As the pandemic rages on, many people are stuck inside with limited places to go and are searching for creative ways to occupy their time outside of the occasional trip to the grocery store. This new reality has led to a heavy increase in day trading due to the availability of free trading apps, such as Robinhood. This uptick in trading volume combined with an increasingly “online” culture has led to several cases of abnormal trading activity, including:
- Signal Advance stock jumping by more than 5000% after a powerful Twitter user tweeted about a different company with a similar name.
- GameStop shares increasing 10x in price over a week-long span sparked by a Reddit group trying to cause hedge funds to lose money.
While these exact situations may be extreme and particularly rare, they are powerful examples of why it is important for companies to use robust measurement periods when granting awards that are earned based on its absolute stock price performance (either closing price or absolute total shareholder return (“TSR”)). If absolute awards are earned based on a one-day closing price then short-term anomalies due to tweets or Reddit users or any other fathomable “freak” incident could potentially deliver huge swings in value to award holders even if the achievement of those goals could be considered unwarranted or unsustainable. A few design considerations to help mitigate these risks in awards with absolute stock price objectives.
- Use an averaging period: If the awards are earned based on the average closing price over a significant window, short term anomalies are not as likely to skew the achievement of goals. The most common period is 20-trading days which is effectively 1 month. Longer periods may be warranted especially as the award size increases.
- Require price to be maintained for a consecutive day period: Similar to an averaging period, requiring the performance hurdle to be achieved and maintained for a period would eliminate the short-term effects of a single trading day or week.
- Only measure performance at the end of the performance period: While many absolute awards pay out if the performance hurdle is met at any time during the performance period, awards can be designed so that the performance metric must achieved (or maintained) at the end of the performance period. This design more closely aligns award holders with shareholders, who are not able to exactly time the market and recognize the absolute maximum return achieved over a certain period.
Most companies will never experience the extreme oddities that Signal Advance and GameStop encountered, and it is impossible to predict how your company’s stock will perform over long periods of time. However, awards with absolute stock price performance measurements should still be designed with an eye towards mitigating the risk of experiencing short term anomalies or a disconnect between realized value and return to shareholders.
