It used to be that ISS would make only a few changes per year to its voting policies that affected stock compensation. Some years the changes didn’t even warrant a blog entry. But now ISS has the Equity Plan Scorecard and a scorecard requires constant tweaking. As a result, we now have a lengthy list of changes to review every year. Today’s blog entry is a summary of the ones I think are most significant.
It’s Harder for S&P 500 Companies to Earn a Passing Score
Big news for S&P 500 companies: your stock plans now have to earn an extra two points (a total of 55 pts) to receive a favorable recommendation. Everyone else’s plans still pass with only 53 pts.
The Burn Rate Test Gets a Little Easier for Acquirers
More big news: all companies can now request that ISS exclude restricted shares granted in consideration for an acquisition from their burn rate. Companies that want to request this must include a tabular disclosure reporting the number of restricted shares granted in this context for their most recent three fiscal years.
Partial Credit Eliminated for Some Factors
No more partial credit for CIC provisions, holding requirements, and CEO vesting requirements, and in some cases, the requirements to receive full credit have been relaxed.
To earn full credit for CIC provisions, the provisions must meet both of the following conditions (unless the company doesn’t grant time-based awards, in which case only the condition related to performance awards matters):
Performance awards can allow the following: (i) pay out based on actual performance, (ii) pro rata pay out of the target level (or a combination of i and ii), or (iii) forfeiture of awards.
Time based awards cannot provide for automatic single-trigger or discretionary acceleration of vesting.
To receive full points for the holding period requirement, shares must be required to be held for 12 months (down from 36 months in past years) or until the end of employment. No points for requiring shares to be held until ownership guidelines are satisfied.
To receive full points for the CEO vesting requirements, awards granted to the CEO in the past three years cannot vest in under three years (down from four years in the past). Still no points if no performance awards have been granted to the CEO in the past three years, but grants of time-based awards are no longer required to earn full credit.
The treatment of equity compensation in a change-in-control is complicated and perhaps the most complicated of all is the spin-off. We recently posted an article by Michael Gorski of Semler Brossy that looks at various ways outstanding stock grants are handled in a spinoff (“Keeping Your Equity Strategy in Balance Through a Corporate Spin‐Off,” originally published in workspan).
Gorski explains that, to minimize concerns over employee relations, companies should seek an outcome in which the pre-spin equity value is preserved. He breaks the approaches into various types, including the following two most common methods:
Shareholder (or Portfolio) Approach: Equity holdings are treated the same as those of a company shareholder in that they are divided into equity in both the remaining company and the spun-off entity on a one-for-one basis. For options, the exercise prices are converted, but the number of options remains the same.
Employee (or Concentration) Approach: Equity holdings are entirely in either the remaining company or the spun-off entity. This is the approach used most often as it ensures employees are aligned directly with the success of the company they are working for post-spin. For options, both the number of options and the exercise prices are translated to maintain the existing value.
Gorski provides a few examples from high-profile deals. For instance, when PayPal was spun off from eBay, it used the “employee approach” for employees staying with eBay or shifting to PayPal, but for executives in charge of a smooth transition, it used the “shareholder approach.”
When Kraft Foods spun off from Mondelez International, Gorksi notes that the transaction used the “shareholder approach” for options, SARs, restricted stock, and deferred stock units to encourage a collaborative environment between the companies. However, for performance shares, it used an “employee approach” to align directly with each company’s post-spin goals.
Last Friday, ISS issued an updated FAQ for its Equity Plan Scorecard. For most companies, the overall scorecard structure remains unchanged: a max of 100 points and 53 points is a passing grade. For companies disclosing three years of equity data, the points available under each pillar also remain the same, but the scores for each test within the pillars may have been adjusted (ISS doesn’t disclose the number of points each test is worth).
Here’s what ISS is changing for 2016 (effective for shareholder meetings on or after February 1, 2016):
New Company Category
The IPO/Bankruptcy category has been renamed “Special Cases” and includes any companies that have less than three years of disclosed equity grant data. This is still largely newly public companies and companies emerging from bankruptcy, but it could include other companies. For example, if a public company implemented a new stock compensation program in 2016 and had not previously granted any equity awards, they would presumably be in this category (because they wouldn’t have any equity grant data to disclose for prior years).
In addition, the Special Cases category is now divided into S&P 500/Russell 3000 companies and non-Russell 3000 companies. The S&P 500/Russell 3000 companies can earn 15 points for the Grant Practices pillar; to provide these points, their max score for the Plan Cost pillar is reduced by ten points to 50 and their max score for the Plan Features pillar is reduced by five points to 35. Scoring for the non-Russell 3000 companies in this category is the same it was for IPO/Bankruptcy companies last year: 60 points for plan cost, 40 points for plan features, and no points for grant practices.
CIC Provisions
The “CIC Single Trigger” category under Plan Features is renamed “CIC Equity Vesting” and is a little more complicated (last year it was pass/fail).
For time-based awards:
Full points for 1) no acceleration, or 2) acceleration only if awards aren’t assumed/substituted
No points for automatic acceleration of vesting
Half points for anything else (does this mean half points for a double trigger?)
For performance-based awards:
Full points for 1) forfeiture/termination, or 2) payout based on target as of CIC, or 3) pro-rata payout
No points for payout above target (ISS doesn’t say if this applies if performance as of the CIC is above target)
Half points for anything else
Post-Vest Holding Periods
The period of time required to earn full points for post-vest holding periods increased from 12 months to 36 months (or termination of employment). 12 months (or until ownership guidelines are met) is still worth half credit.