It used to be fairly common for publicly traded companies to provide a larger initial equity award to newly elected directors (i.e., the grant date fair value for the first equity award to a newly elected director would exceed the value of the regular annual award to ongoing directors). The premium was considered an inducement to join the company’s board and fostered immediate alignment with shareholders.
Traditionally, the initial award would have a relatively long vesting "tail" of three to five years and could be anywhere from twice to three times the size of an annual award to continuing directors. However, initial grant premiums have been declining over the past two decades. Now that virtually all publicly traded companies provide annual awards, the expectation of regular future awards relieves some of the pressure for larger initial grants. Ownership guidelines in conjunction with an increased emphasis on equity compensation as a significant element of total compensation promote long-term shareholder alignment even in the absence of a significant grant upon initial election.
Note that this practice differs from what is still typical for pre-IPO companies, where newly appointed non-investor directors often expect a one-time onboarding grant that would (hopefully) provide significant value upon a successful IPO, and do not expect annual awards until after the company has gone public.
Looking forward, we may see a slight resurgence of the use of initial grants as a recruiting tool among public companies as they compete for qualified directors—especially individuals who have sought-after experience or satisfy diversity objectives. Furthermore, as we continue to see ownership guidelines increase, such initial grants can help new directors comply with these requirements within the stated time frames.
As companies consider whether adoption of an initial grant structure makes sense for them, it is important to assess these awards in the context of the total compensation program and its objectives. Helpful questions for directors to ask include:
- Has the company had difficulty attracting qualified directors?
- Are current annual equity grants sufficient for directors to meet their ownership guidelines?
- If the company has recently adopted shareholder-approved limits to director compensation (either for annual equity awards or total annual compensation levels), is there “room” to implement an initial grant strategy?
- How will the company explain the rationale for initial grants to investors?