4 Reasons Mega Grants Are Problematic
March 03, 2022
In my blog about Elon Musk’s sales, I noted that the massive tax bill resulting from mega grants is yet another reason not to grant them. Some of you might be wondering what the other reasons are.
What Are Mega Grants?
Mega grants are exceptionally large grants that are issued to executives. They are typically the size of what would normally be several years’ worth of grants. A memo from Pearl Meyer notes that mega grants typically have the following characteristics:
- A grant date value of more than 10 times the executive’s salary.
- Represent a significant percent of common shares outstanding (e.g., 3% to 12% or more of common stock outstanding).
- Represent several years’ worth of equity awards, with the expectation that no further equity awards will be issued to the recipient during this time period.
- Extended vesting/performance periods, often seven to ten years.
Don’t Do That! Reasons Mega Grants Are Problematic
We’ve never been a fan of mega grants here at the NASPP. Here are some of the reasons they are problematic (in addition to the aforementioned tax bill).
1. Too Much Compensation Tied to a Single Price Point
If the stock increases in value, mega grants are excessive and can result in overcompensation. If the stock declines in value, the return delivered (and the executive’s perceived value) is not commensurate with the expense that the company recognizes for the award. This is especially true if granted in the form of stock options that end up underwater, but even restricted stock/units are wasteful in that the company recognizes an expense that could be several times higher than the benefit paid out to the executive.
In the past, some mega grants ultimately ended up so worthless that executives surrendered them for no compensation. Unfortunately, surrendering the grants doesn’t give the company a do-over on the expense—it all stays on the books.
Smaller grants at more frequent intervals are considerably less risky for both the company and executives.
2. Executives Have Short Memories
Let me tell you a story. In 2000, Apple granted then CEO Steve Jobs an option to purchase 20 million shares. At the time, it was one of the largest options that had ever been granted and represented 44% of the total options Apple granted that year. A little over a year later, Apple issued Jobs another option, this time for 7.5 million shares.
Why two such large grants in quick succession. According to testimony given by Jobs, the second grant was because he felt neglected by the board. Essentially, his feelings were hurt that he hadn’t gotten another grant when all the other Apple execs were getting grants. This despite the fact that he had received a record-breaking grant just a year ago.
Even though mega grants are intended to compensate executives for a multi-year period, executives have short memories. A few years in, they are going to be wondering why they haven’t gotten any grants lately.
3. The Best Laid Plans…
Here’s another story. In 2012, Tesla granted CEO Elon Musk an option to purchase 5 million shares. The option vested in ten tranches, each contingent on a market and operational metric. With ten tranches the grant might have been expected to compensate Musk over a period of around ten years. Instead, just six years in, nine of the ten tranches had vested and Tesla’s board was faced with the need to grant Musk another option.
Grants that are intended to last several years sometimes don’t.
4. Mega Grants Beget More Mega Grants
Oh, and that follow-up grant issued to Musk in 2018? That was an option to purchase over 20 million shares. Because one big problem with mega grants is that once executives receive them, they want their future grants to be even bigger. No one thinks their grants should be getting smaller.
And this expectation can be contagious. In the tradition of his predecessor, Apple CEO Tim Cook has also received some very sizable grants (most recently an RSU worth over $80 million).
A Few Other Considerations
In his memo, Robert James of Pearl Meyer discusses some important considerations for mega grants:
- There can be such a thing as too much pay-for-performance. Mega grants tied to operational metrics can be risky because it’s hard to set operational goals for a seven to ten-year time horizon.
- Dilution is concern, as well as the impact of the grant on proxy advisor pay-for-performance alignment assessments.
[If it’s significantly above market—and it almost certainly will be—prepare to defend the rationale in the proxy, to investors, and even to ISS and Glass Lewis to reduce the likelihood of an “Against” say-on-pay recommendation/vote.]
Consultants at Aon weigh in with their own memo on considerations for mega grants (which they refer to as “Special Executive Transformational Grants”). Some of their recommendations:
- The award’s value should be expressed as a percentage of the value that will be created for shareholders.
- Consider requiring executives to forego other compensation during the performance period of the award.
- Shareholder approval may be necessary for awards of this size. Even if not required, consider seeking approval to mitigate the risk of shareholder litigation.
- Consider imposing a post-vesting holding period on the awards.