How to Size Grants When Your Stock Price is Volatile

Stock price volatility can wreak havoc on company burn rates and stock plan reserves. Recently, I interviewed Amanda Benincasa Arena for the NASPPs Equity Expert podcast on why this is and strategies companies can use to mitigate the effect of volatility on grant sizes. Here is a summary of our conversation. Check out the full podcast to learn more.

How Stock Volatility Affects Grant Sizes

Amanda explains that public companies have largely converged around using a value-based approach to size equity awards. Companies will define a target value of equity they want to award to an employee. To convert that value to shares, they’ll divide the value by the per-share stock price or per-share fair value of the equity award.

For companies that have volatile stock prices, this can result in significant swings in the size of equity awards. When the stock price is up, equity awards are smaller. When a company’s stock price is in decline, companies must grant larger awards to maintain the same target award value. As a result, an unexpected decline in stock price can cause a company to run through its share reserve faster than anticipated.

This can create a situation where companies need to ask shareholders to approve more shares for the plan sooner than they expected to and shareholders are less willing to do so. Here’s how Amanda describes the situation:

It's a self-fulfilling prophecy at that point because you burn through the pool so much quicker, which means you have to go back to your shareholders so much quicker. And shareholders are only really amenable to that a couple times before they're saying, “Hey, why am I so diluted at this point?”

Pay Equity Considerations

When employees are awarded grants on different dates (e.g., in the case of new-hire awards), variances in the stock value on each date can result in each employee receiving a different size award, even if they all receive a grant for the same target value. Amanda explains:

One person can get hired and get 10,000 RSUs, a month later somebody in the same position could get 15,000 RSUs, a month later it can be 8,000 RSUs. Well, a few years down the road, those are all worth very different amounts of money.

Amanda also points out that companies that issue equity broadly often approve annual grants to executives on a different date than grants to rank-and-file employees. As a result, their grant sizes are determined using different values; if the stock price is higher for the nonexecutive grants, this can feel unfair to employees.

If you grant to your executives on one day, and then you grant to the rest of your employee base on another day, that's going to look a little bit funny, particularly if your employee base that's non-NEO is on the losing end of that calculation. That can really demotivate your population of employees that finally do have access to the wealth creation that exists in equity compensation.

Using a Multiday Average to Size Grants

One way to mitigate the effect of stock price volatility is to use a multiday average to determine grant sizes rather than a spot price. Instead of dividing the grant value by the fair market value on the date that the grant size is determined, you use an average fair market value calculated over, say, the past 30 days.

In the NASPP/Deloitte Tax 2022 Equity Administration Survey, the percentage of respondents using an average value to size grants increased to 42%, up from just 27% in 2019. Amanda says that Aon is seeing a similar shift to multiday averages in their TSR survey.

Using a multiday average can make a significant difference in evening out grant sizes, as I illustrate in the NASPP Blog “2 Reasons Multiday Averages Make Sense for Grant Sizing.”

Amanda finds that most companies use either a 20-trading day or a one-month averaging period, which generally works out to be essentially the same time period (most months have around 20 trading days). While calculating the average price adds an extra step into the grant process, the averaging period doesn’t have to be the 20 to 30 days immediately preceding the grant date. Ending the averaging period a few days before the grant date can help alleviate the administrative burden.

The most significant disadvantage Amanda sees with using a multiday average is that it causes the fair value of the awards for ASC 718 and Summary Compensation Table purposes to differ from the target value communicated to the award holder. NEOs will notice that the value reported for their award in the SCT is different from the value communicated to them. The longer the averaging period, the greater the difference will likely be.

Other Approaches

Switching to a multiday average isn’t the only way to address the effect of market volatility on grant sizes. Amanda says that Aon is seeing a lot of different approaches to this issue.

• Capping Awards: One way to control burn rates and share usage is to cap the size of awards. This ensures that no matter how low the value used to denominate grants is, grants will never exceed a specified number of shares. Caps can be established by employee role, rank, or other criteria.
• Last Year’s Grants: Companies who feel that their current stock price volatility is an anomaly might simply choose to keep grant sizes the same as last year, regardless of what that works out to in terms of the grant value.

With either of the above approaches, Amanda notes that the communication to award recipients can be tricky:

When employees have become accustomed to a grant process, it's hard to also say, “Your target amount is going to go down because we're suddenly putting a cap on it.”

One approach Amanda isn’t seeing yet is companies narrowing eligibility for equity awards. She notes that for many companies that grant equity broadly, this would not align with their compensation philosophy. And, for the moment at least, the tight labor market makes it difficult for companies to cut back on equity benefits.

More Information

To learn more, check out my interview with Amanda in the Equity Expert podcast or read her article, “Sizing Grants During Periods of Market Volatility,” in the NASPP Advisor.