Why Buyout Grants Are a Bad Idea

It is common for companies to issue buyout or make-whole grants to newly hired employees. According to our 2021 pulse survey on grant practices[1], over 80% of companies offer buyout grants to at least some of their employees. But are buyout grants really a good idea? I’m not so sure.

What are Buyout Grants?

Buyout or make-whole grants are awards that are issued to a new employee to replace the awards they have forfeited by leaving their prior employer. For example, say that an individual working at company A currently has unvested awards worth $50,000 and has applied for a position with company B. The individual might be wavering about leaving company A and thus forfeiting the $50,000 worth of awards. To neutralize this concern, company B might offer to offer to grant the prospective employee an award that will replace all or some of the forfeited stock.

Pay Misalignment

One of my most significant concerns with buyout grants is that, in my example above, it is likely that company A’s pay strategy differs from company B’s strategy. Maybe company A allocates a greater percentage of its compensation to equity than company B does. By buying out the former company A employee’s equity awards, company B could end up issuing grants to its new employee that are out of alignment with its own (hopefully well-thought out) grant guidelines. Because equity is a form of long-term compensation, this misalignment could exist for years. In addition, the buyout grant potentially gives the new employee an incorrect expectation about future grants.

Pay Equity

Another problem with buyout grants is that what you really may be buying out is another company’s poor pay practices. You have no way of knowing whether your prospective employee’s former employer was paying employees fairly. Does the former employer have appropriate grant guidelines? Does the former employer evaluate pay regularly to ensure it is equitable? If your prospective employee is negotiating for a buyout grant from you, how much additional equity did he or she negotiate for at his or her former employer?

Buyout grants are a form of pay that is inherently unfair. Employees who did not have the good fortune to work for companies that issued equity at their rank won’t receive buyout grants, even if their value to your company is equal or greater than that of their fellow new hires who are receiving buyout grants. We have all become aware of the dangers of paying newly hired employees based on their salary history; this practice perpetuates institutionalized pay discrimination. With buyout grants, you could quite literally be buying the discriminatory pay practices of your employees’ former employers.

Another pay equity concern is that buyout grants are often awarded not to everyone but only to new hires who ask for them when negotiating their pay package. Even if prospective employees have equity grants that they will forfeit upon termination from their current employers, it may not occur to them to ask for a buyout grant. And we know that men are more likely to negotiate for additional compensation than women.[2] As a result, buyout grants can widen the pay gap between men and women.

Here again, because equity awards are multiyear vehicles and because equity can continue to create wealth for recipients long after awards have vested, the pay and income disparities that buyout grants produce can be long-lasting.

Context Is Everything

It is a mistake to make decisions about equity awards outside of the context of an employee’s full pay package, but that may be exactly what is happening with buyout grants. When prospective employees ask for a buyout grant, it’s likely that you require them to provide proof of the equity awards they will be forfeiting. But do you also require them to provide a comprehensive inventory of the full range of pay and benefits they receive, so that you can accurately assess how that package compares to your offer? Probably not.

In fact, in over 20 states and many US cities, companies are prohibited from asking for an employee’s salary history. If the salary you are offering is significantly higher than the prospective employee’s current salary, does it make sense to offer buyout grants on top of that? Yet, you may have no way of knowing if this is the case.

Likewise, do you consider the financial condition of the current employer and trajectory of their stock price? Those grants you are buying out may have been declining in value and may be on a path to being worth even less in the future.

Are You Rewarding the Right Behavior?

You compensate employees so they will perform their job. Incentive compensation, such as equity, is intended to align employees with your corporate objectives and motivate them to perform better. Buyout grants, however, largely reward employees for being better negotiators. I’m not convinced that this is a sound basis on which to make compensation decisions.

Unconscious Bias and Emotion

The decision to recommend an employee for a buyout grant is often made by the hiring manager. It is often a decision made in the emotion of the moment, which can put the manager at a disadvantage and can result in a poor decision. In addition, managers’ own unconscious biases often factor into their decisions. This can result in buyout grants being offered and made on an unfair basis.

Are Buyout Grants Really Necessary?

Employees leave jobs for a variety of reasons, many of which take precedence over staying to earn their equity awards. Are employees who feel they are paid unfairly going to stick around for equity awards? Likewise, will equity awards retain employees who have an issue with their manager or are unhappy with the work they are assigned?

Sure, when a company is recruiting an employee who otherwise would not be considering new opportunities, the potential forfeiture of equity awards may be a factor in the employee’s decision. But I suspect that in many cases, employees who are considering or actively seeking other opportunities may already be prepared to forfeit their existing equity awards.

[1] This pulse survey is part of the Equity Compensation Outlook program, a collaboration of the NASPP and Fidelity Investments.

[2] Women Don’t Ask: Negotiation and the Gender Divide, Linda Babcock and Lara Laschever