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PSUs in an EXECUTIVE EMPLOYMENT AGREEMENT

Experienced legal representation in reviewing, negotiating, drafting, improving executive employment agreements.

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Contact Neufeld Legal PC at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

Performance Share Units (PSUs) are a form of equity-based compensation based on the achievement of specific performance goals, which emanates from the executive employment agreement, with the intention of aligning the interests of executives with those of the corporation and its shareholders. As compared to Restricted Stock Units (RSUs), which typically vest based on a time-based schedule (e.g., three years of continuous employment), PSUs are contingent on both time and performance.

The rationale of corporate employers using PSUs as a significant compensation component with their executive employees, includes:

  • Aligns Pay with Performance: PSUs are the gold standard for linking executive compensation to the company's success. They directly incentivize leaders to make decisions that will create value for shareholders.

  • Encourages Long-Term Thinking: The multi-year performance period discourages executives from focusing on short-term gains at the expense of long-term sustainability.

  • Shareholder Preference: Many institutional investors and proxy advisory firms prefer PSUs over other forms of equity compensation because of their strong performance linkage.

With respect to the key elements that executives should be aware of as to Performance Share Units includes:

  • Grant Date: The company grants a "target" number of PSUs to the executive. At this point, the units are a promise, not actual shares. They are typically an unfunded and unsecured promise from the company.

  • Performance Period: A multi-year timeframe (often 3 years) is established during which the company's performance is measured against predetermined metrics.

  • Performance Metrics: These are the key goals that must be met for the PSUs to be earned. They can be based on:

    • Financial Metrics: Earnings per share (EPS), revenue growth, return on invested capital (ROIC), or profitability.

    • Market-Based Metrics: Total shareholder return (TSR), which measures the company's stock performance relative to a peer group.

    • Operational or Strategic Metrics: Product development milestones, customer satisfaction, or ESG (Environmental, Social, and Governance) targets.

  • Payout Structure: The number of shares an executive ultimately receives is determined by a "multiplier" that scales with the level of performance. A typical structure might look like this:

    • Threshold Performance (e.g., 80% of target): 50% payout of the target number of units.

    • Target Performance (e.g., 100% of target): 100% payout of the target number of units.

    • Maximum Performance (e.g., 150% of target): 200% payout of the target number of units.

    • If the threshold is not met, the payout is often 0%.

  • Vesting: Once the performance period ends and the company's compensation committee certifies the level of goal achievement, the earned PSUs vest and are converted into actual company shares. The executive then owns these shares outright, subject to a potential additional post-performance vesting period.

  • Payout: At vesting, the executive receives the shares or a cash equivalent, at which point the value is taxed as ordinary income.

As to the executive employment agreement and the specifications for the executive's PSUs, the following aspects are of particular importance and should be clearly defined:

  • Target Grant: The specific number or value of PSUs granted at the start of the performance period.

  • Performance Metrics and Goals: A precise description of the metrics, the time period over which they will be measured, and the specific targets required for different payout levels (e.g., threshold, target, maximum).

  • Payout and Vesting Schedules: The specific formula for calculating the number of shares earned and when they will vest.

  • Treatment upon Termination: What happens to unvested PSUs if the executive's employment is terminated. This is a crucial and often highly negotiated part of the agreement and can vary depending on the reason for termination (e.g., termination without cause, resignation with good reason, death, disability, or a change in control).

  • Administrator of the Plan: The agreement will typically state that the PSUs are governed by the company's long-term incentive plan, which is administered by the board or a compensation committee. The committee has the authority to interpret the plan and certify performance.

Executive employment agreements deserve considerable scrutiny and legal analysis given the financial implications emanating from the legal employment contract not being consistent with the negotiated specifics of one's intended employment arrangement. The differences in executive employment agreements may not be readily apparent to most people (often being very subtle and driven by legal terminology), yet the long-term financial implications to the executive employee can be staggering. As such, it is important to properly understand all the contractual aspects pertaining to an executive employment and their compensation.

For knowledgeable and experienced legal representation with respect to executive employment agreements, and other legal matters pertaining to one's employment as an executive employee, contact our law firm by email at Chris@NeufeldLegal.com or by telephone at 403-400-4092 / 905-616-8864.

 

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