Why Multiday Averages Make Sense for Grant Sizing

When granting equity awards, close to 90% of companies use a value-based approach to determine grant sizes [1]. Rather than starting with a number of shares, they first determine the amount of value they want to deliver to employees. This helps companies evaluate and size equity awards in the context of employees’ overall compensation (e.g., employees might receive equity awards equal to 20% of base salary).

Ultimately, however, grants must be expressed as a number of shares. Thus, companies that use this approach must decide on a per-share value that will be divided into the aggregate value to determine the total shares granted. One way to do this is to use a spot price, i.e., the FMV for any day on or before the award is granted.

For companies with relatively stable stock prices, a spot price can be a great solution that is both easy to implement and explain to award holders and results in predictable share usage. But spot prices can be problematic for companies with more volatile stock prices, resulting in wide variances in grant sizes that can seem arbitrary to award holders and make it challenging to manage burn rates and share usage. These companies should consider using a multiday average price to determine grant sizes.

What Is a Multiday Average?

A multiday average is just that: rather than use the FMV from a single date, you would average the FMVs for a specified period (e.g., 30 days) leading up the grant date and use the average value to determine grant sizes.

The averaging period doesn't have to end on the grant date. For example, if using a 30-day average, you could use the period from 35 to 5 days before the grant date. This takes some of the pressure off when calculating the average value; it doesn't have to be a last-minute rush. 

Multiday Averages Result in More Equitable Grants

Using a multiday average evens out grant sizes, which helps ensure that employees aren't unfairly penalized because they have the bad luck to be granted an award when the price is high and also don’t receive a windfall because they have the good luck to be granted an award when the price is low.

Let's look at an example of a fictitious company that trades at 1/100th the value of the S&P 500. (I’m using 1/100th of the S&P price because the S&P trades at thousands of dollars per share and that high of a value makes the example clunky. The aggregate values would work out the same regardless of the per share price. Also, I’m rounding to the nearest dollar because decimals are confusing and distracting in examples. Otherwise, this is a historically accurate example.)

To put my hypothesis to the test, I'm using a particularly volatile period in the S&P's history: February 20 to March 20, 2020.  February 20, 2020, is the day before the market started to slide due to the COVID pandemic and March 20 is just a couple of days before the market hit its low point for the year. This example mirrors what many companies experienced with their stock prices during that period.

Let’s assume that my fictitious company is granting RSUs to two employees, both of whom are relatively equal in terms of rank, tenure, and performance. Each employee is to receive an RSU worth $10,000. Employee A’s RSU is granted on February 20, when the stock price is $34 per share. Employee B’s RSU is granted one month later, on March 20, when the stock price has dropped to $23 per share.

If we use the FMV on the grant date to determine the number of shares in each grant, employee A will receive a grant for 294 shares ($10,000 divided by $34 per share) and employee B receives a grant for 434 shares ($10,000 divided by $23 per share). Employee B’s grant is almost 1.5 times the size of employee A’s grant. Not because employee B deserves more shares but merely because employee B’s grant was timed fortuitously.

Six months later our fictitious company’s stock has fully recovered, to $34 per share.  At that price, Employee A’s grant is worth about $10,000 (slightly lower because of rounding). Employee B’s grant, however, is worth $14,756. Over the long term, Employee B could end up realizing significantly more compensation from his/her RSU than Employee A. This would be fine if it is our intention, but this isn’t the case—we intended them both to receive grants that were relatively equal in value.

Using even just a 30-day average would have smoothed out the differences between the two grants considerably. The 30-day average for Employee A’s grant is $33 per share. The S&P 500 was fairly stable for the 30 days leading up to February 20, so the 30-day average doesn’t have a big impact on Employee A’s grant. It would be for 303 shares instead of 294 shares.

But using a 30-day average has a significant impact on Employee B’s grant. The 30-day average on March 20 is $30. This reduces the size of Employee B’s grant to 333 shares, which is more comparable to the grant that Employee A received just a month before. The current value of both grants is also more comparable. After six months, when the stock has recovered to $34 per share, the value of employee A’s grant is worth a little over $10,000 and Employee B’s grant is worth a little over $11,000. From a compensation standpoint, this seems like a better result than when we used the grant date spot price to determine the size of each grant.

Multiday Averages Result in More Predictable Share Usage

As demonstrated in my example, using spot prices to determine grant sizes results in a large variation in grant sizes. Wildly different sized grants make it harder to forecast share usage and, when the company’s stock price declines, it can cause the company to burn through its plan reserve at record speeds.

When the company in my example uses a spot price to size the grants to employees A and B, it uses up significantly more shares than it was planning to. But when the 30-day average price is used, the company’s share usage aligns with about what it was planning on at the start of the year.

For more thoughts on managing burn rates through volatile periods, see the NASPP article "Sizing Grants During Periods of Market Volatility."

The Drawbacks

Using a multiday average introduces complexities beyond having to calculate the average FMV. The expense recorded for accounting purposes will differ from the value communicated to employees. In my example, the expense for Employee A’s grant will be $10,302 (303 shares multiplied by the $34 grant date FMV) and the expense for Employee B’s grant will be $7,659 (333 shares multiplied by the $23 grant date FMV). But unless the employees are executives (or work in finance or accounting), there’s no reason for them to know the expense recorded for their grants.

For named executive officers, the grant value reported in the Summary Compensation Table and Grants of Plan-Based Awards Table is tied to the value of the grant for accounting purposes. Thus, this reported value will also differ from the value communicated to these executives.

While these considerations should not be underestimated, I think the advantages in terms of fairness to employees and forecasting outweigh the disadvantages. 

Participate in Our Survey to Find Out What Other Companies Do

In the 2022 NASPP/Deloitte Tax Equity Administration Survey, the percentage of respondents using an average value to size grants increased to 42%, up from 27% in the 2019 survey. Of those, most (29%) use a 20 to 40 day average, which is largely representative of using a month’s worth of share prices to denominate the award. 

We are currently in the process of updating this survey; you have until May 9 to participate. Issuers must participate in the survey to gain access to the full survey results. 

Do Your Own Analysis

As much as I want you to participate in our survey, I have to admit that this is an area where other companies' practices may not be that relevant to your own company's practice. The decision to use a multiday average should be driven by whether the results produced in terms of fairness to award holders and management of share usage outweigh the administrative overhead of having to calculate the average price. This is going to largely be a matter of how volatile your stock price is. 

I suggest performing your own historical analysis. Assume grants for the same target value were issued on each of the grant dates during the past year (or select a period during which your stock price was particularly volatile). Select a target value that makes sense for your company. Calculate the size of each grant using the spot price on the grant date and using a multiday average. Consider comparing a couple averaging periods (e.g., a 30-day vs. a 60-day average) to the actual grant sizes and assess the following questions:

• How much of a difference would the multiday average approach have made in the grant sizes? Would the grants have been materially more equitable in size throughout the period?
• How would this approach have affected share usage over the period?
• What would the grants be worth today? Would the grants be materially more equitable in value?
• How much do you expect your stock price to grow over the vesting period of the grants and how will the anticipated value at vest compare under the different approaches?

If the multiday average approach produces materially better results (e.g., grants that are more fair, more predictable share usage), your company may want to consider this approach. 

1 Data source: 2022 NASPP/Deloitte Tax Equity Administration Survey