The Value Proposition - My Fidelity Site Value... · statement The Value Proposition 6 Value Target...

The Value PropositionWhich Value is This Again?

Sandra Pace, Steven Hall & PartnersTed Manley, Dunkin’ Brands Group, Inc.Kristin Johnson, Quintiles IMS Holdings, Inc.CJ Van Ostenbridge, Aon plc

The 9th Annual New England NASPP Regional Conferenceco-hosted by the Boston and Connecticut NASPP ChaptersJuly 14th, 2017

CPE Credits…

The Value Proposition2

Continuing Professional Education (CPE) Credits are Available! You will receive one (1) CPE credit after attending this session You must attend the entire session to be eligible In order to earn the available credit(s) for this session, you must see

the room monitor at the end of the session to receive your stamp to be officially signed out.

Electronic certificates will be emailed to you a few weeks after the conference with the cumulative number of credits earned

The National Association of Stock Plan Professionals (NASPP) is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. Web site: www.nasba.org

Agenda…

The Many Types of Value Award Sizing Award Design vs. Value RSUs Options PSUs (Non-Market Based) PSUs (Market Based)

Questions


Value

Target

Accounting Fair Value

Compensation Expense

DisclosedRealizable

Perceived

Realized

The Many Types of Value - Target

Target Value The “intended” value of the

grant Often equal to a percentage of

base salary Target Value must be

converted to target number of award using a divisor Stock price at grant Average stock price over

the month prior to grant Accounting fair value


The Many Types of Value – Accounting Fair Value

Accounting Fair Value Dictates the amount of

compensation expense recognized by the issuing company

Originally estimated on the grant date, but can change throughout the life of the award in certain situations Non-employee awards Liability awards


Value

Target

AccountingFair Value


DisclosedRealizable

Perceived

Realized

The Many Types of Value – Compensation Expense

Compensation Expense Equal to Fair Value x Target

Awards Vested for options and market-based PSUs

Equal to Fair Value x Actual Awards Vested for options and non market-based PSUs

Impacts company’s income statement


Value

Target



DisclosedRealizable

Perceived

Realized

The Many Types of Value - Disclosed

Disclosed Value Displayed in the “Summary

Compensation Table” of a company’s proxy statement

Equal to the Accounting Fair Value x Awards Probable to Vest as of the grant date

Receives scrutiny from shareholders and governance firms


Value

Target



DisclosedRealizable

Perceived

Realized

The Many Types of Value - Realizable

Realizable Value Displayed in the “Grants of

Plan-Based Awards Table” of a company’s proxy statement Threshold Value Target Value Maximum value

Can also be expressed as threshold, target, and maximum number of awards

Specific to performance awards


Value

Target



DisclosedRealizable

Perceived

Realized

The Many Types of Value - Perceived

Perceived Value The value that an award holder

believes an award has Hard to quantify Closely related to motivation

and/or retentive value


Value

Target



DisclosedRealizable

Perceived

Realized

The Many Types of Value – Realized

Realized Value The value that an award holder

ultimately receives Hard (or impossible) to predict Closely related to motivation

and/or retentive value


Value

Target



DisclosedRealizable

Perceived

Realized

A Simple Relationship

Example: A company increases a target grant of time-based RSUs from 100 shares to 150 shares Target value increases by 50% Accounting fair value does not change Compensation expense increases by 50% Disclosed value increases by 50% Perceived value increases by 50% Realized value increases by 50%

This is easy!


A Complex Relationship

Example: A company decides to grant cash-settled PSUs awards whereby the Target Value ($1,000,000) is converted to target shares by dividing the Target Value by Accounting Value. The company is considering a maximum payout of either 150% or 200%.

This is hard!


150% Max Payout 200% Max PayoutTarget Value $1,000,000 $1,000,000

Accounting Fair Value $11.00 $12.50

Target Awards 90,909 80,000

Compensation Expense Dependent on Performance Dependent on Performance

Disclosed Value $1,000,000 $1,000,000

Realizable Shares 180,000 200,000

Perceived Value ??? ???

Realized Value Dependent on Performance Dependent on Performance

A Key Decision

How Target Value is converted to target shares is a critical decision Divisor equals Accounting Value at grant:

Target Value = Compensation Expense = Disclosed Value for employee equity awards

Design decisions (and therefore Accounting Value at grant) affect the number of target shares granted, complicating the relationship between Target Value / Compensation Expense / Disclosed Value and Perceived / Realized Value

Can result in angry employees if they get fewer awards than they expected (Accounting Fair Value > Stock Price)

Divisor equals stock price at grant (or similar): Target Value only equal to Compensation Expense and Disclosed

Value if Accounting Fair Value equals divisor Design decisions flow more directly to award holders and issuing

company


RSUs – Dividend Equivalents

Simplest value relationships because often Accounting Value = Stock Price Exception when company does not provide dividend equivalents


Grant Size Based on Accounting Fair Value

Dividend Equivalents

No Dividend Equivalents

Target Value $1,000,000 $1,000,000




$1,000,000 $1,000,000

Disclosed Value $1,000,000 $1,000,000


Realized Value Higher at lower future stock prices

Higher at higher future stock prices

Grant Size Based on Stock Price

Dividend Equivalents

No Dividend Equivalents

Target Value $1,000,000 $1,000,000




$1,000,000 $940,000

Disclosed Value $1,000,000 $940,000

Perceived Value Higher Lower

Realized Value Higher Lower

Would award holder rather have more awards or dividend equivalents?

Is perceived value of a dividend equivalents worth $60,000 in additional compensation expense and disclosed value?

Options – Divisor is Fair Value

When award size is based on Accounting Fair Value there is a trade-off between design features and number of awards granted Contractual Term: Longer contractual term means higher Accounting

Fair Value, fewer awards granted Would employee rather have 1,000 10-year options or 1,200 7-year options?

Vesting Schedule: Longer vesting schedules mean higher Accounting Fair Value, fewer awards granted Employee would prefer more options that vest over a shorter time period Company must balance retentive value with perceived value

Realized Value dependent on future stock price path and individual exercise behavior


Options – Target is Fixed

When award size is fixed there is a trade-off between Perceived Value and Compensation Expense to company Contractual Term: Longer contractual term means higher Perceived

Value, but also higher Accounting Fair Value, Compensation Expense, and Disclosed Value Sometimes, but not always, results in higher Realized Value

Vesting Schedule: Longer vesting schedules mean higher Accounting Fair Value, Compensation Expense, and Disclosed Value but lowerPerceived value Company must balance retentive value of longer vesting schedule with other

consequences Realized Value dependent on future stock price path and individual

exercise behavior


Options – Contractual Term



7-year Term 10-year Term

Target Value $1,000,000 $1,000,000




$1,000,000 $1,000,000

Disclosed Value $1,000,000 $1,000,000


Realized Value ??? ???

Grant Size Fixed

7-year Term 10-year Term

Target Value $1,000,000 $1,000,000




$1,000,000 $1,250,000

Disclosed Value $1,000,000 $1,250,000

Perceived Value Lower Higher

Realized Value ??? ???

Would award holder rather have more awards or longer to exercise?

Is perceived value of a 10-year term worth $250,000 in expense to the company?

Options vest annually over 3-years, strike price equal to stock price

Options

Considerations Value Cap – Limit gain on option to a certain level (i.e., 600% of exercise

price) Lower Accounting Fair Value, magnitude of discount will depend on volatility Impact on Perceived Value may be low Could lower Realized Value

Indexed Options – Tie exercise price to Index return Lower Accounting Fair Value, magnitude will depend on volatility and correlation to Index High impact on Perceived Value, will affect Realized Value Can result in adverse tax consequences (exercise price may be lower than stock price at

grant) Valuation

Lower expected life and/or volatility assumption will lower Accounting Fair Value with no impact on Perceived or Realized Value, but must stay within accounting guidance

Same with exploring a different valuation model (i.e., Lattice Model instead of Black-Scholes)


PSUs – Not Market Based

Accounting Fair Value = Stock Price at Grant Disclosed Value depends on most probable level of performance at

grant Compensation Expense based on number of awards that actually

payout Perceived value dependent on the performance goals set and buy-in

from award holders Realized value dependent on actual performance, as well as stock

price movement, and can vary widely




PSUs

Target Value $1,000,000

Stock Price at Grant $10.00

Accounting Fair Value $10.00

Target Awards 100,000

Most Probable Performance at Grant 100%

Disclosed Value $1,000,000

Realizable Awards 200,000

Low Performance High Performance

Stock Price at Vest $5.00 $20.00

Payout Percentage 50% 200%

Compensation Expense $500,000 $2,000,000

Perceived Value Equal at Grant Equal at Grant

Realized Value $250,000 $4,000,000

PSUs pay out 0% to 200% depending upon EPS over a 3-year performance period



$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$3,500,000

$4,000,000

$4,500,000

Rea

lized

Val

ue

Payout Percentage

Realized Value vs. Payout Percentage

$5 Ending Stock Price $10 Ending Stock Price (Compensation Expense)

$15 Ending Stock Price $20 Ending Stock Price


Considerations Setting performance goals that are probable to be achieved at a

target level as of the grant date will ensure that disclosed value equals target value

After grant, many of the types of value diverge Perceived value will be impacted by performance Compensation expense will ultimately equal fair value x actual shares earned Realized value will depend on performance and stock price movement


PSUs – Market Based

Accounting Fair Value determined using Lattice or Monte Carlo model and incorporate probability of possible payout scenarios

Disclosed Value equals target shares x Accounting Fair Value Equal to Target Value if Accounting Fair Value used to determine

target shares Often greater than Target Value if stock price used to determine

target shares, as Accounting Fair Value is often greater than stock price

Compensation Expense equal to Disclosed Value and fixed at grant Perceived value dependent on the performance goals set and buy-in

from award holders, can be very different from Target / Disclosed Value and Compensation Expense

Realized value dependent on actual performance, as well as stock price movement, and can vary widely



3-year relative TSR award with maximum payout of either 150% or 200%



150% Max Payout

200% MaxPayout

Target Value $1,000,000 $1,000,000




$1,000,000 $1,000,000

Disclosed Value $1,000,000 $1,000,000



Realized Value Higher at performance close to or below target

Higher at performance near maximum

Grant Size Based on Stock Price

150% Max Payout

200% MaxPayout

Target Value $1,000,000 $1,000,000




$1,050,000 $1,250,000

Disclosed Value $1,050,000 $1,250,000


Perceived Value Lower Higher

Realized Value Lower Higher



$40,000

$70,000

$100,000

$130,000

$160,000

25.0% 30.0% 35.0% 40.0% 45.0% 50.0% 55.0% 60.0% 65.0% 70.0% 75.0% 80.0% 85.0% 90.0% 95.0% 100.0%

Valu

e to

Aw

ard

Hol

der

Percent Rank

150% Max Payout 200% Max Payout

Percent Rank Payout 1 Payout 2

75th and Above 150% 200%

50th 100% 100%

25th 50% 50%

Below 25th 0% 0%

Fair Value $10.50 $12.50


Assumes flat stock price over performance period*

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

$160,000

$180,000

$200,000

$220,000

25.0% 30.0% 35.0% 40.0% 45.0% 50.0% 55.0% 60.0% 65.0% 70.0% 75.0% 80.0% 85.0% 90.0% 95.0% 100.0%

Valu

e to

Aw

ard

Hol

der

Percent Rank150% Max Payout 200% Max Payout

Assumes flat stock price over performance period*



Percent Rank Payout 1 Payout 2

75th and Above 150% 200%

50th 100% 100%

25th 50% 50%

Below 25th 0% 0%

Fair Value $10.50 $12.50


Expense $1,050,000 $1,250,000



$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$3,500,000

$4,000,000

$4,500,000

0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% 90.00% 100.00%

Rea

lized

Val

ue

Percent Rank

Realized Value vs. Percent Rank

Compensation Expense $5 Ending Stock Price$10 Ending Stock Price (Compensation Expense) $15 Ending Stock Price$20 Ending Stock Price


Considerations Value Cap – Limit gain to a certain level (i.e., 6x stock price at grant)

Lower Accounting Fair Value, magnitude of discount will depend on volatility Impact on Perceived Value may be low Could lower Realized Value

TSR Cap – Cap payout if absolute TSR falls below a threshold Lower Accounting Fair Value, magnitude will depend on volatility and correlation to peers Likely low impact Perceived Value, may affect Realized Value Shareholders love it (Governance Value?)

Other Adjustments to Plan Design Lowering maximum payout will have large impact on Accounting Fair Value, Disclosed

Value, and Compensation Value, but also lowers Perceived Value and often Realized Value

Same with increasing performance necessary to reach payout levels Finding more correlated peers can lower Accounting / Disclosed / Compensation Expense

without impacting (or even improving) Perceived Value


Post-Vest Hold Periods

An award with a post-vest hold period cannot be sold or transferred for a certain period of time after vesting Executives often hold their awards after vesting regardless, so formalizing the

requirement often has low impact on Perceived Value Can have large impact on perceived value for broader employee populations

Governance Value - Creates defined pathway to meet ownership guidelines and enforce claw-backs while further aligning executives with long-term shareholder interests

Provides discount to Accounting Fair Value Magnitude of discount depends on company volatility and length of holding period


Holding Period Length 30% Volatility 50% Volatility 70% Volatility

1-year 5% - 8% 6% - 13% 7% - 15%

2-years 7% - 11% 10% - 18% 14% - 23%

3-years 8% - 13% 13% - 20% 16% - 27%

Value

Target



DisclosedRealizable

Perceived

Realized

Wheel of Take-Aways


How Target Value is converted to Target Shares is a critical decision, with many downstream consequences

Fixed for time-based awards and market-based PSUs, variable for non-market-based PSUs

Can affect number of target shares granted, and is often higher than expected for market-based awards

Dependent on Accounting Fair Value and expected level of performance at grant (for non-market PSUs)

Possible value/shares delivered

Very nuanced –engage with your award holders!

Hard to predict, and heavily dependent on award design

Contact Us

CJ Van Ostenbridge, CEPSenior ConsultantAon [email protected]

Kristin Johnson, CEPDirector, Equity ProgramsQuintilesIMS484.567.6054KHoefling-Johnson@us.imshealth.com

Sandra PaceManaging DirectorSteven Hall & PartnersPhone: [email protected]

Ted ManleyVP, Total Rewards & HR OperationsDunkin’ Brands, Inc.Phone: [email protected]


The Value Proposition - My Fidelity Site Value... · statement The Value Proposition 6 Value Target...

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