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IPOs and spin-offs case studies: Take a fresh look at purpose and executive compensation

Executive Compensation
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By Scott Oberstaedt | May 3, 2018

This month, our Guiding Principles case studies concentrate on initial public offerings (IPOs) and spin-offs, how purpose, one of the four overarching principles, can change as ownership changes, and the challenges of aligning executive compensation with the interests of a different set of owners.

Chapter 3 of our Guiding Principles is now available on our website. It includes new case studies along with a new video on this application of the Principles.

As EC professionals, it is our job to make sure the interests of management are aligned with the interests of a company’s owners. When there is a significant change in ownership, there will likely be a shift in purpose, mission, strategy and objectives. Because an IPO involves, by definition, a transition among owners, the key overarching EC principles to consider are purpose and alignment. Specifically, the role of EC in an IPO is to realign the interests of management from the purpose of one set of owners to that of another, as expressed through the firm’s mission, strategy, and objectives. This shift in strategy and mission - and how that is reflected in executive pay - is as important to articulate and get right as the long checklist of legal and regulatory steps that must be taken for a successful IPO.

An IPO often involves a transition in ownership from concentrated private equity (PE) or venture capital (VC) to broad ownership by an ever changing mass of public shareholders and investment funds.

While every PE company has its own philosophy and methodology, in general, PE owners intend to sell a company or go public, and realize a significant return from the transaction. The time horizon is short and the risk level is high. This purpose is typically reflected in very focused and unforgiving incentives that reward rapid performance improvements, growth in value and the execution of a successful sale or IPO.

While PE – and most other private company owners – have a role in determining a company’s purpose, mission and strategy, public company shareholders are, by definition, more passive investors (with the obvious exception of “activist” investors). They buy a public company’s stock because they see it as an attractive investment – and part of that decision may be based on the company’s purpose, mission and strategy.

So, when a private company prepares to go public, it will need to articulate a direction, strategy and objectives – and demonstrate that it has tied EC to the successful achievement of that strategy. The newly public company will probably have the same products and services, but may have a different growth plan, risk orientation, capital structure, time horizon and  expected ROI, among other attributes. The public company may have a different management team with more of a career focus, as opposed to a transactional focus. And it will have the ability to use publicly traded stock as part of its EC structure.

EC for a post-IPO company is typically more focused on ongoing, steady, sustainable performance, consistent value growth and returns to shareholders, than when it was private. Rewards tend to be earned steadily over time as the company achieves its objectives, follows its long-term strategy and pursues its purpose.

Similarly, when one company spins off a division or business unit, the spun-off company has to articulate its own purpose, mission, strategy and business case – and customize its EC programs accordingly. The rationale for a spin-off is often based on the belief that the “spinco” will perform better and have a higher market value as a separate organization. The spinco often has a different strategy and position in the market than the parent company. Its definitions of success, measures of performance, growth rates, risk levels, time horizons, value drivers and expected rates of return will likely be different than those of the parent company. Accurately redefining purpose and strategy using performance measures and expectations will be critical to the spinco’s success. And building those measures and expectations into effective EC programs is a powerful way to align the success of management with the success of shareholders.

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