The lion’s share of large-cap companies in the United States now require named executive officers (NEOs) and board members to attain a certain level of stock ownership within a defined time period, and then to maintain that ownership during the course of their tenures.
The rationale for stock ownership guidelines (SOGs) is that when officers and directors have actual “skin in the game,” their interests will be more aligned with shareholders, and they will have more incentive to focus on long-term value creation.
It’s not just large-cap companies that are adopting SOGs though. According to the National Association of Corporate Directors, 46 percent of public companies with revenue between $50 million and $500 million now have some form of SOGs for board members (up more than 25 percent from 2012).
A small-cap company’s SOGs might, for example, require: (i) the CEO to own three times their annual base salary in stock; (ii) other NEOs to own one times their annual base salaries in stock; and (iii) non-executive board members to own three times their annual cash retainers in stock. SOGs often provide five years for NEOs and board members to comply, and most have hardship exemptions that are reviewed by the board, or applicable board committee, on a case-by-case basis.
For the myriad micro- and small-cap boards that haven’t yet adopted SOGs, they might wish to consider a few common buy-side perspectives in this regard.
Shareholder vs. option holder. Most institutional investors draw a sharp distinction between shareholders and option holders. Since public companies are operated and governed for the benefit of shareholders, there’s an inherent rub from the perspective of many fund managers when those who are doing the operating and governing aren’t, themselves, shareholders. From a buy-side perspective, stock options don’t constitute “skin in the game.”
Don’t let the minutiae frustrate the purpose. In an era where boardrooms are beset by increasingly complex compliance issues, it’s easy for directors to lose track of what’s important to investors with respect to SOGs. Many small-cap fund managers are more focused on whether or not a company has SOGs versus the prescribed ownership thresholds. Rather than get mired in potentially conflicting advice from consultants, proxy advisors, and counsel, companies should consider simplifying matters by discussing SOGs with their largest investors.
Prepare to answer a very frank question. Ultimately, officers and directors need to be able to answer the following question that is increasingly being asked by experienced retail investors and institutional investors: “The officers and directors of your company know far more about the company than investors do. If you’re not willing to buy and hold some multiple of your annual compensation in stock, then why should we?”
Adam J. Epstein advises the boards of pre-IPO and small-cap companies through his firm, Third Creek Advisors, LLC. Prior to founding Third Creek, Epstein co-founded Enable Capital Management, LLC (ECM); ECM’s special situation hedge funds invested in more than 500 small-cap financings. Epstein speaks monthly at corporate governance and investor conferences, he is the small-cap contributing editor for Directorship magazine, and he’s the author of The Perfect Corporate Board: A Handbook for Mastering the Unique Challenges of Small-Cap Companies (New York: McGraw Hill, 2012).
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