The NASPP Blog

April 12, 2011

Burn Rates

I was thinking that we might be dealing with a shutdown government this, which, while otherwise not such a good thing, would have provided some interesting fodder for my blog. But it appears to be business as usual at the IRS and SEC, so today I blog about something completely different: burn rate guidelines.

Burning the Candle at Both Ends: Burn Rates and Stock Compensation
“Burn rate,” also referred to as “run rate,” is a mechanism for measuring how much equity a company grants to employees on an annual basis as compared to the equity held by shareholders. It’s a way for shareholders to guage how much their equity is being diluted annually through stock programs in a worst-case scenario (i.e., ignoring any offsets to that dilution, such as forfeitures and repurchase programs).

There’s no legal definition of burn rate, so every investor, proxy advisor, and survey has their own calculation, but the basic formula is the number of shares granted during the year divided by the total shares of common stock outstanding.

Fidelity Investments Announces Use of Burn Rates

Fidelity Investments, a large institutional investor with holdings in many public companies, has announced that it will begin using a burn rate analysis in determining whether to vote for stock plan proposals. The policy establishes the following acceptable maximum burn rates:

  • 1.5% for a large-cap company
  • 2.5% for a small-cap company
  • 3.5% for a micro-cap company

Fidelity will vote against new stock plans and share authorizations if a company’s three-year burn rate exceeds the relevant maximum, unless Fidelity believes there is a compelling justifcation for the high burn rate.

For a great summary of the new policy, see the ExeQuity client alert “Fidelity Issues 2011 Proxy Voting Guidelines” (April 6, 2011). See also, the full text of Fidelity’s policy.

ISS Burn Rates

ISS (formerly RiskMetrics, formerly ISS–how many times can one company change their name) has used a burn rate analysis for as long as I can remember. (I confess, these days, that time period isn’t as long as it used to be, but, in this case at least, is many, many years. 10 points to anyone who knows when ISS first started using their burn rate analysis in evaluating stock plan proposals.)

There are a few key differences between the ISS burn rate analysis and Fidelity’s new policy:

  • ISS burn rates are published by industry and by whether or not the company is in the Russell 3000 index, so ISS has a more than just three burn rate categories.
  • ISS applies a multiplier to full value awards, so one award share granted counts as greater than one share in the burn rate calculation. The multiplier is based on the volatility of the company’s stock.
  • Where a company’s burn rate exceeds ISS’s guideline, the company can still get ISS to recommend voting for their stock plan proposal by making a commitment to keep their average burn rate for the next three years within the higher of: a) 2% of the company’s common shares outstanding or b) the mean plus one standard deviation of its applicable industry burn rate.

Higher Burn Rates Equals More Generous Grants? Not So Fast

ISS’s acceptable burn rates were generally higher this year than last year, so companies may be feeling like they can be a little more generous with this year’s grants. Keep in mind, however, that ISS uses a three-year average in its analysis. Granting more shares this year means that, three years down the road, your average will be higher and, by then, the ISS guidelines for burn rates may be lower.

Online Fundamentals Starts on Thursday–Don’t Miss It!
The NASPP’s acclaimed online program, “Stock Plan Fundamentals,” begins this Thursday, April 14. This multi-webcast course covers the regulatory framework and administrative best practices that apply to stock compensation; it’s a great program for anyone new to the industry or anyone preparing for the CEP exam. Register today.

NASPP “To Do” List
We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog. 

– Barbara