Equity compensation: Can an employee own too much company stock?

Many people work for publicly traded companies. The business might be a franchise, branch or division of the parent company. Their shares trade on a major exchange. If your business is in the information technology industry, 86% of companies represented in the S&P 500 Index offer Employee Stock Purchase Plans (ESPP). Healthcare and Financials are 68% and 52% respectively. Purchasing company stock at a discount gives every employee the ability to become a part owner. But can you have too much of a good thing?

Buying stock in ESPP plans is a conscious act on the part of the employee. They choose to have money taken out of their paycheck for this purpose. Although the stock might be purchased on a quarterly basis, once the buy is made, the employee owns the stock and can sell it whenever they choose. Put another way, if the employee gets a 10% discount on buying shares in their company, if they sell immediately, it is like getting a 10% immediate return with little or no risk.

Buying your own company stock gives you a sense of participation in the company’s success. Employees can often feel when the company is doing well and wants to benefit directly in ways other than their salary. Years ago, when I worked at a financial services firm, one of the managers quipped he had sold some stock to buy a sofa for his home. As the years went on and the stock rose in price, he realized he was sitting on the most expensive sofa you could ever buy! Without access to “inside information,” most employees can tell when the company is on the path to great achievements and they want to be part of its success.

Here is the problem employers should be cautious about:  This problem can be a bigger issue for members of the management team too! This is the danger of building a concentrated position without being consciously aware you are doing it. A concentrated position is what happens when one stock starts to represent a significant percentage of your net worth. Members of the board of directors and C-suite executives often find themselves in this position. Their shareholdings are often part of the public record. Owning a large stake in the company you run shows the investment community you have confidence in the future of the company. Their shares are often considered control or restricted stock, meaning it cannot be sold as easily and regular employees can sell shares.

Let us consider how a longtime employee or manager could find themselves with a concentrated position without realizing it:

• ESPP purchases. The employee gets a 10% discount on buying shares, funded through a payroll deduction. They take advantage.
• Company retirement plan. Some employees might be covered by a Defined Benefit Pension Plan set up by the company. One of their major investments might be stock in the parent company.
• 401(k) investments. One of the choices available within the company retirement plan is to choose to put money into shares of their employer’s stock. They do it.
• Performance bonuses. The employee receives an annual bonus for hitting their numbers. Some is paid in cash, another part is paid in company stock. Some of it might be tied up for a few years.
• Stock options. Part of the employee’s bonus might include options to purchase company stock at a specific price in the future. These options might be valid for a few years, but the company stock needs to move up in price to make exercising the stock options worthwhile. They don’t own these shares yet, but have the option to buy them in the future.

All of this seems to make sense, assuming the company does well. Does anyone remember Enron? If loyal employees had a large amount of their retirement assets directly or indirectly connected to their company stock, their retirement will be jeopardized if the company stock plunges and does not recover. Many company retirement plans have held large amounts of their own company’s stock. These examples from 2018 show percentages:  Sherwin Williams (62%), Colgate Palmolive (56%) and McDonalds (39%).

Related: Equity compensation: Drive home the value of this valuable benefit during tax season

This message has three distinct audiences:

• Employees in general need to think about diversification. This lesson might be included in annual benefit reviews.
• Members of the management team might be at greater risk because a larger percentage of their compensation might be in stock.
• C-suite executives and board members often hold large positions as a way of showing the investing community they are confident in the future of the company.

Bryce Sanders is president of Perceptive Business Solutions Inc. He provides HNW client acquisition training for the financial services industry. His book, “Captivating the Wealthy Investor” is available on Amazon.