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  • Equity Dilution in Long-Term Incentives

Equity Dilution in Long-Term Incentives

Video
January 2019

Transcript

David Bixby: One of the big issues that you deal with as a cyclical industry is that when you're in the down part of the cycle, your stock price goes down, you have less available capital in the stock plan, because every time you grant shares and you try to hold that value constant, you end up granting more shares when you're in the down cycle, which can create additional dilution and can reduce the lifespan of your stock plan and frankly cause some problems with your shareholders who don't like to see so many more shares going out the door. It's counter-intuitive, also, to some external observers that you're in a downturn. Why are you granting more shares to executives who at the same time have been riding the same cycle with shareholders?

The shares you're holding are worth less, so what the company is trying to do in a certain sense is, first of all, to remain competitive with the market for executives who could move to other industries or other sectors where stock is performing better and also keep them locked in long enough for the shares they're sitting on and the shares you're granting them now to really be worth something and to really pay off for sticking through the cycle and helping the company keep things together and be ready for the recovery.

So, one of the ways that you can help to, and companies have found, to help conserve those shares and also address retention concerns is to shift a portion of their long-term plan to cash. So, instead of granting a traditional mix of restricted shares with performance shares or restricted shares, stock options, and performance shares, move to a cash-based long-term performance program. It's a practice that we've seen increase in prevalence over the last couple of years, not surprisingly because of the downturn. It presents some advantages not only during the downturn, but also just over the longer term.

Because of the mechanics, the way these performance plans work, when you're in the down cycle on the bottom end of the plan, there's more certainty about the payout you get with the cash plan as a participant. Your payout may move down as a percent, but the value of the underlying commodity is still $1.00 per unit as opposed to the stock price, which also is moving down. So, if your payout is down below target, each share is worth less. So, it provides a little bit more certainty on the down side, which is helpful in a situation where you're trying to retain people, because there's a tendency for plan participants to think more about the down side and that part of the cycle than they are about the long-term opportunity.

One of the other advantages that it provides is when you're in a down turn, you often will find executives and directors sometimes who will have shares vest at a higher price and have taxes come due when the shares are at a lower price. And unless the withholding is handled properly at the front end, sometimes you could end up—in the worst case scenario—you could end up paying more tax on the shares than the shares are worth at the time you're paying the taxes. And then you also have executives having go out into to sell shares to cover that tax obligation, which can send conflicting messages to the market about what executives think is going to happen with the company going forward.

So, having cash in the long-term incentive plan, when those awards vest, there's ready currency to handle tax obligations, for example. And that's another one of the reasons that we found companies and executive teams appreciate having a cash component to the long-term plan. So, we have had some companies adopt cash during a down turn to address dilution and then keep the cash over the longer term because of some of the other benefits. It smooths out some of the leverage in the program, some of the cyclicality in the program for the executive team as well, which is helpful from a retention standpoint.

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Managing Director
Houston

David Bixby

(713) 568-2205

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