who must comply with them.

Are shareholders asking about your stock ownership policies? 

If shareholders aren’t asking about your stock ownership policies, it may still make sense to establish guidelines (per the two questions above). However, if shareholders are raising questions, it is important to understand why. It could simply indicate rising governance expectations. More alarming, investor interest could directly reflect specific concerns, such as frequent insider share sales and (or) low levels of executive or director ownership. Shareholder interest in these topics may be a key signal to determine how quickly — and how aggressively — the board should respond.

What is your EGC/SRC status? 

Will your company lose EGC or SRC status soon and be subject to Say on Pay or expanded disclosure on compensation and compensation-related governance? If so, it may be appropriate to consider the role that stock ownership guidelines may play in strengthening the company’s governance profile.

Principles for Developing Ownership Guidelines

How you think about developing your company’s ownership guidelines depends on your compensation practices and company culture. Well-designed ownership guidelines should reflect a set of guiding principles that address these key areas:

Time period for compliance

Executives should not have to go into the market to purchase stock. Most companies implement a five-year window for executives to meet the guideline, with an understanding that executives should reasonably be expected to satisfy the guideline in this timeframe through normal annual equity grants.

Baseline or best-in-class

Is your goal to have company guidelines meet minimum governance expectations or to be best-in-class? (See Exhibit 1.) How aggressive or conservative you choose to be is typically reflected in the required ownership as a multiple of base salary. This point of view (as well as the underlying design of the compensation program) may also influence what counts toward the guideline. For example, do you include some portion of unexercised stock options in addition to shares owned outright?

Executive LevelBaselineBest-in-Class
Boards of Directors3x cash retainer5x cash retainer
CEO5x salary6-10x salary
Other NEOs2-3x salary3x salary
Vehicles Included– Shares owned outright
– Unvested restricted stock units (RSUs)
– 50% of in-the-money options
– Shares owned outright
– Unvested RSUs
Time Period for Compliance5 years5 years
Retention Requirement50% of net after-tax shares upon vesting or exercise until ownership guideline is met
Exhibit 1: Baseline vs Best-in-Class Compensation and Stock Ownership Guidelines
Volatility

It may also be helpful to describe how market volatility could or should influence compliance with the guidelines. For volatile stocks, a fixed share requirement may be more appropriate than a dollar-based approach — some companies even define as a “lesser-of” a fixed share or dollar-based threshold. A retention requirement on vested shares can also help manage volatility so that if an individual no longer meets the guideline, they merely need to retain a portion of the shares from future vesting events (e.g., 50% of the net, after-tax shares) to remain compliant.

Conclusion

Whether your company is a leader or a follower, having stock ownership guidelines is, eventually, a governance best practice for every company. Share ownership aligns management’s interests with shareholders. Boards will want to encourage key individuals to hold a significant portion of shares granted via equity incentive plans. Establishing and disclosing formal guidelines for ownership ultimately becomes table stakes for mature public companies. However, for newer public companies, creating and adopting guidelines for the right reasons, at the right time, requires careful consideration. This assessment will be multifaceted and based on internal and external considerations.  


View the full article as it was originally published.

Mark Emanuel

Kristofer O’Toole

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