Why is equity such a significant component of executive compensation?
What percentage of employees hold stock options or shares in the company they work for?
Companies ranging from two-person startups to the Fortune 500 have found that granting partial ownership in a company is among the best methods to attract and retain exceptional talent. In the United States, partial ownership through stock options has been a key part of pay for executives and other employees since the 1950s.* As recently as 2014, 7.2% of all private sector employees (8.5 million people) and 13.1% of all employees of companies with stock held stock options, according to the National Center for Employee Ownership.* Many believe employee ownership has paidfostered innovations in technology, especially in Silicon Valley, from the early days of Hewlett-Packard to recent examples like Facebook. Stock options helped the first 3,000 employees of Facebook enjoy roughly $23 billion at the time the company went public.*
controversy Some controversy surrounds the use of equity compensation for high-paid executives. Public companies offer executives equity compensation in no small part because of a tax loophole. In 1993, President Bill Clinton attempted to limit executive pay with a new section* of the Internal Revenue Code. Unfortunately, the legislation backfired; a loophole made performance-based pay—including stock options—fully tax deductible, thereby creating a dramatic incentive to pay executives through stock options.* From 1970–79, the average compensation for a CEO of one of the 50 largest firms in the United States was $1.2M, of which 11.2% was from stock options. By 2000–05, the same numbers had risen to $9.2M and 37%, respectively.*
Growth and Risk
Generally, equity compensation is closely linked to the growth of a company. Cash-poor startups persuade early employees to take pay cuts and join their team by offering meaningful ownerships stakes, catering to hopes that the company will one day grow large enough to go public or be sold for an ample sum. More mature but still fast-growing companies find offering compensation linked to ownership is more attractive than high cash compensation to many candidates.
With the hope for growth, however, also comes risk. Large, fast-growing companies often hit hard times. And startups routinely fail or yield no returns for investors or workers. According to a report by Cambridge Associates and Fortune Magazine, between 1990 and 2010, about 60% of venture capital-backed companies returned less than the original investment, leaving employees with the painful realization that their startup was not, in fact, the next Google. Of the remaining 40%, just a select few go on to make a many of their employees wealthy, as has been the case with iconic high-growth companies, like Starbucks,* UPS,* Amazon,* Google,* or Facebook.*