Effectively Managing Stock Compensation
Welcome back to Aeqium's Compensation Playbook Series! 🎙️
In today's episode, we delve into the dynamic world of stock compensation with Ilene Milne, Senior Director of Compensation at Palo Alto Networks and a seasoned compensation expert. Ilene shares her insights on the latest trends and best practices in managing stock-based compensation, including:
- The impact of market volatility and burn rate on stock-based compensation plans
- Emerging vesting schedule strategies, such as one-year vesting and front-loading
- Common mistakes to avoid, like using the term "refreshers" and not having clear guidelines
- How to effectively test and measure the success of your stock-based compensation programs
Peter: All right. Hey, everyone. Welcome back to another episode of Aeqium's Compensation Playbook series. Today, we have Ilene Milne, who is Senior Director of Compensation at Palo Alto Networks and a veteran of the compensation industry for many years. Really excited to have you on the show here, Ilene. Thanks for joining us.
Ilene: Thank you, Peter. Happy to be here with you.
Peter: Awesome. Well, today we are talking about a hot topic, managing stock compensation. I know it's one that you have a depth of experience with. We have a number of things to go over, so I'll just get right into the questions. I'm really excited to hear what you have to share with us. The first question that I wanted to talk to you about is really, it seems like over the last few years and maybe even more, there's been a lot of evolution in how people think about stock based compensation. We've heard things about changing vesting schedules, changing proportions of how you use it. Really just want to hear from you and your perspective, having been in the industry for a long time. What are the biggest changes that you've seen in stock based compensation and how do you think about those?
Ilene: Sure. So I do have a long history in stock compensation. It is my favorite compensation element because you can get quite creative with it. And at multiple companies where I've worked, I have redesigned equity programs a few times. Each time with a goal of accomplishing some different kind of business objectives. So, equity compensation was pretty static for a long time. The big shift kind of maybe fifteen-ish years ago was going from options to RSUs, but then it was kind of just, that's what everybody did and still most employees received them. And then, things started to change and companies have gotten much more, I would say, targeted with who receives equity, as expectations from shareholders, shareholder services, have become more stringent. So that's certainly one thing that I think has changed. But other things are really in response to like volatility in the market. So, this pandemic, if we're talking about kind of recent few years, the pandemic, everybody was first staying at their companies and then we had the great recession and that kind of threw things all over the place for companies issuing stock, depending on the industry, tech stocks, prices were soaring. So burn rate certainly wasn't a factor, but with the market corrections that have come through in the more recent years after that big boom, some companies might really be focused heavily on burn rate, which is going to require them to either drastically change their guidelines or really, really restrict who's going to be receiving equity. Even that element can depend on the stage of maturity of a company, because if you're recently public and still have evergreen share, you can replenish your share pool, not a concern. But if you are beyond that and are trying to manage a certain burn rate for ISS or Glass-Lewis to approve a shareholder proposal for your equity incentive plan to add shares, that could be a real problem for some of those companies. So that's certainly on the burn rate side, things that have been, I'd say, top of mind in the last couple of years as the markets themselves have just been quite volatile. On the vesting schedule side, this is where I think some companies have started to get very creative. Companies are doing a one year vest, right? You get one year value. going to be a premium for that one year. But when you walk in the door, we're only going to guarantee you one year of stock. And after that, it's kind of up to performance. That can work really well when your design is also to commit to a total compensation package. Right. When somebody is coming in the door, So it's as long as you are performing, you will get this much equity kind of year on year, which of course could get dialed up if they're a top performer. So that's one really, I'd say, material change in how to think about comp in general. There's some companies that very famously do total comp and let employees choose how they want to receive that. But I'd say I know that the vast majority of companies are still like your base, your bonus, your equity, and equity has multiple years of vesting.
Peter: That one year vesting seems so hot in the news right now. I feel like there's a lot of discussion about it. Are you saying you feel like the main reason for that is a response to volatility?
Ilene: I think it depends on if the company is public or private, how many shares they have, right? That's a great strategy if you have a burn rate problem, right? Because if you're now giving one year grants versus committing four years to an employee who you don't even know will be there in four years, because as soon as you grant their shares, they're out, right? And they're in your burn. So I think it depends on kind of not necessarily the volatility, but perhaps if people's stock prices have dropped materially. Yeah, good question.
Peter: What are some of the other vesting schedule kind of innovations you've seen recently?
Ilene: So certainly like front loading, like companies that do a standard kind of at least three, maybe four year new hire award, front loading that vesting. Full transparency, it's something that we're in the midst of redesigning our equity incentive plan for the second time since I've been with my current company. One of the things that I want to look at, and this is in response to our stock has really outperformed the market, which is a great position to be in. But what this is doing, this is kind of the age old problem for stock plans or the stock team is you give these shares, your stock really does great. And when that new hire award vests off in three or four years, the employees are like, hey, what are you gonna do to make me whole? Because I had this much unvested value and I'm dropping to here. Even if they've been getting like pretty solid ongoing grants. So that's the problem that my company is fortunate to be in, but it is a problem nonetheless, even if it's a good problem to have. So we are actually thinking about front-loading new hire equity so that it's like maybe a forty thirty twenty ten. So with appreciation that last year, it's still not going to be this huge cliff that they're falling off of. Certainly some considerations for that are do you think your stock is going to continue to outperform and so that you're really solving that kind of cash flow problem appropriately? And two is your expense. So I would say the other thing that has been I'd say driving a lot of the changes that I've made again multiple companies that I've worked for is that eye on your expense and what whether it's your CFO or your CEO or your shareholders are really asking you to kind of keep that stock-based expense below a certain threshold as a percentage of your of your revenue and obviously if you front load vesting you're increasing the expense for the short term at least. So you have to be able to accommodate that in your planning.
Peter: Yeah, that makes a lot of sense. I feel like whether it's the one year vest or the front loaded vest, maybe volatility isn't kind of the main thing. Maybe you're correcting for, hey, dealing with that kind of problem on the back end with some of the employees. But in either way, it almost to me feels at least like you're making stock based compensation a little bit closer to cash. You're taking away some of the, hey, what happens if it goes way up or it goes way down? In light of some of those kinds of reactions in twenty twenty five, just how do you think about as a public company why you should be using stock based compensation? Has that changed over time? And what would you say the main reasons are today?
Ilene: Sure. So my answer on this is definitely a little bit narrow in focus only because I've only ever worked in the tech industry where obviously equity is a huge, huge, huge portion of people's pay. So it hasn't really been a, an uncommon vehicle that gets used, which I know is the case certainly in other industries. But because of these pressures about expense, I think that's probably most people's biggest concern. And it also depends on your business model, right? Like some of the big, big tech players, this is not a problem for them because their revenue is so enormous, right? That they can give out all the equity they want. And guess what? Those are the folks who pay the best in the market. And we all know those companies. But, I think, companies, first and foremost, it is there for retention and when done right, it accomplishes that. I think what people need to think about in twenty twenty five, if you don't have all of the shares in the world and don't have it's about how many shares you have, it's about how much you can actually afford to spend and meet your financial goals, is who are the people that you really need to retain?
Ilene: It can't be a peanut-buttering. This has been something I've been trying to train managers and leaders on for over a decade because it used to be a peanut buttering exercise. They have a difficult time prioritizing people. And really thinking to not just who just did a great job in the past twelve months, but who is going to materially contribute to where the company is trying to get to. Equity should not be a reward for what's been done. Equity should be a tool to engage people to do what needs to be done over the next three plus years. So I think it's really getting laser focused on that and prioritizing your shares and your budget and your expense, where you'll get the most bang for your buck. And that will look different for every company based on their unique situation.
Peter: Yeah. I love that point. It's a long-term incentive and that's how you have to think about it as opposed to kind of that. It's not a bonus. You're not awarding them for the last six months, for example.
Ilene: Yeah, exactly. Exactly.
Peter: I guess like on that point, in addition to maybe going for the peanut butter spread approach, what are the other common mistakes that you've seen organizations make when designing or managing their stock-based plans?
Ilene: Sure. So the first one, gosh, this is actually a pet peeve of mine and it's something that I'm, two years in dealing with, with my current organization is people referring to, not new hire grants, so ongoing awards or merit grants as refreshers. And it's prevalent, right? It's not just my company. They talk about it in many companies. Unless that is your company's compensation philosophy, which it is in some places that it is communicated that you will get this amount every year and it truly is a refresh. If that is not your compensation strategy, do not say that because it sets an expectation with employees that you are keeping them whole for some amount. Right. Or that, I got a hundred thousand dollars last year, so I'm expecting that this year. And as companies grow, as they move from say the Russell three thousand to the S&P 500 and those expectations from, outside of, outside of the four walls of your company, change. That's going to change it. Well, I've, I've seen now multiple companies where I've worked to go from almost everybody getting an equity grant to much, much fewer people getting, what I would call kind of an ongoing or a merit-based equity award. So that's my first one.
Peter: That's such a good point. I feel like I have sat in conversations, like calibration conversations at the end of a cycle where, managers are asking, well, hey, this person needs a refresh. They're at that point. And then a senior executive is going, well, they're not a top performer. And so it all goes back to your point of like, what expectations did you set up front? Because if you're making that call after someone's stocks already dropped off and kind of a vesting schedule, then you're in trouble.
Ilene: Right. And I think like that actually brings up the point of, the executive saying, but they're not a top performer is and I don't know if this is really a direct answer to this question, but I think it's something that in light of equity stock compensation that management needs to be very aware of is right. You can't retain everybody. When you peanut butter, you're not going to have a strong enough hold on any one individual. So you really need to prioritize and you might need to be prepared for, I don't know, thirty, forty percent of your organization to walk, right?
Peter: Yeah.
Ilene: And that could be the thirty to forty percent of your organization that are they might be doing the job you expect them to do, but they are not knocking it out of the park. And that's tough...It's tough, right, especially for the line manager who's like, oh, well, will I get a backfill? And it'll take time. I'm going to be without a person for three to six months. Like, I get it. I've worked on teams. I've led teams with turnover, and it's painful, right, because the work still needs to get done. But you can't retain everybody. You can't, so double down on the people who it's going to be the most painful if they were going to walk out the door.
Peter: Yeah, such an important point for stock-based compensation and other forms of compensation.
Ilene: So another thing that I think is a common pitfall companies can make is not really ensuring that they're governing their plan as tightly as possible. At the end of the day, the SEC can swoop in and stop you granting any stock from your equity incentive plan if you are doing things that look questionable. Sometimes you might get somebody swooping in and saying, hey, we were supposed to give this person a grant, but four years ago, which means the entire thing should, would vest, the day that you granted it because you kind of, so I would definitely, take time out, talk to your stock admin team, talk to your legal partner, ensure that when you get some of these, super weird and niche questions that you're working as a team to come up with the right solution. So you wouldn't want to do anything that would put your entire program at risk.
Peter: Not the place to get too creative.
Ilene: Exactly.
Peter: Anything else in terms of the pitfalls?
Ilene: Certainly with choosing your, like how you set your guidelines. I know it can be, it can be really helpful and help kind of build attraction in the market and just, kind of goodwill from employees. If you communicate what percentile of the market you target for not just stock, but also for obviously, base salaries and whatnot. But for some of the reasons that I mentioned before, as companies grow and they can't, they can't afford, to grant as much stock, targeting percentiles, you may need to look at those. So I would think about it, know really in the context of not just where the company is today but where you expect yourself to go and certainly then whether or not you're communicating what percentile of the market that you are targeting to set those equity guidelines...
Peter: That makes a lot of sense all about setting the expectations whether it's calling a refresh or telling people where you're targeting in the market too...
Ilene: Yeah, because some companies, if their stock has done this and it's done that for fifteen years, they might have a very sound comp strategy to target higher in the market. They're going to target the seventy-fifth or the ninetieth percentile for equity because the stock price isn't depreciating. But if you work at a company where your stock's been growing steadily for a number of years and you expect that to continue, well then maybe you target lower because you're already creating greater wealth for employees just because of the appreciation of the stock. But we don't have a crystal ball and nobody really knows necessarily how the company will perform.
Peter: That's right. Yeah. Makes total sense. You gave us a couple of things to look out for there in terms of mistakes or some of your pet peeves, which I think are really on point as well in terms of stock compensation programs. How should businesses and teams think about testing whether or not their programs are working for them? What are the signals? What are the signs that you're doing the right things?
Ilene: Great question. And something that we spend a lot of time on at my current organization, we're very kind of pay for performance focused, very algorithmic. And we go into our pay planning cycles, including when we grant our equity awards with goals. And then after the cycle, we assess how well we achieved what we intended to do. And certainly because equity is by far the most differentiated program I would say at most companies today at least in the tech world obviously everybody has a big salary most if not all people have a cash bonus of some flavor right whether it's commissions or a company bonus but again not everybody gets stock so you need to number one, see like, you should go in with a goal of what percentage of your employee population you expect to receive a grant. So I would look at that. That's kind of telling you if it's, if, if, if managers are doing what you ask them to do, right. And prioritizing and not doing the peanut butter that we've, discussed multiple times now. So that's one. Another is like, know who your key people are and are they staying right? What is the, what's the retention rate of critical talent compared to the general population? I think I said it before, maybe I didn't, equity first and foremost is a retention tool, right? It's long-term, for a reason, or at least most companies, it's, it's at least a multiple year vest period. So look at that population of the people who you're kind of saying that you're betting on that you really don't want to leave what's their attrition rate. And then what's the attrition rate of the overall population. Hopefully the attrition rate for this group, is much lower. So that would be, another one and gosh, when I think about, new hire awards or kind of how, how people's unvested holds are, if you have an equity guideline and it's fixed or you have a range, I would be looking at where people sit in relation to that guideline. If you do have a range, like how many people are in the H quartile, and does that feel right, based on job function or based on job level, where are people sitting relative to, where are they kind of sitting in that equity range?
Peter: That feels like such an important thought connected to what you said previously of, hey, if you're making a bet on our share price is going to go up, for example, and that that will keep people in the right percentile, then you got to keep track of that.
Ilene: Exactly right. Exactly right.
Peter: I really appreciate the thoughts today. I think that's all the time that we have. But again, just wanted to thank you for joining us and sharing some of your experience. I know it's going to be really helpful to a lot of people.
Ilene: Anytime, Peter. It was a lot of fun. Thank you for having me.
Peter: Of course. Thanks so much. Bye.
Ilene: Bye.
