The challenges facing energy companies across the globe are immense. To name a few: increasing reliance on remote energy sources, and the quest for technological innovation and diversification in the face of climate-change concerns. Add in new market mechanisms, competitive pressures, mergers and an aging workforce. These issues heighten the need for companies to ensure that they attract and retain the very best talent. Some of this assurance is in the form of compensation to provide a competitive edge in recruitment and retention. Recently, many factors have encouraged companies to redesign their equity-based compensation programs-newly emphasized sensitivity to accounting expense, heightened pay scrutiny, conserving cash and controlling stock dilution. But, are these programs really broken? Do companies need to redesign their current stock-based plans to continue to support their strategy just as well or better? And, what impact will changes in equity and long-term incentive compensation for the top executives have on reward strategies for the middle manager and broad-based employee group? Despite the ongoing public debate, equity incentives remain an integral part of many companies' reward models. Energy companies are increasingly choosing the performance option as they align pay schemes more closely to performance goals. PricewaterhouseCoopers surveyed compensation/rewards-plan specialists, stock-plan administrators and human-resources professionals in the fall of 2004 within 131 multi-national companies that have headquarters in 16 countries. Roughly half of the participating companies have revenues of less than $5 billion; the rest, more than $5 billion. Two-thirds employ between 5,000 and 30,000 people; 19%, more than 30,000; 19%, fewer than 5,000. Among them were representatives of 16 energy companies headquartered in five countries. The survey requested information on different types of equity plans, such as stock-option plans, restricted stock/unit plans, employee stock-purchase plans and stock-appreciation rights. The design and administration of these plans were explored via more than 200 multiple-choice questions. This article explores the latest in strategy and concerns on the subject within energy-company participants. Key findings Times of uncertainty. Against a background of regulatory change, an underlying theme of our 2005 survey is uncertainty. Over and over again, the percentage of respondents who chose "do not know," "not sure" and "explore alternatives" is much higher than in any of the surveys PricewaterhouseCoopers has conducted in the past. Ahead of the regulation. Unlike companies in some other sectors, however, energy companies are relatively unruffled by the new expensing rules set by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). More than half of participating energy companies are already expensing options (more than four times the rate of high-tech companies) and they are twice as likely as high-tech companies to be in favor of expensing. Changing the equity compensation mix. In contrast to other sectors, no energy company in the survey reported that it will be eliminating stock-option plans in reaction to new expensing rules. The changing regulatory landscape is, however, prompting energy companies to change the pattern of equity compensation. Half of the energy participants report that they expect to change to other plans or to explore alternatives. This is reflected in a decline in the use of options, Employee Stock Purchase Plans and Restricted Stock (RS) or Restricted Stock Units (RSU) in the energy sector. A move towards performance. Energy companies are aligning equity compensation more tightly to performance. This shift is happening at a faster pace in the energy sector than elsewhere. Energy companies report offering performance stock or performance stock units and performance options at nearly twice the rate as the cross-industry sample. Nearly half of the participating energy companies have some performance measure built into their process for granting options, more than twice the prevalence in the cross-industry sample. Grappling with compliance. The complexity of different regulation in different territories, combined with regulatory change and the changes that come from dynamic M&A activity in the sector, mean that equity-compensation compliance is a major challenge for energy companies. Half of the energy companies surveyed reported not knowing whether a compliance review has been taken in some, most, all or none of the countries in which they operate, compared with 27% of the cross-industry sample. Extending the reach of equity compensation. Developing and retaining local expertise are compelling energy companies to be proactive at deploying equity compensation in their foreign affiliates. Attracting and retaining top talent appears to outweigh the cost of adapting to new accounting and tax requirements. Conquering the communications challenge. Many energy companies report that the effectiveness of equity-compensation plans in meeting their human-resource goals is being undermined by the difficulty of ensuring that individual members of staff understand the plan benefits. Three out of 10 energy companies say that employees do not understand their plan benefits very well. Multinational energy companies face significant human-resource planning and management challenges because they have large workforces with diverse skill sets and operation in numerous locations outside their home countries, including many developing and frontier markets, particularly in the oil and gas sector. At the same time there are significant workforce-replenishment challenges as energy companies contend with an aging workforce. Against this background energy companies are seeking to enhance their employee-incentive strategies by developing uniform global equity-compensation programs. Sixty-eight percent of energy companies say a uniform global program lies behind their decision to offer stock-based compensation to their international employees. The need to match offers, from either local or international competitors, for their talent base, is the motivating factor cited by most of the remaining companies. Regulatory changes These are turbulent times for equity compensation. Corporate failings have heightened scrutiny of executive remuneration. Alongside this, the regulatory context for equity compensation is changing. It is perhaps unsurprising that an underlying theme of the 2005 survey is uncertainty. In December 2004, FASB issued Statement No. 123 (R), Share-Based Payment, revising FASB Statement No. 123, Accounting for Stock-Based Compensation, and it now requires companies to expense the fair value of employee stock options and other forms of stock-based compensation. FAS 123 (R) will have a substantial impact on the financial statements of many companies because of its requirements to expense the fair value of employee stock options and other forms of stock-based compensation, which will decrease income and earnings per share. Most U.S.-type employee stock-purchase plans (ESPPs) will become compensatory under FAS 123 (R) unless they meet a series of conditions, including a "safe harbor" discount to the purchase price of 5% (the majority of existing ESPPs have a 15% discount). For public companies, FAS 123 (R) had to be adopted no later than annual periods beginning after June 15, 2005, or for small-business owners, December 15, 2005. As of January 1, 2005, the IASB has also issued its expensing pronouncement, which covers many non-U.S. companies. Across industry as a whole, companies are gathering the facts, educating themselves about the new regulations, bringing in the experts and investigating the best possible alternatives to be able to take advantage of the changing landscape of equity compensation, rather than be hurt by it. As the new regulations bite, however, a new competitive picture will emerge and "benchmarking yourself against your peers" will once again carry significant weight. Reducing or eliminating stock options. The most immediate reaction to the new accounting regulations is a reduction in stock-option grant levels. The survey shows a decline in "plain vanilla" stock options and an assault on employee stock-purchase plans. But is this really the end of the road for stock options? Among survey participants, stock-option plans continue to be the most popular vehicle for equity compensation. A decline in the use of stock options is evident. More than half of the cross-industry participants reported that, while they mostly intended to continue with the same plans, they would be cutting awards. However, energy participants were three times as likely as the cross-industry group to report that mandatory expensing would have no impact on them. Despite this, 23% of energy respondents report that the impact will be for the company to cut awards. The same trend is noticeable for employee stock-purchase plans, such as "423 plans," in the U.S. However, none of the energy companies in the survey report that they intend to go so far as to eliminate stock-option plans altogether in reaction to new expensing rules. In contrast, 28.7% of companies in the cross-industry sample said they would resort to such measures. Unlike companies in other sectors, notably high-tech companies, options have traditionally been restricted to the higher echelons of energy companies and so the impact of expensing is less significant than in other industries. Indeed, more than half of the energy companies report that they are already expensing options, whereas only 22% of the cross-industry sample were doing so. Despite this, there is a significant degree of hesitation and uncertainty in the energy sector on the effect of mandatory expensing of stock options. While three times as many companies in the energy sector (31%) compared with cross-industry respondents (10%) felt it would have no impact, more energy respondents (38.5%) said they didn't yet know what the impact would be. Switch to another plan or explore alternatives. It is encouraging that companies are not stopping with the first reaction: reduction or elimination of options. More than half of companies in the wider survey will either replace option plans or explore alternatives, thus indicating that the motivational value of long-term incentives remains strong, even in the face of such difficulties as designing a new plan or changing an existing one. Less than 5% of all organizations interviewed, will actually give up on stock-based plans altogether, and this statistic will be closely monitored in future surveys. While 25% of energy companies report that they do not anticipate any changes to their equity plans next year, more than 30% report changing their plan design and 44% more report that they are unsure or will look into alternatives. In keeping with shareholder and investor interests, companies as a whole that are looking to switch to a new equity vehicle are focusing on performance-driven stock plans in the first place and restricted-equity plans in the second. Among energy companies, the order of these two was reversed. Both vehicles, depending on size, may also allow some companies to recognize a smaller expense to their profit-and-loss account. A move to performance conditions. Energy companies have started to add performance conditions to their option plans, trending to U.K.-type incentives that are more focused on company or individual results while starting to restrict employee eligibility in these plans. Energy companies are nearly twice as likely as companies in the cross-industry sample to include performance measures in the conditions for granting employee stock options. Performance-based equity plans and restricted stock/unit plans are becoming more prevalent. Energy companies report offering performance stock and performance stock units even more frequently in the U.S. than ESPPs and a majority of companies are now using a combination of equity vehicles, typically stock options, restricted stock and performance stock/performance stock units. Significantly, energy companies were far less likely than cross-industry survey respondents to include ESPPs in the equity compensation mix, with only a quarter of energy companies deploying ESPPs compared with more than half of the cross-industry sample. While there are signs of a decline in the number of companies offering ESPPs, uptake rates of this type of scheme remain high. Companies need to balance the benefits of the schemes against their accounting expense. The vast majority of companies are unclear about the future of ESPPs and only 20% of energy companies feel sure that they would continue such schemes in the event of increased accounting expense. In summary, it is clear that energy companies are far from taking an automatic stance to reduce equity compensation in reaction to regulatory changes. Indeed, such are the competitive dynamics of their international human-resource climate that as many companies say they will be increasing the reach of equity compensation worldwide in the future as say they have plans to reduce it. Looking ahead The equity-compensation landscape is in flux. Equity-compensation professionals face the pressures of expensing at the same time that the popularity of existing plans is reaching all-time highs. As stock markets improve, stock-option and employee stock-purchase plans have regained much of their power as retention and attraction vehicles. More than 85% of participants in the survey, both cross-industry and specifically within the energy industry, feel that employees are satisfied with their current plans (mostly stock-option plans). Companies themselves also believe that current equity plans have achieved their initial goals and that the investment in them is money well spent. In the energy sector, 62% of respondents say that the costs of global equity plans are generally worth the benefits and a similar percentage report that their plans are designed to encourage a shareholder mindset for all employees. Nonetheless, it is clear that companies are keeping their plans under very active review. Such active review is vital if the significant challenges of compliance, administration and communications are to be overcome. It is also necessary so that companies can be sure that their equity-compensation strategy and choice of schemes is fully aligned with their business and shareholder goals. The next few years will see the emergence of a new pattern of equity-compensation schemes following the current regulatory changes. Companies that get the most competitive advantage from their schemes will be those who have tailored their scheme design and structure carefully to their performance objectives. In this respect, energy companies are well-placed and ahead of the curve but, in contrast, are struggling more than companies in other sectors with administrative and compliance challenges.