Unintended Consequences of Equity Plan Retirement Provisions

Employers plan for executive succession by ensuring a robust pipeline, but should also pay attention to whether retirement provisions for departing executives are incenting the wrong behavior, says FW Cook. A new article, “Re-examining Retirement Provisions,” discusses what measures can be taken to protect the company from unintended consequences while still treating the long-tenured executive fairly.

• The article notes that companies can start by defining “retirement.”  Eligibility requirements often have age and years of service criteria, but it is advised to make the distinction that benefits are for voluntary retirements. Scenarios where an executive is technically retirement eligible but “forced out” for performance might be governed through severance or other HR policies. This will avoid the executive receiving vested equity in addition to any cash equivalent paid under a severance agreement.
  
  
• Another safeguard is to require advanced, written notice from the executive about their intent to retire. Some organizations require 6 month (or more) notice period that allows them time to plan the transition and review the impact on the executive’s unvested awards. Companies can consider adding flexibility here in case a longer lead time is needed or it’s deemed advisable to waive the notice period.
  
  
• Award agreements should explicitly state how awards will be vested and prorated. Cook suggests some best practices in this area, recommending continued vesting per the original schedule versus accelerated vesting so the executive will remain focused on long-term goals and be incented to support the transition. The proration methodology is key so the executive understands what percentage of the future awards they may be entitled to based on time worked during the performance period. This will also help to deter executives from negotiating different terms for their outstanding awards as they approach retirement.
  
  
• Finally, the article warns against the practice of modifying awards on an individual basis, especially for named executive officers, as the compensation committee needs to approve the change and disclose it in the proxy, risking pushback on Say on Pay. And making exceptions may set a precedent for future executives, potentially creating internal equity issues.

A few simple provisions and proactive communication can ensure seamless equity administration and smooth transition for the executive moving into retirement.