Long-Term Performance Awards Continue to Grow in Prevalence

October 9, 2009 (PLANSPONSOR.com) - The Frederic W. Cook & Co. 2009 Top 250 report on executive compensation practices at the top 250 firms in the S&P 500 indicates the shift from the use of stock options (and stock appreciation rights) and time-vesting restricted stock awards to long-term performance awards (performance shares and performance units) appears to have stabilized, though long-term performance awards continue to grow in prevalence.

According to the report, performance shares remain the only grant type significantly growing in use.

Stock options remain the most widely used long-term incentive grant type among companies in the Top 250. Seventy-seven percent of the Top 250 companies grant stock options. Five of the Top 250 companies that used stock options in the past dropped options from their long-term incentive programs this year or expect to do so next year – continuing the steady decline in stock option usage from a high of 99% from 1999 through 2003.

Seven percent of companies in the Top 250 currently grant stock appreciation rights (SARs), compared to 5% in the 2006 report. The report explained that since the 1990s, SARs were rarely granted due to their unfavorable accounting treatment, but that was eliminated under FAS 123.

Fifty-seven percent of the Top 250 companies grant or have begun to grant restricted stock in the last year – excluding companies that use restricted stock grants only in hiring situations or as one-time awards under special circumstances. Restricted stock usage declined this year accompanied by an increase in the usage of performance shares.

Fifty-seven percent of the Top 250 companies have historically granted performance shares, which, according to the report, consist of stock-denominated shares earned based on performance over a predefined performance period. Six percent began to grant performance shares during the latest fiscal year or are planning to do so in the next year – resulting in total performance share prevalence of 63%, according to the report.

Eighteen percent of the Top 250 companies granted or have begun to grant performance units – grants of cash or dollar-denominated “units” which are earned based on performance against predetermined objectives over a pre-defined performance period and may be paid out in cash or stock – in the last year. Though the use of performance units has been relatively flat since the 2006 report, ten of the Top 250 companies dropped performance units from their LTI programs this year or expect to do so next year.

Fifty-nine percent of companies that grant performance awards use some type of "profit" measure as a basis for award payout - the most prevalent performance measure by a large margin, according to the report. Other prevalent measures of performance include capital efficiency ratios (including return on equity and return on assets) as well as total shareholder return (TSR).

In general, the report said, the use of each performance measure category is stable as compared to 2008, with both TSR and capital efficiency declining in prevalence by 4%. Fifty percent of performance award programs utilize only one performance measure category, while the other half utilize more than one category.

Vesting Practices

Eighty-two percent of the Top 250 companies issuing stock options apply uniform (equal installment) vesting to their stock option grants. However, restricted stock grants are often used as retentive awards and therefore companies more often apply "cliff" vesting to them, the report explained. Thirty-eight percent of the Top 250 companies granting restricted stock awards apply cliff vesting, versus only 9% of the Top-250 companies granting stock options.

Nine percent of companies granting stock options and 17% of companies granting restricted stock use non-uniform vesting (e.g., 25% vest after year one, 25% vest after year two, 50% vest after year three, etc.).

Prevalence of vesting types remains generally the same as compared to the 2008 report. Three years is the most common vesting period for both stock options (48% of companies) and restricted stock (50% of companies). Roughly half of the companies choose vesting periods equal to or greater than four years.

The report is here .