June 28, 2016

Putting The Long-Term Back Into Long-Term Incentives

Farient Advisors

There has always been tension between making long-term incentives both motivational and competitive, while at the same time aligning pay design with the longer-term interests of shareholders. Thus is the case with performance and vesting periods. Shorter periods are considered to be good for the talent (motivational and competitive), while longer periods are considered to be good for investors (alignment). The equilibrium for performance and vesting periods has seemed to settle on an average of three years – just short enough to provide line of sight and a reasonable time frame for goal-setting, and just long enough to demonstrate a track record for sustainable shareholder returns.

Having said this, the SEC, investors, and proxy advisors all have tried to put more teeth into long-term sustainable performance through such mechanisms as claw backs and ownership guidelines. Another solution to “having your cake and eating it too” (i.e., having a competitive vesting period while also tying executives to longer-term sustained performance) is to institute post-vesting holding requirements. In a nutshell, post-vesting holding requirements separate the vesting event from the liquidity event so the executive has to hold onto all (or a portion) of his or her net after-tax shares, even after vesting, for a given period of time. This helps to keep the risk of forfeiture in check because the shares are vested, and therefore portable in the case of termination, but remain subject to share price performance during the holding period.

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