Special equity grants: do they create value?

• Author: Cook, Frederic W.
• Position: Includes related article

If mega-grants are to be an effective device in creating shareholder value, they must have special performance characteristics.

Close observers of the executive compensation scene have noticed attention being paid by the business press to special types of equity grants to executives. For the most part, the attention has been favorable. Even more unusual in the cases of Monsanto Co., St. Paul Companies Inc., and perhaps others, the price of their stock jumped after announcement of the new plan. What's going on? Is it possible that executive compensation can be a vehicle for creating shareholder value? I believe the answer is yes. In this article, we will explore why executive incentives can positively affect stock price, the different types of plans which appear to have this effect, and the care that companies and boards must take in crafting such plans.

In the week when Monsanto announced its new equity incentive program in March 1996, its stock price increased 9%. Monsanto launched a four-part program consisting of (1) EVA as a measurement device for annual and longer-term incentives, (2) special stock options at premium prices significantly above market when the options were granted, (3) a loan program for executives to purchase stock, with loan forgiveness tied to Monsanto's total shareholder return versus a market index, and (4) an all-employee stock option grant.

In the case of St. Paul Companies, its stock price jumped 6% after the announcement of its new program on February 7, 1997. St. Paul Companies' program involved increased stock ownership requirements for executives, loans to purchase stock, and a mega-grant of stock options which can only be exercised if its stock price reaches certain high hurdles within relatively short periods of time.

While both programs had multiple elements and many positive features, the common characteristic that attracted shareholders' attention was a requirement that the stock price advance to levels which were above normal expectations in order for the grants to have value. If the market for the company's stock followed more normal patterns, the grants would be forfeited or have little or no value. Both announcements included the specific stock prices that had to be met and the time period for meeting them. Both grants were mega-grants - that is, they were significantly above normal competitive grants, and there were other elements in the program that involved risks of loss or give-ups if the goals were not achieved.

Impact on shareholder value

Grants such as we have described affect shareholder value because they operate as signaling devices to the market as to management's intentions and goals. When the goals are set forth clearly, when they involve achieving stock price levels that would be above normal market expectations, and when the market sees that management has significant incentive for achieving the goals and has incurred risks if the goals are not achieved, the market views this as a bullish signal on the stock. Shareholders "co-invest" with management, believing that executives would not buy into the plan if they did not believe they had a good chance of reaching the goals.

If the share price for a company's stock jumps on announcement of a new executive compensation program, will this...