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Article | Executive Pay Memo North America

Equity plan design at U.S. IPOs

Mergers and Acquisitions|Executive Compensation
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By Scott Oberstaedt , Dan Leon and Robert Hermenze | March 2, 2021

A look at long-term incentive practices of 100 of the biggest IPOs from 2014 to 2020

For companies that are considering an initial public offering (IPO), one of the most critical items to address is the establishment of a long-term incentive (LTI) plan strategy and share reserve for equity awards. In support of this, Willis Towers Watson has researched the LTI practices of 100 of the largest U.S.-based IPOs by market capitalization ($1.1 billion to $75.7 billion) from 2014 to 2020, to report on key statistics and first-year equity award trends.

A company’s long-term incentive plan needs to consider four main topics during an IPO:

  • Share reserve is typically defined as the number of shares requested for post-IPO equity awards. This reserve is the “bank” of shares upon which the company draws as it grants equity-based LTI awards, such as stock options and restricted shares. This is also commonly called a company’s overhang. For IPO companies, this often includes a mix of both awards that were made pre-IPO and a new additional share reserve for future awards.
  • Run rate, also known as dilution or burn rate, is the rate at which the share reserve is reduced each year. The run rate measures the rate at which investors’ value in the company is diluted each year through equity awards to employees and directors, and it can be measured as a percentage of total shares or in total accounting cost terms.
  • Grant allocations are the distributions to various key employees (e.g., CEO, CFO). How many employees should be eligible for long-term incentives, and what percentage of the awards should be given to the top executives versus others?
  • Equity mix is the use of different types of long-term incentive awards, such as options, time-vested shares and performance shares.

Willis Towers Watson last published market details on LTI design among recent U.S.-based IPO companies in 2014. Where possible, we report on changes in market practices over that time period.

Share reserve

Our analysis revealed that a median of 7.3% of non-diluted outstanding shares were reserved for future equity awards. This median is slightly lower than the median found in the 2014 analysis, when companies reserved a median of 7.9% of outstanding shares.

New equity plan reserve
(% of total stock outstanding)
Non-diluted
overhang
Fully-diluted
overhang
75th percentile 11.0% 25.5% 20.3%
Median 7.3% 12.9% 11.5%
25th percentile 4.5% 7.6% 7.1%
Mean 8.6% 17.6% 13.9%
Overhang at IPO

Note: All data included herein was provided by Willis Towers Watson’s Global Executive Compensation Analysis Team.

IPO year run rate

The study revealed a wide range of IPO year run rates as a percentage of total shares among the study group. The median non-diluted run rate was 1.3%, meaning that if the median company had 10 million total shares at IPO, it would have granted 130,000 shares as first-year equity awards. Those awards could be in the form of options or full share awards.

Non-diluted run rate
75th percentile 4.5%
Median 1.3%
25th percentile 0.5%
Mean 2.7%
Run rate during the IPO year
(% of total shares outstanding)

This 1.3% median is substantially lower than the median from the 2014 IPO study, when the median company distributed 2.3% of total shares in the IPO year as equity awards. However, as noted below, this lower run rate is likely due primarily to a shift in LTI award trends, away from stock options and toward full-value share awards.

IPO year grant allocations

Our research revealed that CEO equity awards during the IPO year have increased in prevalence. This analysis found that 79% of CEOs received an IPO year equity award, versus 67% of CEOs receiving an IPO year award in the 2014 report.

At the median, CEOs received 10.4% of all grants in the IPO year. All other named executive officers (NEOs) combined, excluding the CEO, received a median of 14.0% of total grants.

  • Non-employee directors received a median of just under 1% of total stock awards in the IPO year.
  • All other employees received approximately 75% of the total shares allocated in the IPO year.

CEO Other NEOs
% of total grants % of total stock
outstanding
% of total grants % of total stock
outstanding
Median 10.4% 0.13% 14.0% 0.14%
Mean 15.2% 0.36% 15.2% 0.26%


Directors Other employees
% of total grants % of total stock
outstanding
% of total grants % of total stock
outstanding
Median 0.9% 0.01% 69.9% 0.9%
Mean 4.4% 0.04% 65.3% 2.2%
Grant allocation during the IPO year

IPO year LTI value transfer rate

Among IPO year companies, equity award values as a percentage of market capitalization at the median were well below 1%. At the median, the equity award values for CEOs were slightly larger than the equity award values of all other NEOs combined. The value transfer rate to all other employees at the median (0.40%) is significantly higher than the value transfer rate to all NEOs (0.23%); however, the number of employees receiving equity is typically significantly higher than the number of NEOs present in an organization.

Total company CEO Other NEOs All NEOs Other
employees
75th percentile  2.32% 0.29% 0.25% 0.43% 1.35%
Median     0.86% 0.12% 0.11% 0.23% 0.40%
25th percentile     0.35%  0.06%  0.05% 0.08% 0.16%
Mean      1.67% 0.36% 0.20% 0.47% 0.64%
Equity award values as a % of market cap

It’s also important to note that there are significant positive outliers among the companies studied. The mean IPO year equity award value transfer rate (1.67%) is nearly double the median of 0.86%. A handful of companies in the study had a significantly higher LTI value transfer rate, which creates such a disparity between the mean and median.

IPO year equity mix

As is most common among mature public companies, IPO companies are increasingly likely to grant full-value stock awards in the IPO year, versus grants of stock options exclusively. Of the companies that disclosed the details of their IPO equity awards, the most common approach is to grant a mix of both full-value stock awards and stock options (62%). For CEOs, a first-year award of full-value shares only (29%) and a mix of full-value shares and options (28%) are nearly equally common.

    Prevalence1
Total company CEO
Stock options only 9% 13%
Full-value stock awards only        28%  29%
Mix of stock options & full-value stock awards        62%  28%
No equity grants           1%  30%
Equity vehicles granted in the IPO year %

1 31% of companies did not disclose IPO year equity award details; those companies are not included in this table.

Conclusions

The anticipated recovery from the COVID-19 pandemic and lockdowns, combined with continued strong conditions for equity markets, will likely encourage more companies to conduct IPOs throughout 2021. It is important for companies to consider the wide array of approaches to equity awards that can be used during the IPO year to help to achieve their objectives. Equity vehicles have the power to ensure that the interests of executives, directors and employees are aligned with the interests of shareholders and stakeholders. The data from this study can be leveraged to help companies in the process of going public to create a sustainable and effective executive compensation strategy.

Authors

Scott Oberstaedt
Director, Executive Compensation

Senior Associate

Analyst, Rewards (New York)

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