Firms Replacing Stock Options With Restricted Shares Face a Tough Sell to Employees

David Ayre approaches employee communications like a marketer approaches an advertising campaign. As senior vice president of compensation and benefits at Pepsico, he focuses on getting his audience engaged, keeping the message simple and making sure employees understand what it means to them specifically.

    “Employees and executives are consumers,” he says. “It is essential to communicate to them as you would to your consumers.”

    So last year when Pepsi changed its compensation program, affecting 80,000 employees, Ayre didn’t get bogged down in the minutiae. Often, he says, companies get too focused on explaining the changes they are making to investors and regulators. “They are so focused on what their investors think that they forget the people that they are really changing the compensation for, which is the employees,” he says.

    Rules from the Financial Accounting Standards Board requiring companies to expense the cost of stock option grants are causing an increasing number of firms to switch from granting stock options to restricted stock and performance-based stock units. Given the complexities of such programs, many companies are at a loss about how to effectively communicate the changes, says Peter Chingos, senior executive compensation consultant at Mercer Human Resource Consulting.

    “When you ask them about how they rate themselves on changing their compensation programs, companies give themselves the lowest marks in communications,” he says. Making sure employees understand the business rationale behind the new program is essential particularly because companies pour millions of dollars into their compensation programs and if employees don’t understand the value of them, it’s all for nothing, Chingos says.

The Pepsi challenge
    In 2002, Pepsi, like many companies, realized it eventually would be required to expense stock options and got to work on developing a new compensation program. By the end of 2003, after conducting employee focus groups and online surveys, the company came up with a plan for adopting stock option expensing. The firm changed its U.S. broad-based option program and reallocated half of it into a 401(k) match in company stock.

    For its 3,000 managers, Pepsi replaced part of its stock option program with a cash incentive program in which executives could receive cash over a three-year period based on annual performance. On top of that, managers were also given a choice of receiving a mix of stock options and restricted stock units. The amount of restricted stock they could get depended on their performance.

    Because the new plan affected different employees differently, Ayre knew it was essential that each employee understood what the changes would mean for them and their staffs. “As much as employees told us that they wanted performance differentiation, they also wanted to understand that it was being applied equitably,” Ayre says.

    The new program, which took effect in 2004, was announced December 2, 2003, leaving Ayre and his team 60 days to get employees up to speed on the changes. “We decided that the right decision was to move fast rather than take a year to communicate,” he says.

Talking points
    Making sure that employees understand that nothing is being taken away from them is crucial, Ayre says. This is particularly challenging for companies that switch from granting stock options to restricted stock because employees receive a smaller number of units.

    “It was difficult for people to grasp that with restricted stock they were getting the full market value of the shares-as opposed to options, when you are not,” says Jill Pfefferbaum, director of compensation at Priceline.com, which switched last year from granting stock options to giving restricted stock. Priceline developed a question-and-answer document with the help of an attorney to address this and other questions.

    Being as upfront as possible is also essential, compensation executives agree. For Wendy’s International, this meant communicating to employees that there would be upcoming changes to the company’s compensation program even before company leaders knew what exactly those changes would entail, says Lisa Turner, director of compensation. By February 2004, the company had decided it was going to replace its stock option program with something cash-based. The plan was set to debut in 2005, but the details wouldn’t be worked out until fall 2004.

    Rather than wait until the details were finalized and approved, however, the company decided to tell employees as early as possible that a change was coming, Turner says. “I think it was a matter of being transparent and letting them know things as we knew them,” she says. Throughout 2004, the company sent out communications telling employees that it was the last year they would receive stock option grants and that their current options would remain intact.

    In fall of that year, the company unveiled its new plan to its 120 top officers and held a webcast for the company’s 75 human resources managers about the changes in the program. In December, employees received a letter from Wendy’s CEO Jack Schuessler explaining the changes.

    Under the new program, all of the company’s 200 directors were added into the management stock incentive plan, which had switched from stock options to restricted stock in 2004. Also, the company increased the bonus targets for all managers who had participated in the stock incentive program. Finally, Wendy’s created a broad-based cash incentive plan for full-time employees who were not managers to replace the stock option program.

    American Express, which changed its compensation program in 2003 and again this year to be more performance-based, found that it was effective to communicate to senior management first and have them talk to their staffs about changes, says Maggie Gagliardi, senior vice president of global compensation and benefits. “The more people you can get behind the issue helps and makes it more of a partnership and engagement model,” she says.

    By holding meetings with senior management and senior human resources staff about the changes and then having them communicate that to employees, Gagliardi says the company had more people who understood the issues and could anticipate the questions. “We could have just done a webcast, but it would not have been as effective,” she says.

Tapping technology
    Pepsi, on the other hand, decided to use technology to get its message across because it believes it’s more effective to go straight to the employee, Ayre says. The company sent out an e-mail from CEO Steven Reinemund explaining the strategy behind the changes, along with a brochure that got into the details. Employees were prompted to go to the company’s password-protected Web site, where they could see their current holdings, and choose how they wanted to set their grant mix between restricted stock and stock options. By the deadline for the changes on February 22, 2004, 80 percent of employees had made their choice, and the rest were defaulted into a 50/50 mix of restricted stock and stock options.

    Ayre followed up with some hand-holding. He spent the next several months visiting about 900 executives in 13 different locations around the world explaining the changes and fielding questions. Being able to talk to Ayre, who had played such a crucial role in developing the new compensation program, helped a lot of the executives to really understand the program, he says.

    Even that outreach, he says, wasn’t enough. “I realized that even though I was meeting all of these people, I wasn’t getting to everyone. And so we decided we needed to create a way for the people who knew the program best to communicate to employees.”

    Pepsi created a Web site that featured a video of each head of business, who discussed how that division performed over the previous year. That was followed with a video of Ayre discussing the changes in compensation program and showing how it would play out over a 10-year timetable. Ninety-six percent of Pepsi’s employees who qualified for the program watched the 16-minute presentation. “It was the most effective way of communicating the program,” Ayre says. “It showed how the employees at various levels would fare under the new program over 10 years. That created a huge level of transparency and motivation.”

    Bob Toohey, vice president of total rewards at Verizon, agrees that personalizing broadcasts can be very effective. When Verizon changed its compensation program from stock options to restricted stock and performance-based stock options last year, Toohey did a live webcast with head of human resources Marc Reed to walk executives through the changes. During the broadcast, the company e-mailed personal statements to each of the 2,800 executives who would fall under the new plan spelling out how it would affect them. “The first question you get when you talk about compensation is ‘How will it affect me?’ ” he says. “After the broadcast, they checked their e-mail and had all of their information in front of them.”

Lessons learned
    Wendy’s Turner says her advice to companies making changes to their compensation is to view the communications effort as a long-term process. “We plan to do communications quarterly to let employees know how their business units are performing compared to their goals,” she says. “It helps set expectations on a good or bad year.”

    Following up with communications is particularly important when you switch to restricted stock so that employees understand their choices when the stock vests. “A year from now, they are going to all forget what they hear,” Pfefferbaum says.

    Ayre advises companies that are going through these changes to spend as much time figuring out their communications strategies as they do on the design of the program. “Communication doesn’t have to be expensive, but it does require thought and energy,” he says.

Workforce Management, September 2005, pp. 71-73 —Subscribe Now!