Introduction
In the Pharmaceuticals, Biotechnology, and Life Sciences industries (for purposes of this article, referred to collectively as “PBLS”), compensation strategy is a balancing act among multiple factors, including incentivizing innovation along with financial discipline, creating stability while managing volatility, and aligning rewards with milestones that may be years in the making.
To better understand how long-term incentives (“LTI”) are structured in this space, this CLEARthinking analyzes LTI practices at over 400 public PBLS companies. While this industry shares some traits with the broader market, it also shows clear divergences that reflect the unique nature of R&D cycles, heavy upfront investment, and valuation unpredictability.
Why Pharma, Biotech & Life Sciences are Different
Most public companies align executive pay with shareholder value over time. But among PBLS companies, value creation is often binary and episodic, hinging on regulatory approvals, clinical trials, and more. As such, the following practices are particularly characteristic of PBLS LTI practices:
- Greater reliance on stock options, especially in early-stage companies
- Customized performance award metrics that evolve with the evolution of each company (heavy focus on project milestones early on, with a shift towards TSR and financial metrics at a later stage)
- LTI sizing that often considers grant value as both a dollar value and as a percentage of market cap, to account for valuation swings
Key Takeaways
Flexibility Matters: PBLS companies, particularly earlier-stage, favor tools that align with unpredictable value-creation:
- Milestone-based vesting reflects binary clinical progress
- Stock options preserve cash and reward long-term upside
Size Drives Design: LTI mix and metrics evolve with scale. Specifically, as companies grow:
Restricted stock unit (“RSU”) and performance-vested award prevalence increases, while the prevalence of stock options decreases (though options remain majority practice across all sizes)
Note: Performance-vested awards typically introduced ~5 years post-IPO
Most common performance award metrics shift from predominately project milestones to TSR and financial metrics
Benchmarking Approach Accounts for Volatility: Companies often benchmark LTI grants as a percentage of market cap (or number of shares as a percentage of common shares outstanding) to support consistent equity sizing amid stock price volatility.
LTI Vehicle Prevalence: A Size-Driven Evolution
Stock Options: Consistently Prevalent
Prevalence: Stock option use is widespread (particularly for smaller companies) and more prevalent than in the broad market recognizing that options align with long development timelines, conserve cash, and offer a high risk/reward profile.
Vesting: 4-year vesting is standard, typically pursuant to a combination of annual and/or monthly vesting (e.g., 25% vests after 1 year, with remaining 75% vesting on monthly basis).
Restricted Stock Units (“RSUs”): More Common with Scale
Prevalence: RSU use is more mixed among earlier-stage companies and becomes majority practice ascompanies grow, reflecting a shift toward more stable/retentive and less dilutive awards.
- Note: Shift toward RSUs aligns with broad market butgenerally happens later among PBLS companies given longer period of early-stage uncertainty
Vesting: 4-year annual vesting is most common, followed by3-year annual vesting, which is generally aligned with broad market.
Performance-Vested Awards: Introduced with Scale & Maturity
Prevalence: Performance-vested awards (e.g., performance share units, “PSUs”) are not common in early-stage companies, but significantly increase in prevalence as revenue grows (consistent with broad market, prevalence increases with company maturity and ability to set credible long-term goals).
Performance Period: Smaller companies’ performance periods vary (e.g., 1-,2-, 3-years) depending on ability to set credible long-term goals, whereas larger companies typically have a 3-year performance period.
Metrics: Milestones Matter
As PBLS companies evolve from binary, development-driven organizations to commercial enterprises with recurring revenue and earnings visibility, LTI metrics migrate from milestone-heavy structures toward balanced financial metrics and, ultimately, sustained TSR and profitability measures.
Conclusion: Prepare for Change
As companies in the Pharmaceuticals, Biotechnology, and Life Sciences industry grow, their LTI strategies should evolve too. While early-stage companies rely on stock options and milestone-driven equity to reflect development risk and uncertainty, larger ,more established companies increasingly align their LTI practices with those of the broad market (e.g., PSUs tied to revenue and TSR), reflecting operational maturity and rising shareholder expectations.
For Compensation Committees, this evolution underscores the importance of regularly reassessing LTI strategy to ensure continued alignment with company stage, performance goals, and shareholder priorities.
