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Market Volatility and Burn Rates

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March 17, 2020 | Barbara Baksa

Market Volatility and Burn Rates

When it comes to the Coronavirus; I got nothin’; the issues in the forefront of the pandemic—wages, teleworking, health insurance, etc.—are not topics I know much about. But I have a related topic for today’s blog—how the current market volatility may impact burn rates.

The Silver Lining

A decline in stock price can be a fortuitous time to grant equity awards. For all equity vehicles, the per share fair value will be lower than in periods when the stock price is high, and in the case of stock options, the exercise price will be low. Moreover, because most companies (87%, according to the 2019 NASPP/Deloitte Consulting Domestic Stock Plan Design Survey) determine grant sizes based on award value, awards will be for more shares than when the price is high, which may cause employees to perceive the awards as being worth more.

The Traps

But there are traps to be wary of when granting during a period of volatility. First, it’s hard to know when you’ve hit bottom. The stock price could continue to decline; stock options can be underwater before the grant paperwork is issued.

Another trap is how this market volatility can impact your burn rate. If grant sizes are based entirely on value, companies may find that they are suddenly granting a lot more shares than expected. This can cause companies to run through the shares in their plans faster than anticipated, necessitating share requests. Compounding the problem, the higher average burn rate may cause shareholders to be more conservative in terms of the number of shares they will approve.

Numbers to Watch

If you are experiencing a decline in your stock price (and what public company isn’t right now), it is critical to keep an eye on your burn rate. Here are three numbers to watch:

  • How does the number of shares granted this month compare to the same month a year ago?
  • How many shares are expected to be granted this year and what percentage have already been granted? Again, how does this compare to this period last year?
  • How many shares are available for grant in your plan and how long will they last if the stock price remains where it is for an extended period or declines further?

Consider a Multi-Day Average

Where you have concerns about grant sizes/share usage, consider determining award size using a multi-day average price, rather than a single day price. A 20 to 60-day average price can help smooth out the impact of market volatility on award sizes (the longer the averaging period, the less variability there will be in grant sizes). This average is used only for purposes of determining how many shares will be granted; award fair value for accounting purposes is still based on the grant date FMV, and the exercise price of stock options is still equal to the grant date FMV.

This is an excellent practice regardless of whether your stock price is up or down. Not only does it help with your burn rate, it also helps mitigate inequities between employees. Yet few companies employ it. Only one-fifth of respondents to the NASPP/Deloitte survey use an average of 20 days or greater when sizing grants.

Reduce Grant Sizes

Reducing the size of grants during the period of the downturn is another potential solution. There are several ways this can be accomplished:

  • Reduce grants for all participants by a specified percentage, e.g., grants this year will be equal to only 80% of the value awarded last year.
  • Set a cap on the number of shares that can be granted per person. The cap can be graduated based on rank, job title, salary grade, etc.
  • Set an overall cap on the aggregate number of shares to be granted and adjust individual grants accordingly.

Don’t Be Caught Unawares

Ten years ago, when the financial crisis depressed stock prices for years, many companies found themselves facing a shortfall due to high burn rates. Staying on top of your burn rates is a great opportunity for you to demonstrate how the stock plan administration team can add value to the grant process. 

Take care of yourselves and stay healthy!

- Barbara

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