3 Trends in Performance-Based Equity
March 31, 2022
Some of the most interesting findings of the 2021 Equity Incentives Design Survey are reported in the section on performance-based awards. This section provides a comprehensive look at how companies currently structure their performance-based equity—that’s everything from grant eligibility to performance metrics, performance periods, and forfeiture provisions.
We invited Ian Dawson of Deloitte Tax back to the Equity Expert podcast to discuss some of the key trends we saw in performance awards. Here are a few highlights from our conversation.
Trend #1: Technology Companies Lag Other Sectors in the Use of Performance Awards
One notable trend that we see in the survey is that technology companies are less likely to grant performance-based awards than companies outside of the technology sector. Only 80% of technology companies currently grant performance awards, compared to 87% of companies overall. In some sectors, the percentage of companies granting performance awards exceeds 90%. Fully 98% of manufacturing companies and 95% of financial/insurance companies grant performance awards.
Ian attributes this difference in practice to the fact that some large household-name tech companies still have founder CEOs:
They very often have clear visions on the culture that they want to build and how equity can support that culture. And oftentimes, honestly, performance-based awards just don't fit in with that vision.
Moreover, as founder CEOs, they don’t have to be as concerned about shareholder sentiment because the tech sector has generally seen very strong performance and because many of these CEOs own significant portions of their companies’ stock (or control a significant percentage of votes).
Trend #2: There Has Been Significant Growth in the Use of TSR Awards
The survey has tracked remarkable growth in the use of total shareholder return (TSR) as a performance metric. In 2007, only 30% of companies that granted performance awards tied vesting to TSR. This percentage rose to over 60% in the 2021 survey. No other performance metric is so widely used; the second most commonly used metric in the survey, return on invested capital (ROIC)/return on net assets (RONA), is used by only 26% of companies.
Ian explains that two major factors have contributed to the growth in the use of TSR awards. He notes that the uptick dates back to the implementation of Say-on-Pay votes under the Dodd-Frank Act. Shareholders view TSR awards quite favorably; tying vesting to shareholder returns is a simple and straightforward way to align executive compensation with shareholder interests. With the added influence that Say-on-Pay affords shareholders, they (and proxy advisors) have pressured companies to adopt TSR awards.
Another major factor driving companies to adopt TSR awards is the simplicity of goal setting. Establishing appropriate multi-year financial or operational targets can be challenging, especially during periods of economic volatility, like we’ve been experiencing for the past several years.
Ian says that TSR, on the other hand is a “set and forget metric”:
You pick your peer group or your index, you establish the payout and performance curve, and away you go.
Right now, that simplicity is probably pretty attractive to a lot of compensation committees.
Trend #3: ESG Still Hasn’t Caught on for Equity Awards
One area where the survey didn’t see a lot of growth was in the percentage of companies that tie vesting in awards to ESG metrics. Only 4% of respondents used any of the ESG metrics that we asked about. Yet I continue to hear that companies are interested in tying compensation to ESG, so I asked Ian what he thinks the future is for ESG in long-term incentives and equity awards.
Ian points out that there are a lot of challenges in making long-term incentives (and, for that matter, even short-term incentives) contingent on ESG-related targets. It’s currently unclear that doing so will drive the behavior that investors are looking for and there are so many worthwhile metrics to choose from that it’s impossible to include all of them in an incentive compensation program.
Another significant consideration Ian sees is that there isn’t always consensus on how to measure success when it comes to ESG metrics. Everyone generally agrees on how to calculate financial metrics, like, say, earnings per share. But with ESG metrics, two companies could be measuring the same metric using very different methodologies.
Ultimately, Ian does think that more companies will move to adopt ESG metrics for equity awards. But he agrees that it makes sense to start with annual incentives and he expects that progress towards ESG in long-term incentives will be slow, given the many challenges involved.
About the Survey
The 2021 Equity Incentives Design Survey is part of a trio of surveys that the NASPP and Deloitte collaborate on. The surveys take an in-depth look at the design and administration of all forms of worldwide stock compensation. The 2021 edition focuses on the design of time-based full value awards and stock options as well as performance awards.
We conducted the survey in early 2021 and received close to 400 responses. All respondents are public companies representing a wide range of industries and company sizes, from the newly public to the very mature. About a third of respondents are in the technology sector and nearly all are multinational companies headquartered in the United States.
Be sure to check out the full podcast with Ian and here are additional resources on the 2021 Equity Incentives Design Survey:
- NASPP Webinar: Top Trends from the 2021 Equity Incentives Design Survey
- NASPP Webinar: Trends in Global Equity Incentives
- Equity Expert Podcast: Trends in Equity Award Usage and Eligibility
- Equity Expert Podcast: Trends in Global Equity Incentives
- Equity Expert Podcast: Trends in Performance Awards
- Full Survey Results: 2021 Equity Incentives Design Survey