The Equity Methods Mailbag – Q2 2025

In the course of working with hundreds of companies every year, we field thousands of questions from every corner of the market. They range from covering the basics for stock-based compensation beginners to highly technical and company-specific topics.

Frequently, we find ourselves answering questions that are both nuanced enough to be interesting and general enough to apply to many companies.

It is from this sea of knowledge that we bring you the Equity Methods Mailbag. Below, we answer real questions from clients and friends, edited for clarity, brevity, and anonymity.

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The stock market has seen a turbulent year so far. The S&P 500 hit an all-time high in February, then lost almost 20% of that value by April, and has now regained most of it. What effect is this market volatility having on award valuations?

– Controller, consumer packaged goods industry

The current market volatility isn’t affecting equity award fair values as much as you might expect. The primary effect is on the stock price: If you granted at the bottom of the trough or at the top of the rebound, you have very different fair values and a different number of shares issued.

But beyond that, the effect on modeled fair values for options and relative TSR awards has been muted so far. In some industries, volatilities have genuinely spiked, driving up values. But for many companies, the stock price this year has seen consistent down periods and consistent up periods, which doesn’t drive volatility as much as it creates day-to-day ups and downs. Relative TSR awards have also been further insulated because individual industries tended to be similarly affected, leading to companies’ stock prices moving in sync with their peers.

Of course, every case is different, and the key is to look at your particular award structure and timing. However, we don’t expect to see systematic fair value effects from current market volatility in the same way we did during the 2008 financial crisis or the 2020 COVID crash. Rather, the largest effect on equity programs is the greater difficulty in setting long-term performance targets in light of heightened uncertainty around supply chains and other key issues.

Our forecasting is expected to be really good, and our variance analysis even better. How do your other clients approach these for equity compensation?

– Controller, information technology industry

Companies with the best management of equity compensation and its impact on the financials have two things in common. First, they have integrated assumptions across all forecasting areas: compensation expense, tax benefits, earnings per share, and burn rate. Second, they run one or more carefully considered scenarios at a granular level (ideally for each individual vesting tranche of awards).

Equity compensation is complex, with material impacts on numerous functions in an organization. This dispersion across functions can lead to siloed approaches to both planning and reporting.

For our clients, we coordinate with FP&A and other functions to develop a common set of forecast assumptions. This includes expected future grant amounts, rates of forfeiture and exercise, performance achievement, and stock prices. Having one unified set of data going through expense and other calculations ensures the most accurate impact across the financial statements.

Sometimes, one set of assumptions isn’t enough. Running multiple forecasts with distinctive, cohesive assumptions provides a range of potential outcomes within which the actual one will likely fall. At Equity Methods, we leverage technology to run thousands or even millions of tranches through multiple scenarios. We can then compare this tranche-level data to actual activity (e.g., new grants or settlements) or a prior forecast to conduct a variance analysis.

Each tranche is reviewed and assigned one or more variance reasons, which can then be aggregated by cost center or any other level for further analysis. Some differences may be easily explained, such as when more new awards were granted during the annual review cycle than originally expected. Other differences may require more monitoring over time–for instance, if forfeitures are higher or lower than historically seen.

The cutting edge is to load that information to the cloud for visualization, trending, and what-if analyses. Our recent webcast is an invaluable resource for anyone building or rebuilding their forecasting process or trying to get more insight from the data at hand.

I’m not anticipating a restatement. Should I still be doing anything in consideration of the newly implemented clawback rule?

– CHRO, consumer durables industry

While most companies haven’t had a restatement since the clawback rule went into effect, many are being proactive about how they will apply their policies in case of a restatement, as well as preparing their compensation program for what may happen if that day comes.

In addition to those who have had to test their plans to see whether there was any erroneously awarded compensation, we have talked to a number of firms looking to stay ahead of the curve. We’ve seen companies pursue any of three options:

• Implement a post-vest holding period for covered employees, such that in case of a clawback, the shares are readily available. Our recent article discusses the current state of this practice.
• Review their clawback policy and playbook to make sure they reference appropriate methodologies to determine erroneously awarded compensation due to stock price inflation.
• Perform sample analyses to illustrate to executives and the compensation committee what a clawback would look like and the potential exposure.

For more insights on clawbacks, check out our hot topics page here.

We’re implementing a performance award with a TSR modifier. The financial metrics (revenue and EPS) scale from 0% to 200%, and TSR modifies the payout between 75% and 125%. Should we cap our overall award payout at 200% even if all metrics perform at maximum, or should we let the payout go to 250% in such cases? Many of our peers cap their payouts at 200%, but we’re not clear as to why.

– Director, Executive Compensation, healthcare industry

Sometimes, a compensation practice exists for a very good regulatory, accounting, or governance reason. And sometimes, it’s simply customary without an overarching reason. Performance awards with maximum payouts of 200% fall into the latter category.

Certainly, there are good governance reasons in general for limiting upside. An enormous upside can incentivize risk-taking, and wide payout variances can cause unexpected cliffs in unvested value that can lead to retention concerns. Additionally, if a company already has high target pay or is under higher scrutiny due to poor say-on-pay outcomes, a firm cap at 200% can make further sense.

Beyond that, though, there’s nothing inherently special about 200%. We find that many companies set their upside to 200% simply because others do so. There are no regulatory requirements or tax rules that are tripped beyond that level. Proxy advisors don’t have any policies against higher upside for outperformance; we’ve only ever seen high payout opportunity raised in qualitative review when there was already elevated concern about pay. The disclosed value in the Summary Compensation Table is the same for either structure. There’s also no accounting downside to higher payouts beyond having higher expense, just as when payouts move up and down below the maximum level. In fact, capping the award at 200% overall creates more accounting complexity than letting it ride to 250%.

All in all, feel the freedom to do what’s right for the business. Allowing the higher 250% payout for excellent performance across multiple metrics can be a way to deliver more pay, in a performance-driven way, without major tradeoffs for many companies.

Our compensation committee has directed us to propose a design for relative TSR. But when we have gone to select a peer group, we’ve found that we really only have five good peers. How should we handle this for relative TSR award designs?

– Senior Director, Executive Compensation, consumer discretionary industry

This is always a tricky situation. There’s no silver bullet, but there are a few ways to tackle it.

First, we encourage our clients to reconsider whether there are truly only five peers that are good enough for this purpose. They may not be direct competitors for customers or talent, but if they’re similarly affected by market trends, they can still be a good peer for TSR purposes. We help our clients look at different sector and industry indexes through lenses of correlation, beta, and backtesting of past performance cycles. Often, this analysis finds that a larger sample size is attainable.

If that fails, and five truly is the number, then there are a few angles to consider. One would be using a TSR modifier rather than a standalone metric to minimize the payout “spread” from one peer to the next. Spreading five peers across a 0–200% payout range is more extreme than across a 75–125% modifier.

Another angle to consider is a “delta” or “outperformance” design. Rather than ranking among the peers, base payout on how much you outperform or underperform the group as a whole. Often, this is done by comparing against the median peer.

Alternatively, we’ve seen some clients create a synthetic index using a weighted average of the peer TSRs. Either way, the idea is that the payout is based on the delta. For example, if your TSR is 20% and the comparator has a TSR of 15%, then you outperformed by 5%. Based on your specific payout schedule, that 5% outperformance could equate to a 120% payout.

Finally, there are bespoke ways of defining percentile rank that can mitigate cliffs in payout from passing each peer. For example, one such approach ranks the peers without the target company. The target company then interpolates its “ranking” between the peers ahead of and behind it based on its TSRs and those of the two companies. This allows for a linear rather than step or cliff relationship when going from one ranking to the next.

These situations don’t have one-size-fits-all answers and require a careful look at how the different alternatives are operationalized in the individual context.

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Do you have a question you’d like to see us cover? Or do you have a situation like one of those above that you’d like to unpack using your particular circumstances? Please feel free to contact us.