People Are Worried About Equity Compensation

A lament on the decline of broad-based equity compensation meted out by public companies including technology firms, a trend apparently several decades in the making:

Equity compensation where average employees get to own shares of the companies they work for through restricted stock or stock options has declined dramatically in many large publicly-traded corporations…In 2002, 58% of the employees of the U.S. computer services industry were employee owners of their company, while 57% held company stock options. By 2010, only 20% of employees were employee owners in the computer services industry and only 17% held employee stock options, which represents a 60% to 70% drop in equity compensation among creative workers in one of America’s most leading innovation industries. By 2014, these numbers continued the decline.

The alleged culprits are, at a minimum, three-fold:

1. “During the 1990s, tax incentives developed to encourage Employee Stock Ownership Plans (ESOPs) in large publicly-traded companies were eliminated due to budget cuts. This led to a slow elimination of ESOPs from stock market companies.”
2. “After the abuses of stock options by top executives in the Enron and Worldcom scandals of the early 2000s … government regulators pushed for companies to expense stock compensation.  This change in accounting … led companies to downsize their stock compensation programs in order to keep the expense low.”
3. “Employee Stock Purchase Plans have become less generous in many companies with lower or no discounts and the elimination of “lookback” options.”

To be clear, the concern here primarily relates to rank-and-file employees’ ownership of employer companies.  A related paper states that executive equity compensation has survived, even thrived, despite numerous tax and policy changes (some allegedly designed to curtail such remuneration) over the years.  The author contends that (for example, in the case of ESOPs) equity grants represented an additional layer above market levels of pay; ergo the decline in equity compensation resulted in an effective reduction in workers’ total earnings.

On the one hand, it is not difficult to imagine that tax changes would have some effect, at the margin, on the mix of the various forms of employee compensation – current cash, deferred/contingent cash, or equity scrips.  (Our blog has addressed some tax aspects of equity pay, including from the perspective of the employees.)  The compensation mix would presumably also reflect characteristics of the employer firm, including age and revenue/earnings variability.  We continue to observe young (technology) companies that are short on cash but enormously hungry for talent use equity pools as a meaningful component of both worker compensation and their capital stacks.  Presumably, these equity pools allow start-ups and their employees to bridge the bid-ask spread reflecting particular company needs, personnel-specific skill-sets, and desired/available cash outlay.  The fading use of equity compensation by more mature companies likely reflects i) relatively cash-rich treasuries, ii) greater interchangeability of personnel to fulfill work functions, and iii) workers’ risk-tolerances (or lack thereof).

On the other hand, it is difficult to conjecture a causal relationship between changing financial reporting requirements and lower aggregate (risk-adjusted) take-home worker compensation.  Whatever the merits and effectiveness of the new reporting rules, they are unlikely to have affected meaningfully the cost of compensating employees (using equity or otherwise).  An exhaustive commentary on the labor market is beyond our remit, but a decline in total worker pay over the decades (to the extent it can be articulated) is likely more reflective of the vagaries in the demand for and supply of (particular kinds of) labor and not the form of compensation or, especially, the act of measuring such compensation.

Related Links:

• Look Before You Leap: Evaluating a Section 83(b) Election
• 8 Things You Need to Know About Section 409A
• Consequences of Calcified Cap Charts: A Few Thoughts on Startup Equity-Based Compensation
• Rest and Vest
• Review Finds Equity-Based Compensation Reporting Works as Intended
• Equity-Based Compensation: Tax Considerations