“Pay for Investment”: Looking to the Long Term

Joseph Bachelder is special counsel in the Tax, Employee Benefits & Private Clients practice group at McCarter & English, LLP. This post is based on an article by Mr. Bachelder, with assistance from Andy Tsang, which first appeared in the New York Law Journal. Work from the Program on Corporate Governance about executive compensation includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried, discussed on the Forum here.

Today’s post considers what might be done in the design of executive pay to encourage commitment by executives to the longer-term interests of their employers.

A very interesting examination into design features in an incentive program that puts emphasis on long-term considerations of executive pay is contained in the proxy statement for Goldman Sachs. (Elements of this program discussed below have been developed by Goldman Sachs over a period of years—the CD&A section of the 2013 proxy statement provides a description of the program.) Following are two interesting aspects of that program.

  • Restricted Stock Unit Awards (RSUs). Goldman Sachs awards restricted stock units to its senior management (among others). The “2012 Year-End RSUs,” as discussed in the proxy statement, “were vested at grant” subject to terms and conditions as provided in the award agreements (including forfeiture and clawback under specified circumstances). The RSUs pay out in shares on each of the first three anniversaries of the grant date (one­ third on each anniversary). One-half of the shares issued are free to be sold by the executive (in order to have the cash to pay the taxes). The other half must be held until the fifth anniversary of the grant date.
  • Awards Under the Long-Term Performance Incentive Plan (LTIP). Each of the LTIP awards is payable in cash subject to the attainment of performance targets. According to the description in the proxy statement, “there is no continuing service requirement under the award; however, upon termination of employment for any reason, including retirement, payments are not accelerated, and performance measures continue to apply.” The LTIP awards are subject to forfeiture and clawback provisions that are similar to those applicable to the RSU awards. The performance period is three years. On or before the second anniversary of the original award the compensation committee of the Board of Directors may extend the performance period an additional five years (making the total performance period eight years). [1]

In addition to these two longer-term characteristics in its incentive program, Goldman Sachs requires its senior executive officers to hold 75 percent of the stock awarded to them (reduced by the shares they are allowed to sell in order to pay taxes) until they cease to serve in that role (presumably, for most, this would be upon termination of employment). [2]

Suggested “Pay for Investment” Program

To the extent equity continues to be tied to the company over a significant period of time beyond the point that it has been earned, the executive becomes an investor in the employer for whom he or she works. In effect, once the stock is earned and vested, pay for performance “converts” into a longer-term investment by the executive in the stock for a period of time during which he or she is not free to sell it. Following is an example with suggested elements of such a program.


1. Original Grant. A restricted stock unit (“RSU”) award is made July 1, 2013 and vests one-third on each of the three anniversary dates of the award: July 1 of each of 2014, 2015 and 2016. The employer’s practice has been to issue shares of stock represented by RSUs on each of the three vesting dates, that is, July 1 of each of 2014, 2015 and 2016 in this example.

2. Delay of Transferability. Under the “Pay for Investment” program, while the shares are paid out, as previously, on the vesting date, the executive is required to hold at least a portion of the shares (he or she may not sell or otherwise transfer those shares except as noted in the following paragraphs) until the fifth anniversary of the grant date—that is, until July 1, 2018. [3]

3. Exception for Shares Needed to Pay Taxes. Because the executive will incur taxes on each of the three payout dates (July 1 of2014, 2015 and 2016) he or she will be allowed to cash out the number of shares necessary to pay the taxes.

4. Determining Portion of Shares (After Taxes) That Cannot Be Sold. The employer, in our example, requires the executive to hold 50 percent of the shares remaining after payment of taxes until the fifth anniversary of the grant date. (Presumably whatever portion is subject to non-transferability would be subject to exceptions for emergencies such as unanticipated medical needs.)

5. Liquidity Deferral Credit (LDC) in Consideration for Executive’s Being Required to Defer Sale of Shares. Once the shares are “earned” (that is, one­ third vesting on each of July 1, 2014, 2015 and 2016 in the example) the executive becomes (or, more correctly, is required to become) an “investor” in the shares, as already noted. That investment is subject to significant restrictions on its liquidity. These “no-sale” restrictions are summarized in Table 1.

Table 1

Applicable “No-Sale” Investment Period Once Tranche Vests Length of “No-Sale” Investment Period
Tranche #1 From July 1, 2014 until July 1, 2018 4 years
Tranche #2 From July 1, 2015 until July 1, 2018 3 years
Tranche #3 From July 1, 2016 until July 1, 2018 2 years

Thus, each tranche has its own “no-sale” investment period for which the employer will make an LDC payment to the executive. (No LDC payment is made for the period required for each tranche to be earned out—the so called “pay for performance” period.) The LDC payment for the “no-sale” investment period would be determined as in Table 2.

Table 2

Applicable Holding Period Following Vesting Date LDC Payment Amount as a Percentage of Grant Date Value
A 4 year “no-sale” investment 25%
A 3 year “no-sale” investment 20%
A 2 year “no-sale” investment 15%

6. Factors Determining the LDC Amount. The LDC amount is not based on a fixed formula. It reflects factors such as:

  • interest (that is, for the period of time between the date the shares vest and the date the shares are free to be sold by the executive (the fifth anniversary of the grant date in this example)); and
  • risk involved in the required holding period, a period during which the stock is at risk of dropping in value.

7. Timing of the LDC Payment. The LDC payment would be made at the end of the required investment period. That would be at the same time the shares being held become free to be sold by the executive. [4]

Professors Propose Certain Extensions to Holding Requirement

In an article appearing in the University of Pennsylvania Law Review in 2010 (previously discussed here), Professors Lucian Bebchuk and Jesse Fried of Harvard Law School provide a very complete analysis of issues involved in long-term, equity based incentive compensation. [5] In the article they express concern over allowing senior executives of public companies to unwind their holdings promptly following the end of the non-transferability period (that includes whatever additional holding period is imposed following the vesting date, as described above).

As part of the article, Professors Bebchuk and Fried propose eight “Principles for Tying Equity Compensation to Long-Term Performance.” Two of these principles (Principles 3 and 4 in the article) would impose limits on the rate at which equity awarded to an executive can be “unwound” (that is, sold) by the executive, extending beyond the date, or dates, the executive otherwise would be free to sell.

Principle 3. “Grant-Based Limitations on Unwinding.”

After allowing for any cashing out necessary to pay any taxes arising from vesting, equity-based awards should be subject to grant-based limitations on unwinding that allow them to be unwound only gradually, beginning some time after vesting. [6]

To illustrate this principle, the article suggests that unwinding the stock by the executive might be limited, by the terms of the grant, to, say, 20 percent per year. It also suggests, as an illustration, a two year period following the vesting date before the executive can commence unwinding the stock. [7] The article cites examples of major U.S. corporations that have adopted rules delaying unwinding. [8] In the author’s own experience grant-based rules that delay the unwinding of shares otherwise free to be sold is not yet an established practice among U.S. public corporations in making equity grants.

Application of Principle 3 in Contrast to the Example in This Column of a “Pay for Investment” Arrangement. This principle of Bebchuk and Fried would significantly extend the holding period for the award described in the suggested “Pay for Investment” program described earlier in the column. Applied to the RSU award in that example, the principle would extend the holding period for two years after each of the three respective vesting dates and then limit unwinding to 20 percent per year thereafter. Instead of being free to sell the entire award at the end of five years (in our example) the executive would not be able to completely unwind the July 1, 2013 award until July 1, 2022, the ninth anniversary of the grant date.

Principle 4. “Aggregate Limitations on Unwinding.”

All equity based awards should be subject to aggregate limitations on unwinding so that, in each year (including a specified number of years after retirement), an executive may unwind no more than a specified percentage of her equity incentives that is not subject to grant-based limitations on unwinding at the beginning of the year. [9]

Professors Bebchuk and Fried clarify in the article that in Principle 4 they are proposing “in any given year, executives should not be permitted to unload more than a specified percentage of the total vested equity they hold at the beginning of the year.” [Emphasis added.] [10] The purpose of this Bebchuk/Fried principle is to prevent the executive from accumulating a large amount of awarded equity and then selling it in a short period of time.

Application of Principle in Contrast to the Example in the Column of a “Pay for Investment” Arrangement. Following is an illustration of how this principle of Bebchuk and Fried might apply assuming 20 percent as the “specified percentage” under the principle. Assume that an award is made on July 1, 2013 and that the award vests one-third on each of the first three anniversaries from the date of grant (as described in the “Pay for Investment” program earlier in the column). Also assume that the total number of after-tax vested shares in each of the three tranches is 100 and that the executive has no other awards outstanding. Each year he or she unwinds all the shares that he or she is permitted to unwind. The restriction imposed by this principle would prevent the executive from selling any shares in respect of the award in 2014 because at the beginning of 2014 no shares would be vested.

The executive would be allowed to sell 20 shares (20 percent of 100 shares in respect of the tranche vesting on July 1, 2014) in 2015. In 2016, to the extent he or she sold the 20 shares in 2015, he or she would be allowed to sell36 shares (20 percent of 180 shares (the remaining 80 shares plus the 100 shares in respect of the tranche vesting on July 1, 2015)). Carrying this analysis out to 2018, the executive would still hold 156 of300 shares (52 percent) that he or she has not yet been able to unwind. (Compare this with the earlier described “Pay for Investment” program under which the executive is free to sell all shares on July 1, 2018.) Table 3 summarizes the foregoing. Again, it assumes that the executive sells all shares as soon as they become eligible to be unwound. [11]

Table 3

2014 2015 2016 2017 2018
Total vested shares held as of the beginning of indicated year 0 100 180 244 195
Number of shares free to be unwound 0 20 36 49 39
Number of shares yet to be unwound as of the end of indicated year 300 280 244 195 156

This principle, theoretically, would require an indefinite amount of time to unwind all shares. Bebchuk and Fried indicate that this principle should cease to apply at some point—they suggest perhaps five years after retirement. [12]


A program for extending the holding period beyond the vesting date for at least a portion of stock awarded would seem an appropriate long-term design feature for stock-based incentives, provided a reasonable “premium” is paid to the executive (the column calls this an “LDC payment”) for subjecting the stock to additional delay in transferability and accompanying additional risk. Some commentators, such as Professors Bebchuk and Fried, would impose further restrictions on the unwinding of awarded stock-restrictions that could continue for years after the shares are free of vesting and free of any “add-on” holding period going beyond the vesting period. (An example of an add-on period was given in the “Pay for Investment” program described in the column.) While it may be doubtful whether such recommendations will be adopted widely in the near future, to the extent they are adopted it would be logical to extend the concept of the LDC payment to the shares in which unwinding is further delayed under these principles.


[1] The discussion in the text of the column of the long-term features of the Goldman Sachs incentive program is not a complete discussion of that program. For example, it does not include a description of the terms of forfeitures and clawbacks as applicable to both the RSUs and the LTIP awards. Again, for a more complete discussion, see the Goldman Sachs 2013 Proxy Statement.
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[2] According to the executive summary contained in the 2013 Goldman Sachs proxy statement, “Our seven senior executive officers (CEO, COO, CFO and Vice Chairmen, collectively, Senior Executives) must retain 75 percent of after-tax shares received as compensation, and all of our approximately 460 participating managing directors (PMDs) must retain 25 percent of such shares, in each case, for so long as he or she holds such position.”
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[3] Some commentators indicate that shares awarded should be held more than five years. Some suggest a requirement for holding so long as the executive is employed. The Goldman Sachs plan, as noted in the text, requires each senior executive officer to hold 75 percent of all equity awards made to that senior executive officer until the executive ceases to hold a senior executive officer role at the firm. (A somewhat similar holding requirement (lower in percentage) applies to other participating managing directors. See Footnote 2 above.) At the present time, very few companies have such stringent holding requirements.
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[4] An alternative to the LDC payment described in the text would be the delivery of additional shares at time of grant. The number of additional shares would reflect a discount in the fair market value (that is, the price at which the stock is trading on the date of grant) reflecting the same factors as described in the text for determining the LDC. To illustrate: If 100 shares otherwise would be granted and assuming a discount of 20 percent, 80 percent would be divided into 100 shares, producing 125 shares (an additional 25 shares to reflect the discount).
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[5] Lucian A. Bebchuk and Jesse M. Fried, “Paying for Long-Term Performance,” 158 U. PA. L. REV. 1915 (2010). See also Robert J. Jackson Jr., “Private Equity and Executive Compensation,” 60 UCLA L. REV. 638 (2013).
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[6] Bebchuk and Fried, supra, at p. 1931.
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[7] Bebchuk and Fried, supra, at p. 1928.
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[8] Bebchuk and Fried, supra, at pp. 1929-1930.
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[9] Bebchuk and Fried, supra, at p. 1934.
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[10] Bebchuk and Fried, supra, at p. 1933.
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[11] The column does not address factors that would make Principle 3, on the one hand, or Principle 4, on the other hand, more onerous for the executive. (In the article, Bebchuk and Fried propose that both principles should be applied together with the other six principles set forth in the article.) Different results might occur under different circumstances (such as when the executive sells).
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[12] Bebchuk and Fried, supra, at p. 1933.
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