Apple’s stock price is somewhere around $108 today. Over the past five years it has been anywhere from $50 to $132. Medpace was the most recent Initial Public Offering (IPO) on NASDAQ. Thursday, August 11, 2016 their IPO price was $23. By Friday, August 12, the price was above $28 by close of the market. Both of these are great stories, but why should their employees care?
Many people have the misconception that the company gets some piece of the price paid for the stock on the public market. This isn't true, even at the time of an IPO. At an IPO, the company sets a price to begin initial trading. They get that price for a block of shares sold in the offering. Once the stock has been sold, any gain or loss goes to or from the investors, not the company. This remains true for every one of those shares that remains outstanding after the IPO.
So, in the case of Apple, the price of the stock does not generate any immediate cash for the company. Since the company gets none of the money, the employees can’t expect to get any more money. So, why should employees care about investors?
On August 11, 2015, Macy’s Inc. saw their stock price jump from $34 to $39 when the market opened. This was based on the well-received news that the company was going to shut down 100 stores. Each store has more than 100 employees. Some, perhaps many, will lose their jobs. Again, why should employees care about investors?
It does not appear that investors care about the employees. It is very clear that the investments are not providing more money to the company or its staff. This fundamental disconnect in both perception and reality is the reason for the third leg of compensation’s three-legged stool.
Compensation’s three-legged stool incorporates base pay, variable cash pay and equity compensation. Each leg supports a basic purpose. Base pay is essentially about getting people to come to work and do their jobs. Variable cash pay is about motivating people to their jobs better. Equity compensation is there to get people to care about something bigger than their job.
You can do well with only one leg, but that leg needs to be big enough to provide support (imagine a log to sit on). You can do well with two legs, but this works best if investments are going to the company, not to other investors (imagine many typical privately-held companies.) If you have outside investors who can drive decisions without giving the company money, you need the third leg. You should probably do what you can to align those outside investors with something tangible for employees. Stock options, RSUs, employee stock purchase plans (ESPP) and similar instruments can provide this alignment.
Without this link between stock price and pay, it can be difficult and often impossible to get employees to care about investors. Investors often complain that these plans reduce the value of their investments. Employee equity compensation dilutes their value and takes “their money” and gives it to employees. When these programs are not communicated well or when they are viewed as an entitlement, investors’ complaints have some weight. When the programs are used to drive the cultural, strategic and tactical success of the company, investors should see equity compensation as small fee for better investments.
Nearly all executive compensation programs include a major component of equity compensation for all of the reasons discussed above. If your company doesn’t have programs like this for the majority of your staff you may want ask yourself if your employees have any reason to care about your investors and, by the transitive properties of pay linked to stock price, about what is important to your executives.
Dan Walter, CECP, CEP is the President and CEO of Performensation. He is passionately committed to aligning pay with company strategy and culture and has been deeply involved in equity compensation for a long, long time. Dan has written several industry resources including the recent Performance-Based Equity Compensation. He has co-authored ”Everything You Do In Compensation is Communication”, “The Decision Makers Guide to Equity Compensation”, “Equity Alternatives” and a few other books. Connect with Dan on LinkedIn. Or, follow him on Twitter at @Performensation and @SayOnPay.