The agony of choice – Should employees choose their own adventure when it comes to equity?

This question has come up a few times and is an area where I have heard differing opinions. Here I want to lay out some of the considerations and implications if allowing employees to choose between cash and equity compensation.

To summarize, companies like Netflix and more recently Shopify, offer varying degrees of flexibility when it comes to compensation. For example, they may allow employees to direct more of of their earnings directly into stock options rather than cash, or choose RSUs instead of options to suit the risk appetite of the employee.

Let’s start with arguments in favor of this approach.

Generally speaking more choice is viewed as a good thing. Jon Burg recently made the point on a webinar (I recommend watching this) that we offer employees plenty of flexibility already in the form of 401(k) contributions and ESPP, so why should equity be any different?

Flexibility also allows an employer to accommodate different employee needs and expectations. To some, taking plenty of stock may be ideal since they believe in the mission and don’t need the cash right away. To others, they may be trying to finance their first home or pay for their children’s education and the more base salary, the better. Flexibility means the ability to attract a greater spectrum of candidates in terms of their personal needs and risk appetites.

However the idea of flexibility can terrify even the most experienced stock plan administrator since it can be a bit of a nightmare. Clearly, it is possible, but we shouldn’t overlook the need for effective systems, processes, and people to manage this extra level of complexity. Most current systems are simply not designed to facilitate this approach.

Another challenge is employee understanding. Take this explanation of the Netflix supplemental stock option program, for example – how many Netflix employees do we think has this level of understanding? The fact is, many employees are understandably bewildered by equity, even in its simplest form. It isn’t a basic concept and education is critical to communicate the value of the reward, and ensure we are not misleading people. If we layer on further optionality, things get more complicated. When you offer someone cash, options, or RSUs, do they understand the different risk profiles? Do they understand the conversion factor between cash and equity vehicles? Do they understand that an option is worth zero and could always be worth zero? The Black-Scholes calculation that was used to determine the strike price? What about the tax implications, vesting schedule, implications of leaving, exercise window…?

The educational barrier is not insurmountable, but it is real and needs careful consideration and investment to navigate. I would argue that most companies are not doing enough around equity education as it is, even with more traditional cash and equity models, never mind making it more complicated.

Another very real issue, I believe, is the implication for pay equity. Pay equity analyses are typically confined to base pay. If some employees have chosen to sacrifice their pay for equity, how can we make a comparison? This variable would need to be controlled for in the regression analyses that typically drive pay equity assessments in the form of (I imagine) some kind of weighted average cash:equity variable by employee.

The final issue I can think of is financial planning. Allowing an option between cash and equity may make it more difficult for accounting teams to build long-term forecasts, particularly cashflow, so parameters will need to be put in place to prevent any nasty surprises.

I suspect we will see more companies embrace optionality over time. If this is something your company is considering, it is definitely worth pursuing and discussing the merits of increased optionality as a means to differentiate your EVP in an increasingly crowded talent market. The key to success for me is knowing the obstacles, engaging early with the right stakeholders, and ensuring that employees understand what this means for them.

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