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Compensation packages for executives and other high-income earners can be confusing; acronyms, percentages, and industry jargon can make it hard to identify exactly what you have to gain from an offer. If you don’t completely grasp the pros and cons of what you’re being offered, it can be difficult or even impossible to formulate a long-term wealth plan.
Two common terms you might have heard include restricted stock units (RSUs) and performance stock units (PSUs). Which is better for your personal finances: RSU vs. PSU?
In this comprehensive guide, we’ll take a deeper look at how these two compensation offers impact your overall chance to build wealth through an executive compensation plan.
RSUs vs. PSUs: What’s the Difference?
A robust compensation package may include RSUs and PSUs, but these two different stock units are not as different as you might believe. Both represent equity granted that vests at fair market value at a specific point in time in the future. Typically, you will find that they are valued annually and in conjunction with a corporate long-term incentive program. The main difference is in the terms in which they’re awarded.
According to research conducted by Korn Ferry’s Top 300 CEO pay study, when it comes to the division of RSUs and PSUs, these are most commonly granted as a 50/50 split between the two categories for C-suite executives. If the split is not even, a compensation package will often contain a slightly higher percentage of PSUs than RSUs. Other individuals in leadership positions, such as directors and vice presidents, typically receive only RSUs and stock options, but not PSUs.
Restricted stock units (RSUs) are time-based units, which means that continued employment is the only real factor necessary for them to vest. A portion of RSUs will vest each year on a sliding scale until you reach the full term of your grant.
For example, a three-year vesting period might allow one-third to vest at the end of the first year, the next third at the second-year mark, and the final third to vest at the third-year mark.
While any form of equity holds a balance of risk and reward, since the value of those shares can change over time, RSUs are more predictable than the other compensation types listed here. Since employment is the only requirement, you will be awarded your RSUs regardless of personal or company performance.
Performance share units (PSUs) are typically awarded based on how well the organization meets two to three performance metrics agreed upon at the time of hiring. The metrics can be highly customized and may be based on absolute company performance or company performance relative to its peers. At the end of the set time period (typically three years), metrics are assessed against the goals.
Depending on performance, there is linear interpolation to determine how many shares are awarded. You may be awarded the same shares, more shares (if the target was exceeded), or fewer shares (if targets are not met but are still above the threshold). All of the details regarding PSUs are established at the outset as part of a long-term incentive plan; metrics and targets do not change after PSUs are granted.
In other words, the amount of PSUs you receive will change based on how the company matches up to the established performance metrics. Whereas RSUs will be granted at a steady, predictable rate, PSUs come with a higher degree of risk and potential reward.
PSUs are preferred by shareholders, as performance typically aligns with share price growth. A high percentage of PSUs as part of a compensation package incentivizes the individual to put their best effort into bettering the company. This also means alignment with the shareholders if the company doesn’t end up meeting expectations.
On the other hand, PSUs are a more risky equity type for the employee. Even if they perform to the best of their ability, uncontrollable market conditions or events can make it difficult to meet targets. This is why PSUs are typically based on two to three metrics–the more metrics that are available, the more likely they will be able to meet at least one of them.
Korn Ferry Executive Pay and Governance Expert Laura Balser, CECP explains, “The best practice and shareholder preference is typically a 50/50 split between PSUs and RSUs, although there are variations depending on the company. PSUs are often tied to 2-3 performance metrics so that the executive can achieve some level of payout over those three years. Firms usually set a max and a threshold and then conduct a linear interpolation to determine the number of shares awarded. They may be awarded more if the target is exceeded, or less if the target is missed but still above the threshold. This helps lower the risk to the employee.”
PSUs are typically only part of the conversation with C-suite executives. Read on to learn about other forms of compensation.
In addition to RSUs and PSUs, some compensation packages also include stock options. In the C-suite, you tend to see about 50 percent PSUs, 15 percent stock options (if any), and the remainder RSUs.
Locking in a lower price on a company’s stock can be a powerful way to build wealth over time, especially if you expect the company to grow during your years of employment.
However, stock options are not guaranteed, since there’s no way to predict market conditions or where the company will be in the future. Compensation packages that focus too heavily on PSUs and options carry more risk since the value of those shares granted a year or two ago can quickly fall during a down market. Essentially, workers can end up in the red even if they hit their targets.
According to Balser, “This is the first time in probably 12 years that we’re seeing more material share price declines than we’ve seen in the past. So organizations are concerned about the retentive aspect of the equity. If options have been awarded and they are under water and the options don’t appreciate enough to warrant an individual exercising them, the result is the company has lost the expense and the individual has lost the ability to experience any wealth creation. Which is why having RSUs or time based units be a part of the equity mix is important – because at least it’s a floor. It’s a floor that may decline in value, but it probably won’t decline as much as the value of an option that is underwater and unable to be exercised.”
Common Compensation Packages
Understanding the ins and outs of your package is essential to negotiating a compensation arrangement that rewards your hard work. Beyond your base salary, here are some of the top items included in a robust package.
A signing bonus is often the first item that a new employer will offer their hire. For C-suite executives and other senior leadership positions, this is most often in the form of equity.
Signing bonuses are designed to make up for what you might be walking away from, namely long-term equity or loss of deferred compensation when you leave your current position. For example, if you’re only two years into a five-year vesting period, you’re walking away from a sizable chunk of RSUs.
This signing bonus, also sometimes referred to as a “golden hello,” is often not scrutinized because shareholders understand the bonus accounts for the amount of equity that an individual is leaving behind.
A mega grant is a little different than the other grants already discussed. Under the umbrella of a mega grant, an individual is awarded four to five years of an annual long-term incentive grant all in one shot. Following this, they do not receive any more equity during that time period.
If you are awarded a mega grant, it is typically a mixture of PSUs and RSUs. A portion of it (usually about 50 percent) is always performance-based because shareholders want to see you put your best effort into the performance that moves the needle ahead for the business.
Another type of compensation plan is an outperformance grant, which layers on an additional performance metric for a particular individual. This could be a growth or revenue achievement directly tied to your job performance.
Your Executive Compensation: What You Can’t Control
When it comes to making the most of your executive compensation package, there are parts you simply can’t control. These inevitable truths about your compensation will need to be accounted for and planned around.
For one, keep in mind that both RSUs and PSUs are hypothetical shares. They can increase or decrease in value before they ever earn you a dime on your bottom line, which makes them hard to plan for in terms of how they will ultimately impact your personal wealth picture. Company equity can be a powerful portion of your portfolio, but keep the risks in mind and remember that the value is variable until you lock in those gains (or losses) with a sale.
Market conditions can also affect the value of your shares alongside the feasibility of reaching performance goals. The performance metrics you agree to at the time of your hiring might be achievable at the time of signing, but no one can predict changes to the market – especially when it comes to world events or pandemics such as COVID-19.
Finally, don’t forget that taxes will play a major role in how you reap the benefits of your compensation package. No matter what, you will owe taxes on the units that vest or on options you exercise. Proactive tax planning strategies can minimize the impact, especially if you start sooner rather than later.
Your Executive Compensation: What You Can Control
While there are bound to be items you can’t control when it comes to your wealth planning with a new career move, there are some things under your control. For example, you can negotiate your compensation package and reduce concentration risk.
Here are some of the ways you can make the most of the items under your control.
Negotiating Your Equity Package
When a company makes an offer, they expect a counteroffer. In other words, you should always counter because the worst thing they can do is say no to your request.
This is a chance to display your ability to negotiate – a powerful skill in business that can reinforce the decision to hire you. Just be sure to negotiate fairly and in good faith. Unreasonable demands or a “take it or leave it” approach can be detrimental since it starts the relationship on a poor foot. A good negotiator understands the balance between give and take.
Your negotiations should also include a reasonable balance of short-term and long-term compensation. Too much focus on the short-term can signal to the company that you don’t have an eye for the long-term growth and success of the company. Similarly, pushing too hard for more RSUs and fewer PSUs can be a red flag in the eyes of shareholders that you want to coast rather than push the company’s growth.
What can you negotiate concerning your package? Some levers are generally non-negotiable, while others are open to more wiggle room.
For example, the annual incentive is a percentage of your base salary and isn’t typically a lever that you can move during negotiations. That being said, you can likely ask for a higher base salary which would affect the annual incentive.
You can also request different long-term incentives awarded as either a flat dollar or a percentage of the salary. Flat dollar amounts are likely based on level and may be a range with more equity given to high performers. Long-term incentive equity could be negotiated a little bit more.
Don’t forget about your signing bonus. “You should always negotiate for what you are walking away from. If your annual incentive bonus hasn’t been paid out yet and you are accepting an offer, ask for the new organization to make you whole. Essentially, you want them to offer you what you will miss by walking away from your current role. Get compensated for equity and long-term incentives you are leaving behind,” recommends Balser.
It’s not as common to get car allowances and other executive perks like deferred compensation plans these days, so you likely can’t negotiate for these. However, they might be something to keep in mind if an organization puts them on the table during negotiations.
Reducing Concentration Risk
Of course, there is something to be said for diversifying your portfolio. If you maintain all of your RSUs, PSUs, and stock options as-is, you hold a significant portion of stock in the company you work for.
Should that stock decline significantly in price, you could see tremendous portfolio losses, particularly if the company stock is a majority holding in your portfolio.
In other words, you may want to consider selling some or all of your RSUs as soon as they vest so that you can instead diversify your portfolio, build up your retirement savings, or set some money aside for a rainy-day fund. This allows you to reduce your overall risk which could be associated with a decline in a single stock price.
You will owe taxes no matter what. While you can’t control their inevitability, you can control your plan for handling them.
When it comes to RSUs and PSUs, you will owe tax on both the vesting (as income) and upon the sale of those units (as capital gains).
Most organizations default to selling some shares to pay for the tax burden, though often at a lower rate than a highly compensated executive is actually taxed at. If your compensation has a sizable amount of RSUs and PSUs, planning for the tax impact is especially important.
Stock options (especially incentive stock options, or ISOs) can add even more complexity to your tax reporting, since they have the potential to trigger payment of the Alternative Minimum Tax when exercised.
Overall, the taxation of your compensation package can get complicated quickly. Consider meeting with a CPA to discuss your exercise strategy and ensure you don’t inadvertently create a higher tax bill for yourself.
Last but not least, consider meeting with a wealth advisor. Complex executive compensation packages involve many moving parts, and often you’ll find there’s more than one strategy available to you.
A high-performance career already consumes much of your time and energy, and managing a multi-layered portfolio on top of it can eat into your valuable time spent furthering your business, relaxing with hobbies, or making memories with friends and family.
A wealth manager can help you understand the advantages of a specific compensation package and how it will fit into your overall portfolio. If you find yourself overwhelmed by the technical jargon of your portfolio and RSUs vs. PSUs, then you likely need a new wealth advisor.
Make sure your wealth advisor is also a fiduciary, so you can rest easy that they have your best interests in mind and are strategizing the best way to work toward your long-term goals.
Make the Most of Your Compensation Package
Your wealth and potential for growth is much more than the sum of its parts. Getting the most of your compensation package–whether that includes RSUs, PSUs, options, or something else entirely–should be just one part of your overarching wealth plan. These are tools on the journey to achieving the life YOU want to live.
Rather than stress over the market’s constant rise and fall (with the value of your portfolio along with it), understanding the purpose for your wealth can help make you financially unbreakable and set you on the path to creating something of meaning and purpose. You can rest easy knowing that the plan is still on track.
With Monument Wealth Management, you can count on us to be your partner every step of the way. Our collaborative, creative approach to Private Wealth Design ensures that every portion of your plan is catered to your specific situation, including your compensation package, your current portfolio, your long-term goals, and the legacy you hope to leave behind.
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