5. Form of Settlement & Termination Treatment of Long-Term Incentive Compensation

a. Form of Settlement

Most often, awards that are denominated in cash are settled in cash and awards that are denominated in shares are settled in shares. However, there are times when the form of payment will be different from the form of denomination. For example, in order to facilitate executive compliance with ownership guidelines or to conserve cash, awards that are denominated in cash will sometimes be settled (or partially settled) in shares. Alternatively, awards denominated in shares may be settled (or partially settled) in cash in order to conserve shares or to facilitate the payment of taxes. It should be noted that while the change in the form of settlement will not have any impact on the incentives that the executive has while the award is outstanding, it can have a meaningful impact on how the awards are treated for accounting purposes.

b. Termination Treatment of Long-Term Incentive Compensation

A fundamental characteristic of most long-term incentive awards is that executives are supposed to vest in their awards over time. In fact, one of the key objectives of long-term incentive design is to encourage executives to stay with the company longer by making it costly for them to leave the organization or to be recruited away. If employees leave, they will either walk away from any unvested awards or the company that recruits the employee will have to make the employee “whole” for forfeited awards through the provision of sign-on grants.

With that said, the treatment of vested and unvested long-term incentives upon an executive’s termination of employment often varies depending on the circumstances of the termination event. Generally, companies are more likely to have plan provisions that allow for continued vesting post-termination, pro-rata vesting, or accelerated vesting when the reason for termination is perceived to be less within the control of the executive. Conversely, they are more likely to call for forfeiture of unvested long-term incentives when the decision to leave is more within the control of the executive or is due to an executive’s failure to perform.

In practice, this means that executives who terminate due to death, disability, or retirement are typically treated more generously than executives who voluntarily leave the company or are terminated by the company with or without cause. Treatment upon retirement may be less generous in companies that provide for an earlier definition of retirement, as someone who retires at age 55 may be viewed as making a more elective decision to retire than an executive who retires at age 65.

When a company experiences a change in control, such as in the case of an acquisition, they tend to take a more lenient view of accelerated vesting of equity. In the past, it was common for all unvested equity to become vested upon the completion of a change in control. The rationale for this approach was that the change in control was an opportunity for shareholders to liquidate their investment and that executives should share in that opportunity. Also, for most executives, the change in control falls into the category of an event that is outside of their control. More recently, companies have been under pressure from shareholder advisory firms and institutional investors to move to a “double-trigger” approach for equity acceleration following a change in control. That is, executives will receive accelerated vesting on their unvested equity only if they are terminated (typically within 1–2 years following a change in control) or if the acquiring company does not assume the unvested equity of the acquired company. Proponents of double-trigger vesting argue that this more conservative approach to equity vesting makes the company more attractive to potential acquirers and provides the continuing entity with a tool (in the form of unvested equity) to retain executives following the acquisition.

The table below provides an overview of prevalent practices for the treatment of equity upon termination:

Key Questions for Committee Members to Ask:

• Is our termination treatment consistent with peer practices?
• Are our termination provisions viewed as “fair” by employees? By shareholder advisory groups?
• Do our termination provisions undermine our ability to retain executives as they near retirement age?