Global Equity Effectiveness: A Right Brain Perspective

Global Equity Effectiveness

A Right-Brain Perspective

12th annual international conference • amsterdam • 15-17 june 2011Your company logo here.

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Seeking Equilibrium

• Equity effectiveness requires that companies find equilibrium in share utilization

• Effectiveness refers to both grant efficiency (tax/accounting/dilution) and motivational value

• Optimum utilization occurs when the incentive effect outweighs the cost (dilution and expense)

• This is the equilibrium point where the strongest correlation between share utilization and total shareholder return occurs



Achieving Equity Effectiveness

• During the 1990’s, achieving balance was easy, with little or no concerns about:– Run rates

– Overhang

– Expense

– Allocation

– Motivation




• In the years following the 2001-2002 recession, optimization was more difficult as economic pressure drove increased diversification in the use of equity plans

• Changes were felt across many participation levels and geographies

• For a long time, the solutions were simple…



But no one expected….

• The 2008-2009 recession was unprecedented in:– The depth of its decline

– The duration of its decline

– Its global economic impact

• It also had a profound impact on equity compensation programs



Why was this a surprise?

Are the foundations of global equity programs built on an anomaly?

Growth of $10 invested in the Total S&P500 Index starting in 1900

$1

$10

$100

$1,000

$10,000

$100,000

$1,000,000

1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

Year

Rea

l S&

P 50

0 St

ock

Pric

e In

dex

Total Price Index(Dividends Reinvested)

Long-Term "Equilibrium"Total Return Index: 9.30%/Yr

The “birth“ of global equity



CONVENTIONAL WISDOM/POTENTIAL DISCONNECTS

• An option awarded in March of 2009 with a strike of $4.00 is worth less than a March 2010 grant with a strike of $25.00

• Accountants vs. entrepreneurs

• Surveys are a reliable source of information for compensation comparison and planning

• Data vs. facts

• Equity grants are a powerful motivator

• Reciprocity vs. incentive

• “Stocks for the Long Run”

• Timing is everything



Current State

• Shareholder dissatisfaction is high– Concerns about risk, dilution, and ownership have fueled

broad-ranging governance initiatives

• Employer dissatisfaction is high– Fueled by costs of administration, financial reporting,

compliance, and disclosure during a period in which employee returns from grants have declined or disappeared

• For employees, the motivational value is low– The payoff from a grant is often viewed as a “gift” that they

feel compelled to repay by working harder



Understanding the Disconnect:

Right-Brain vs. Left-Brain

• Left-Brain is dominant:– Tax

– Accounting

– Compliance

• Right-Brain is dormant:– Perceptions

– Behaviors

– Culture

In the design and delivery of global equity programs:



Left-Brain: What is an equity grant worth?

• We use complex models to calculate stock options

• But restricted stock is the face value at grant

• And performance shares are the possible delivered value

• So what is the total value at the date of grant?



The Right-Brain is Driving Company Actions

0%

10%

20%

30%

40%

50%

Will dosomething;exploring

alternatives

More Perf.Shares than

Options

More ServiceRS/RSU than

Options

RelaunchESPP

ReplaceOptions with

cash

More PerfShares than

RS/RSU

Anticipated Changes for Upcoming Year

But actions are often reactions!



Are these actions consistent with

employee perceptions?

Assumes ratio of 3 stock options for exery 1 restricted share

Value of Stock Options vs. Restricted Stock

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

Grant 1 2 3 4 5 6 7 8 9 10

Stock Options Restricted Stock



$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

Grant 1 2 3 4 5 6 7 8 9 10


Two employees

Same company

Different perceptions on value



Why is perception important?

Perceived value is the key to employee engagement



Value is tied to perceptions

• Behavior Finance proposes theories based on psychology to explain anomalies in the market.

• Behavioral finance assumes that the information structure and the characteristics of market participants systematically influence individuals' investment decisions as well as market outcomes.

• Behavioral finance seeks to better understand economic decisions and how those decisions affect prices, returns, and the allocation of resources.

To an employee, perception is reality



How are perceptions formed?

• The three main themes in behavioral finance are:

– People often make decisions based on “rules of thumb”, not rational analysis.

– The way a problem is presented will affect the decision a person makes on how to act.

– There are behavioral explanations for observed market outcomes that are contrary to rational expectations and market efficiency.



So at the date of grant, what is the

perceived value?



$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

Grant 1 2 3 4 5 6 7 8 9 10




$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

Grant 1 2 3 4 5 6 7 8 9 10


The answer is simple, it depends…



Equity characteristics…

But, effectiveness for each individual is driven by their perceived value



But what shapes perceived value?

• Personal biases and experiences

• Generational differences

• Global cultures



Behavior and Personal Perceptions

• Mental Accounting and Consumer Choice– A new model of consumer behavior developed by Richard

Thaler using a hybrid of cognitive psychology and microeconomics.

– People mentally frame assets as belonging to either current income, current wealth or future income and this has implications for their behavior

– Mr. Smith is up $50 in a monthly poker game. He has a queen high flush and calls a $10 bet. Mr. Jones owns 1,000 shares of XYZ which went up today. He is even in the poker game. He has a king high flush and folds. When Mr. Smith wins, Mr. Jones thinks to himself, “If I had been up $50, I would have called too.”

– What are unvested grants really worth to your employees?




• Hyperbolic Discounting:– Given two similar rewards, humans show a preference for

one that arrives sooner rather than later. They discount the value of the later reward by a factor that increases with the length of the delay.

– if all choices appear to be in the longer term, larger benefits will be chosen, even if these appear even later than the smaller benefit.

– If you were offered the choice between $50 now and $100 a year from now, most would ask for the $50. However, given the choice between $50 in nine years or $100 in ten years you would be likely choose the $100 in ten years.

– Application: What is more valuable to your employee s, a $10,000 restricted stock grant that vests in two ye ars, a $25,000 grant that vests in four years or a $50,000 grant that vests in six years?




• Endowment Effect– People place a higher value on objects they own than objects

that they do not.

– For example, people demanded a higher price for a item that had been given to them but put a lower price on the same they did not yet own.

– An employee may continue to hold a large number of worthless underwater stock options rather than exchanging them for a smaller number of new at-the-money options.

– What would work better, an option exchange or a cas h exchange?




• Loss Aversion– People have a tendency to strongly prefer avoiding losses to

acquiring gains

– This leads to risk aversion when people evaluate a possible gain; since people prefer avoiding losses to making gains

– For example, loss aversion has been implicated in the premium for stock returns over bond returns

– It may also explain why an employee who has experienced underwater stock options will exercise and sell an “in-the-money” option as soon as it vests, even though there is no indication that the option will not continue to appreciate.



Behavior and Generational

Differences

• Generational differences manifest themselves in several ways, including how individuals view their compensation.

• There is variation in the nature of intrinsic rewards each generation considers important.

• The generations also relate to their organizations differently.



Some generational differences are obvious



US Generational Differences

Generation Baby Boomers

(1943-1960)Generation X

(1960-1981)

Generation Y

(1982-2001)

Company LoyaltyCommitted to their employers and

do not change jobs frequently

Change employers frequently and

will leave if their rate of career

growth or company culture is not to

their satisfaction

Change employers often and will

continually look for a workplace that

provides them with what they want.

Workplace

Environment

Focus on relationships, outcomes,

their rights and skills.

Flexible work schedule and location.

Telecommuting is very popular with

this generation and supports their

aim for a balanced work-life.

Casual and supportive environment

Very flexible working hours and

location.

What They Look

For in a Company

Stable employment, career

progression potentials

Company that promotes social

stimulus, including social events.

Company that is involved with their

community and encourages their

employees to give back.

Avoids bureaucratic companies and a

company that has a strong viable

social culture and code of ethics.

Management

Style

Comfortable with directive

command and control management

style and values feedback.

Need a mentor or supervisor to

encourage and facilitate their career

development

Requires instant gratification

constant encouragement through

rewards, entitlements and

promotions. Uncomfortable with

directive style of management.

Personality TypeResourceful, individualistic, self

reliant and skeptical of authority

Optimistic, confident, sociable, and

have strong morals and sense of civic

duty. They put great value on their

free time away from work

Have been taught the value of

individuality and independent

thinking.



Global Generational Differences

1950 1960 1970 1980 1990 2000China Post-1950s Post 1960s Post 1970s Post 1980s Post 1 990s

Generation Generation Generation Generation Generation(1950-1959) (1960-1969) (1970-1979) (1980-1989) (1990-1999)

India "Traditional" Generation "Non-Traditional" Gen Y(1948-1968) Generation (1981-onward)

(1969-1980)South "475" Generation "386" Generation Gen X and Gen YKorea (1950-1959) (1960-1969) 1070 - onward

Japan 1st Baby Danso Shinjinrui 2nd Baby ShinjinruiBoomer Generation Generation Boomer Post Bubble Junior Yu tori

(1946-1950) (1951-1960) (1961-1970) (1971-1975) (1976-1987) (1986-1995) (1987-2002)Russia Baby Boomers Gen X Gen Y (Gen "Pu")

(1943-1964) (1965-1983) (1983-2000)

Bulgaria Post War Communist Gen YGeneration Generation (1980 - onward)(1945-1965) (1965-1980)

Czech Baby Boomers Gen X-"Husak"'s Children Gen YRepublic (1943-1970) (1965-1982) (1983-2000)

South Baby Boomers Gen X Gen YAfrica (1943-1970) (1970-1989) (1990-2001)

Brazil Baby Boomers Gen X Gen Y(1946-1964) (1965-1980) (1981-2001)

US Baby Boomers Gen X Gen Y(1943-1964) (1965-1980) (1981-2001)



Implications on Perceived Equity Values

Baby Boomer:Optimistic + Involved + High Risk/High Rewards = Preference for highly leveraged grants like stock options

Generation X:Cautious + Conservative + Distrustful = Preference for low leverage grants like service-based restricted stock

Generation Y:Realistic + Confident + Career Focused = Preference for moderate leverage grants like performance shares



Behavior and Global Culture

• Culture is the underlying value framework that guides an individual’s behavior

• Culture is reflected perceptions, social interactions and business interactions

• Culture guides the selection of appropriate responses in social and business situations



Rapaille’s Archtypes

• The more global, the more local

• Collective cultural consciousness

• For example, quality is a key to success, but quality has different meanings in different countries

– US: It works

– Japan : Perfection

– Germany : Made to standards

– France : Quality = Luxury

– India : Quality = Reliability



Hofstede’s Cultural Dimensions

• Power distance : degree to which members of society accept an unequal distribution of power in organizations and society

• Individualism : degree to which individuals perceive themselves to be separate from a group and to be free from group pressure to conform

• Masculinity : degree to which a society looks favorably on aggressive and materialistic behavior

• Uncertainty avoidance : degree to which members of society deal with the uncertainty and risk and prefer to work with long-term acquaintances and friends rather than with strangers

• Long-term orientation : degree to which members of a culture will defer present gratification to achieve long-term goals




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PDI IDV MAS UAI LTO

World Average

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PDI IDV MAS UAI LTO

United States

Source: Geert Hofstede™ Cultural Dimensions

One Company, One Plan

But One Plan for One World?




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European Countries

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United States

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Latin American Countries

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Asian Countries





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India

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Singapore

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China

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Japan




So, Do We Recognize These Differences?

• Senior management roles are likely to receive an equity grant regardless of global location

• The differences in global participation start at the Managerial level and more apparent at the Individual Contributor level

Equity Plan Participation Rates by Country & Level

96%100% 100% 100% 100% 100%

94%94%

100%

93%

100%

92%

72%

57%

76%81%

75%

50%

17%11%10%

25%

33%34%

0%

20%

40%

60%

80%

100%

120%

United States Uni ted

Kingdom

Germany India China Austra l ia% o

f E

mp

loye

e P

op

ula

tio

n P

art

icip

ati

ng

in

Eq

uit

y P

lan

VP/GM

Director/Sr Mgr

Manager/Supv

Ind Contr

* Buck Consultants Global Long-Term Incentive Practices Survey



Do We Recognize These Differences?

Percentage of Companies with Grant Type

VP Level95% 94%

84% 82%

73%

63% 61%

9%

26%

48%

67%64%

58%62%

2% 3%9%

13%18%

27% 26%

0

0.2

0.4

0.6

0.8

1

2004 2005 2006 2007 2008 2009 2010

SO

RSU

PRS

•The shift from stock options toward full value shares slows

•Full value shares have edged ahead of options for the first time

•Performance-based shares have become a major practice




Do We Recognize These Differences?

Average Value Allocation by Equity Type 2009

VP Level

42% 45% 43% 45%36%

42%31%

38%40% 41%

26%34%

42%

36%

16%14% 15%

28%24%

14%

30%

6%

3% 1% 1% 2%

0%

20%

40%

60%

80%

100%

United States United

Kingdom

Germany India China Japan Austra l ia

Cash

PRS

TBRS

SO

Average Value Allocation by Equity Type 2010

VP Level

43%52% 49% 50% 52% 50%

45%

41%

41% 41% 41% 34% 44%49%

12%6% 9% 9%

9%4% 4%5%

3%2%1%3%

0%

20%

40%

60%

80%

100%

Uni ted States Uni ted

Kingdom

Germany India Chi na Japan Austra l ia

Cash

PRS

SO

TBRS





• If this is what an understanding of global employee behavior tells us, then how do we act today?

• By left-brain– Accounting

– Tax

– Compliance

• Not by right-brain:– Perceptions

– Behaviors

– Culture



What does this knowledge tell us

about plan design going forward?

One Company, One Plan?



Looking Ahead…

One Company, One Plan?

0%

50%

100%

150%

200%

250%

300%

70% 80% 90% 100% 110% 120% 130%

% of Goal Achieved

% o

f Tar

get P

aym

ent R

ecei

ved

Performance Share Plans provide the

flexibility to adapt to global differences

Leverage can also be adjusted to respond to

difference in risk profiles

Performance metrics can be set to create global

alignment and/or maximize line-of-sight

Awards can be paid in stock, cash or a

combination to maximize perceived value



Parting thoughts

• Technical aspects of equity compensation are important, but not enough

• To understand perceived value, a better understanding of the global workforce is needed

• Value is perceived, not calculated

• Classical rational decision-making is not the model for actual employee decision-making

• Triangulate to get answers rather than focusing on the single best base of information

• Design simplicity should be an imperative

• More intuition, less conventional wisdom



Questions

Jim SilleryPrincipal+1 (1) 312 846 [email protected]

Ben WellsSenior Consultant+44 (0) 207 429 [email protected]

Global Equity Effectiveness: A Right Brain Perspective

Business

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master slide

stock options restricted

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global equity effectiveness

equity grant worth

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birth of global equity