Equity compensation in the form of stock options, restricted stock units, and performance shares is an important vehicle that public and select privately held companies can use to attract, retain, and motivate employees. It can be awarded at any time, but the most valuable equity compensation awards are often granted and received during economic downturns.
During those periods, companies face significant challenges and uncertainty. To survive, they reduce costs, increase efficiency, and bolster cash reserves. One cost-cutting measure is to decrease overall employee compensation, which includes lowering salaries, bonuses, and other benefits through reductions in force, freezes, or plan modifications. But companies must still maintain their top talent (especially during difficult times), because it’s crucial to their long-term survival and success.
Equity compensation awards are an effective way for companies to retain their top employees during economic downturns without drawing down cash reserves. These awards grant employees ownership rights in the company, thus aligning their interests with those of other owners and creating a sense of commitment to the company's success. Employees who receive equity compensation awards are more likely to stay with the company for an extended period and work harder to ensure the company's success.
Equity compensation awards also provide a long-term financial incentive for employees. Share prices often reach their lowest points during an economic downturn and rebound later as the economy picks up. When employees receive ownership rights over several years, the increase in share prices creates a strong monetary incentive for them to stay with the company and strive to achieve the organization’s goals. This incentive is precious during economic downturns, when short-term cash rewards may be limited or nonexistent. (Additionally, equity compensation awards are tax-deductible expenses, which may reduce the company's tax liability and periodic tax accruals for a non-cash award.)
During an economic downturn, equity compensation awards can be used to attract new talent to the company from other organizations where existing incentives have been cut or awards are underwater. In a downturn, companies that reduce their workforces populate the labor pool with highly skilled professionals, and other organizations can entice those high-performing employees to join their teams by offering them equity compensation awards. (This approach can be especially valuable for companies looking to pivot their business models or expand into new markets.)
Cash is a precious resource during economic downturns, and companies may need to conserve it to survive. Because equity compensation awards do not use cash, they allow organizations to reduce the amount of cash they otherwise would have diverted to salary or cash incentive expenses. Companies can then use these saved funds to fund their operations and invest in new opportunities.
Finally, equity compensation awards can help companies retain control over their ownership structure during times of economic uncertainty. These awards are typically granted with certain restrictions (such as a vesting period or a lock-up period) to a group that is intrinsically tied to existing management. These “white knights” are especially valuable for companies facing hostile takeovers or significant shareholder disputes when ownership margins are tight.
