Before you send an angry email telling me that I am stupid, please read on. For more than three decades equity compensation has been considered a necessary and ubiquitous element of pay at start-ups and high-growth publicly traded companies. There are two big questions that must be addressed.
- Why do so many companies use a tool that they seemingly do not want people to understand?
- Why do so many employees want something that they so abjectly misunderstand?
Large studies have shown again and again that most (85%) equity compensation recipients do not understand their awards. They do not understand how and why they create value. They do not understand tax consequences. They do not understand how to compare these awards against those of other companies. It should also be noted that companies usually do not understand how to properly determine grant sizes or know how to use this pay element in any intentional manner.
On the other hand, employees want this magical instrument. Most really aren’t sure why they want it (will it make them a millionaire?) but they KNOW that more of it is good. Few employees see it as a truly long-term ownership or value creation tool. How do I know this? Turnover in tech companies is higher than that of nearly any other industry. Equity is much like that new toy my kid wants when he sees it at a store. It’s exciting when you get it, but the luster fades rather quickly.
Equity compensation was once seen as the great equalizer. It was the magic ingredient that allowed cash-strapped, scrappy start-ups to compete against behemoths with piles of money and security. In those glorious yesteryears, companies did one thing far differently than most do today. They made education about equity a centerpiece of their total rewards program.
People seldom appreciate the real value of things they do not understand. Consider the little silicon chips that make handheld computing devices possible. They have far greater value than most people understand. We don’t discuss them much anymore because we kind of assume people know about them. Similarly, employees don’t perceive the value of their equity compensation properly and compensation professionals do not take the time and effort required to fix the issue.
Are 83 RSUs a better value than 10,000 stock options? It all depends on the context. There are so many other aspects to consider! Most companies email a link to a quick presentation and a basic Q&A and hope that their employees figure it out.
Equity awards are worthless without a thorough understanding of their details and how the company will accomplish the lofty value goals projected by a recruiter or optimistic set of slides. Imagine a company worth $3Billion. With a respectable overhang of 15%. The equity compensation value may be close to $450Million. A typical company may spend 2 days a year and $20,000 communicating this program. If 85% of the people do not understand their equity, the company is wasting $382Mllion on misunderstood equity.
Imagine if they spent even one-tenth of 1% of the equity value. The communication budget would jump to $450,000. Now imagine that understanding moves from 15% to 50% of participants. The $450,000 investment would return $225Million! Perhaps equity compensation wouldn’t be so worthless if we started treating it like we want our employees to perceive it.
Dan Walter is a CECP, CEP, and Fellow of Global Equity (FGE). He works as Managing Consultant for FutureSense. Dan is also a leading expert on incentive plans and equity compensation issues. He has written several industry resources including a resource dedicated to 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 other books. Connect with Dan on LinkedIn. Or follow him on Twitter at @DanFutureSense.
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