A guide for policies on stock ownership.

In recent years, many companies have established policies on expected levels of stock ownership for their executives. Examples include Chrysler, Gerber, Eastman Kodak, Hershey, Honeywell, and SuperValu. The policies communicate to the executives that these companies do not want them to treat their stock grants like any other element of compensation or like any other trading security. They want executives to make a commitment to the company by investing certain portions of their personal wealth in the stock.

This approach is a perfect counterbalance to the criticism that, at many companies, executive compensation is not tied to shareholder interests. And, recent research has shown that, in general, the stock price performance of companies with high employee stock ownership levels has been superior to that of other companies.

The business press and institutional shareholders have reacted very favorably to the presence of these programs. Now, many additional companies are considering share ownership guidelines for their executives. When initially presented, the adoption of these guidelines seems like a win-win approach. The view is that shareholders should be pleased to see such a program in place, and executives have been given a somewhat paternalistic capital accumulation opportunity. However, the company should consider all of the implications of these policies before adopting them.

Role of Stock: A primary consideration is whether or not the company's stock grants are used for long-term incentives or whether, as at many entrepreneurial companies, they are a substitute for cash compensation. If executives are being paid at competitive cash compensation levels, then it is reasonable to expect them to use some of their profit from stock gains to purchase shares or keep shares and meet their stock ownership guideline levels. If stock is a substitute for cash, it is not reasonable.

Employment Commitment: In today's environment, many companies are reorganizing, encouraging early retirements, and cutting back on their staffs. At others, a competitive environment may lead to substantial turnover. In these cases, encouraging long-term executive stock ownership is at odds with the company's human resources strategy. Only companies that are committed to having long-term employees would be candidates for stock ownership guidelines.

Personal Financial Situation: The question of establishing stock ownership guidelines intrudes into the executives' personal financial planning decision. The company's executives may each have very different personal circumstances and need for cash at different times in their careers.

CEO Support: The CEO's attitude toward stock ownership and support of the program will strongly impact its chance for success.

Management Style: And finally, the company should analyze whether its culture is one of high management participation and empowerment. If executives feel that they are truly participating in the strategic decisions of the company and have an impact on the company's planning and results, then asking them to invest in those decisions and results is reasonable. If the company culture, however, is autocratic, with one or a few individuals controlling strategic decisions, then it may not be appropriate to ask executives working under those circumstances to purchase company stock.

Design Elements

If after reviewing the above factors the decision is made to establish a stock ownership guideline policy, there are a number of design considerations:

How Much Stock?: Most companies establish salary multiples -- for example, five times salary for the CEO tapered down to one times salary for the lowest executives in the program. The multiples may be converted to shares so that the goals do not fluctuate wildly with stock price. Once this objective has been met, there is no additional pressure to purchase shares.

An alternative approach, and one which should provide ongoing incentive to purchase shares, is to establish a minimum hurdle, for example, four times salary for the CEO and one-half times salary for the lowest level. After that hurdle has been achieved, then individuals would be expected to keep 50% of after-tax profit shares attained through option exercises or vesting of other stock grants.

Enforcement: Should compliance be voluntary, with executives on the "honor system," or should ownership be tracked and reported to senior management or the compensation committee? At some companies, executives who do not meet the goals will receive smaller-than-average grants in the future. At others, executives have to put shares "on deposit" in order to keep their new long-term incentive grants. Consideration should also be given to the executive's career stage. Those at the height of their careers should be expected to own and continue to accumulate more stock than those nearing retirement.

Participants: Another issue is whether the company only mandates that the senior executives own stock or applies the policy to a broad base of management. Most companies limit this program to the top levels of management.

Current Program Compatibility: If a company adopts an ownership program, then its overall incentive program structure should be reviewed to be certain that it is compatible with this stock ownership policy. For example, long-term incentives should be paid out in stock rather than in cash. And the company should facilitate the use of stock withholding to pay taxes so that executives know what their after-tax stock position is the end of any vesting period and use this value in calculating the portion that they will keep.

Time Frame to Meet the Goals: Executives should be given a reasonable amount of time to meet the ownership objective. Ideally, they should be able to meet them with grants that are already in the pipeline. If not, the company may consider exceptions for those who are new to the company and allow them additional time to meet the ownership objective. And, the time frame may be extended at companies where stock price performance has been poor.

Communication: The final step is to prepare an annual communication document for each executive showing his or her ownership target and actual ownership, so that executives and the company will know how close they are to the goal.

A well-crafted and well-communicated executive stock ownership plan can have a positive impact on shareholder perceptions and executive motivation, but careful thought should be given to its adoption and design.

Beverly W. Aisenbrey is a member of the national management compensation consulting firm Frederic W. Cook & Co. Based in its New York office, she works with private and public companies on executive compensation strategy and incentive plan design.