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Beyond Stock Options: Why Performance Shares Are Gaining Popularity

Beyond Stock Options: Why Performance Shares Are Gaining Popularity

February 02, 2024

Performance shares are compensation tailored to specific goals or metrics before their activation. For example, you could be required to close a hundred sales before receiving the shares. Clearly, the objective of performance shares is to create a sense of belongingness for employees and motivate them to hit set targets.

If you’ve received performance shares, it’s essential to understand how they work, any restrictions attached to them, and how they are affected by taxes. This article takes you through the ins and outs of performance shares and how you can take advantage of them.

How Do Performance Shares Work?

Performance shares include performance stock awards (PSAs) and performance stock units (PSUs) with varied structures. They’re tied to meeting absolute or relative targets.

The shares are mostly issued to managers and executives to motivate them to maximize shareholder value. This type of compensation also helps in the retention of employees and creates a link between pay and performance.

Unlike stock options, where an employee receives shares as part of the compensation, performance shares are dependent on set targets. Some of the most common targets include:

  • Cash flow from operating activities
  • Stock performance
  • Return on capital
  • Total shareholder returns
  • Completion of a project within the set deadline

The target can also be set on a combination of the above metrics. Depending on the terms of the shares, an employee can be granted voting rights before the elapse of the restriction period. Also, you can earn dividends from the shares if the terms of the issue stipulate so.

Advantages of Performance Shares

As an employee, you’re motivated to deliver because your compensation is dependent on your performance. However, this can be a disadvantage if the targets are set too high meaning you might consider negotiating for achievable targets.

Performance shares also help you settle with an organization because they’re usually part of a long-term compensation plan. For the employer, it’s a good strategy to retain high-level managers and create confidence among the shareholders.

The sense of fairness and meritocracy that comes from performance-based compensation is essential to motivating employees. The rewards tie individual and collective contributions to the success of the business. This means that diligent workers won’t feel exploited because their compensation is likely to be higher.

Apart from that, performance shares help companies mitigate risks from market volatility. Unlike stock options, performance shares have value even if the company’s stock price doesn’t increase. There is also a possibility of tax benefits for the employer and employee.

Why Performance Shares Are Growing in Popularity

Investors prefer equity compensation tied to factors beyond stock prices or continued employment because even if the stock price doesn’t outperform the market index, they still receive the gains. Today, performance shares are becoming common to show shareholders there is a commitment to increase their value. Organizations are considering performance-based share compensation even beyond senior managers and executives.

There is an improvement in the performance share accounting under FAS No. 123(R) with the introduction of fixed earnings charges and no variable accounting. This principle is contrary to the old accounting rule APB 25 when variable accounting was applicable. Today, when you don’t meet the set conditions or targets, the accrued expenses of the performance shares are reversed after the performance period.

Organizations also use performance shares as a strategy to achieve specific goals within a period. This approach is not only attractive to shareholders because they don’t incur the costs if targets are not met, but it also motivates employees to maximize their productivity. Also, employees get a sense of belongingness, and they are more likely to work harder to meet the targets.

Conclusion

Most organizations have accepted performance shares as part of their compensation, especially for senior managers. The grants motivate employees to maximize shareholder value because they own part of the company. This builds confidence among investors, and may inspire them to invest more.

Your company granting performance shares also means they want to keep you in the long term. You should still evaluate the alternatives and negotiate appropriately to ensure the targets are within attainable limits.

CRN202507-5855637