The Equity Incentive Canadian Startups Need (Hint: It Is Not Stock Options)

Abstract

Growth companies contribute disproportionately to Canada’s job creation, economic development and innovation. Most growth companies can match neither the salaries nor the security of more established competitors for executive talent. This makes their only advantage — the growth prospects of their equity — a particularly important part of their compensation arrangements. Canadian growth companies (and Canadian businesses generally) make less use of equity incentives than their American peers and the kind of incentive they use almost exclusively, stock options, are strongly criticized by politicians, academics, institutional shareholders, and corporate governance experts.

Stock options are accused of contributing to income inequality and creating incentives for value-destroying behaviour in large established corporations, but it is not clear these critiques have much to do with their use by growth companies. As well, it is not clear why these companies should be restricted to the use of stock options as the only equity incentive scheme available to them without adverse tax effects. For example, there are good reasons American growth companies make extensive use of share grants. As Canada enters its fourth round of amendments in this century to the tax rules relating to equity incentives, it is time to consider a tax regime that begins to differentiate between growth companies and their larger , more established counterparts, and that ceases to differentiate between issuing an option to acquire shares and simply issuing shares.

Keywords: Stock options, corporate law, corporate governance, executive compensation, tax policy, startups, entrepreneurship

JEL Classification: K22, K34, J33, J38