3. Denomination of Award & Performance Period

Denomination of Award

While annual incentive plans are generally denominated as a cash opportunity, performance plans can be denominated as a cash/cash unit target or a share/share unit target. Executives prefer cash performance plans that keep them focused on the achievement of the specific performance objectives identified under the plan and insulate them from the impact of stock price movements. While this may not support the objective of alignment with shareholders as effectively as a share-based plan, another reason cash payouts tend to be favored by executives is that they do not need to sell shares to realize value from these awards. Given the insider trading rules that restrict an executive’s ability to sell shares and the scrutiny that investors apply to insider sales, a cash-based plan has obvious advantages. Since stock options and time-vested restricted stock are both stock denominated, performance plans are frequently the only cash-based, long-term incentive offered by publicly traded companies. In addition, companies that have had high levels of shareholder dilution from stock-based compensation may prefer a cash-based, long-term incentive, as they do not need shareholder approval to fund shares for awards.

However, share-based plans are more common than cash-based plans because denominating the award in shares helps to align executives with shareholders while also encouraging pay-for-performance through the plan design. In fact, 87% of the CAP 120 choose share/share units design. While executives may generally prefer cash, denominating the plan in shares allows for greater upside opportunity as the executive can benefit not only from outperforming relative to the pre-established performance criteria and thereby earning more shares, but also from stock price increases. The same is true on the downside.

Key Questions for Committee Members to Ask:

• Do we have adequate shares available under our shareholder-approved plan to fund awards if delivered in shares? Will it reduce the number of years of long-term incentive plan awards that we can make under the existing reserve?
• Are executive plan participants’ liquidity constrained? Would they benefit substantially from a plan design feature that improves liquidity?
• Do executives have enough “skin in the game”?