As we reported in the Nov-Dec 2015 NASPP Advisor, Twitter CEO Jack Dorsey announced in October that he is giving 6.8 million shares of common stock that he owns back to Twitter, to be used in Twitter’s stock plan. I started looking into this a little further and found some interesting details.
Not So Fast
Dorsey donated shares he already owned to the plan, unlike other CEOs who have given back outstanding options or awards. Because of this, the shares can’t simply be added to the stock plan. For most companies, the only way to add shares reacquired from investors into a stock plan is to submit the allocation to a shareholder vote.
Why Not Contribute Awards?
It would have been less complicated for Dorsey to have agreed to the cancellation of outstanding options or awards, as other CEOs have done (e.g., see our coverage of LinkedIn CEO Jeff Weiner’s decision to forgo his stock grant in the Mar-Apr 2016 Advisor). These shares can be added back to the plan without shareholder approval. But Dorsey doesn’t have a lot of outstanding awards to give up; he has voluntarily worked without compensation since becoming CEO and, thus, wasn’t granted any awards in 2015. He only has 2,000,000 outstanding stock options.
Enter the Proxy Advisors and Institutional Investors
Of course, submitting the plan to a shareholder vote leads to an analysis of the plan by proxy advisors and investors. It can even lead to a new Equity Plan Scorecard evaluation by ISS. A bit of news that caught my eye was that Twitter had to agree to prohibit repricing without shareholder approval under the plan to secure a favorable vote. Repricing without shareholder approval is a deal-breaker under the EPSC.
It’s Complicated
My first thought on reading this was “no good deed goes unpunished.” But, on second thought, I’m not sure that’s the case here. I’m not even sure this is a good deed. Rather than submit the proposal as a allocation of shares to their existing plan, Twitter adopted an entirely new plan for just the 6.8 million shares. The amendment to prohibit repricing only applies to this new plan; as far as I can tell, repricing is still permitted without shareholder approval under Twitter’s existing plans (under which any currently underwater options would likely have been granted).
Where’s the Urgency?
I was surprised to note that Twitter had over 110 million shares available in its 2013 plan as of December 31 and that the plan includes an evergreen provision, under which close to 35 million shares were added to the plan this year. It looks like Twitter granted less than 25 million shares last year, so it seems hard to believe that they are going to need those 6.8 million shares anytime soon.
Which makes me wonder why Dorsey donated the shares. Was it just a publicity stunt? A way to increase employee morale? (And, if so, did it work? Better than donating the 2,000,000 outstanding options would have worked?)
In late March, ISS issued an updated Equity Compensation Plans FAQ. This development was largely eclipsed by the FASB’s issuance of ASU 2016-09, so I haven’t had a chance to get around to it until now. Here is a quick summary of the most significant updates:
Plan Amendments
FAQ 2 has been updated and a new FAQ 28 has been added to clarify that plan amendments may be evaluated under the Equity Plan Scorecard (EPSC), if the amendment could increase the potential cost of the plan. (By “cost,” ISS means dilution or shareholder value transfer; ISS is less concerned with the actual P&L expense.)
In other cases, i.e., amendments that don’t increase cost to shareholders, ISS evaluates the amendment based on whether it is favorable to shareholder interests, but without going through the whole EPSC.
Plans submitted for shareholder approval solely for Section 162(m) purposes fall into a separate category and ISS hasn’t changed or clarified anything with respect to these proposals.
Share Withholding
ISS suggests requesting new shares or extending the term of a plan as examples of the types of amendments that would trigger a new EPSC evaluation, but my guess is that this would also include amendments to allow share withholding for taxes up to the maximum tax rate when the shares withheld will be returned to the plan (my blog from last week explains why these amendments are necessary).
It’s possible that the timing of the release of these updated FAQs is not coincidental. It’s also possible I’m paranoid; hard to say. But then again, just because I’m paranoid, doesn’t mean ISS won’t apply the EPSC to your share withholding amendment. This issue is definitely a hot button for ISS. If your plan allows shares withheld for taxes to be returned to your plan, it’s a good idea to discuss this with whoever advises you on ISS concerns before you amend your plan.
Performance Awards
Previously, the FAQ provided that ISS would consider performance awards as being subject to accelerated vesting upon a CIC, unless the amount paid was tied to the performance achieved as of the CIC and was pro rated based on the amount of the performance period that was completed.
The new FAQ states that:
If a plan would permit accelerated vesting of performance awards upon a change in control (either automatically, at the board’s discretion, or only if they are not assumed), ISS will consider whether the amount of the performance award that would be payable/vested is (a) at target level, (b) above target level, (c) based on actual performance as of the CIC date and/or pro rated based on the time elapsed in the performance period as of the CIC date, or (d) based on board discretion.
I’m not sure this changes much, but it does seem to be a more nuanced position.
Last week it was widely reported that the founder of Chobani (yes, the yogurt company) became the latest to join a recent trend of CEOs who are sharing their wealth with employees in the form of stock.
Chobani Founder and CEO, Hamidi Ulukaya, committed to give shares to his 2,000 employees equal to an estimated 10% of the company. Chobani is still a privately held company, so its exact present value is not known. But recent estimates put the company’s value between $3 billion to $5 billion.
While such a practice may be more prevalent in tech startup companies, Chobani is in an entirely different industry – the food industry. That’s part of what makes this move by Chobani’s CEO so unique. Sharing equity (especially pre-IPO) in a food company is not the norm, or even common. It’s a rare occurrence. Additionally, Chobani is giving shares to employees after a decade of being in business and after a value has been established, which makes this even more interesting.
In a New York Times article “At Chobani, Now It’s Not Just the Yogurt That’s Rich,” CEO Ulukaya was quoted as saying “I’ve built something I never thought would be such a success, but I cannot think of Chobani being built without all these people. Now they’ll be working to build the company even more and building their future at the same time.”
One Chobani employee’s reaction was also reported in the NY Times article, and it seemed like the perceived value component that every company strives for when issuing equity to employees. When one of the original employees, Rich Lake, was asked about his new shares, he said “It’s better than a bonus or a raise. It’s the best thing because you’re getting a piece of this thing you helped build.” I know HR consultants and stock plan people everywhere are cheering because isn’t that exactly what you want to hear an employee say about their stock awards?
We’ve seen other CEOs handing over portions of their shares to employees in recent months. Hopefully this trend will continue, as more executives see the value of sharing in the equity pie as a team. After all, to sum it up with a sports phrase – there is no “I” in team. And I’m guessing Chobani’s CEO would agree that given the huge success of the company in a decade, the team is well deserving of their stake in the company.
If you’re feeling curious about how equity plan proposals are performing with shareholder votes, today’s blog has answers. Semler Brossy recently released their 2016 report on Trends in Equity Plan Proposals. Keep reading for some of the highlights.
Upward Trend in Failed Say-on-Pay Votes?
The number of companies each proxy cycle that have failed to obtain say-on-pay (“SOP”) approval from shareholders has remained fairly constant since SOP became mandatory 2011. This time last year, only two of the Russell 3,000 companies had failed their SOP vote. This year, that number has increased to five companies so far. Does this signify an uptick in SOP failures? It appears so, because the number of companies with failed votes so far in 2016 amounts to 3.5%, marking the first time more than 3% of Russell 3000 companies have failed at this time in the cycle to obtain an affirmative vote. Whether this is an anomaly year, or an indicator of a trend, time will tell.
Correlation Between Affirmative Say-on-Pay and Stock Plan Proposal Approvals
One correlation that appears to be rising is that companies who receive a pass Say-on-Pay vote also receive strong support for their equity plan proposals. Since SOP was adopted, the percentage of equity plan proposals that receive affirmative support relative to passing SOP votes has steadily increased (from 83% in 2011 to 90% in 2015). According to the Semler Brossy report,
Similarly, average vote support for equity plans at companies that receive an ISS ‘For’ recommendation has increased over time; this may suggest that ISS voting policies have become well-aligned with shareholder preferences
Companies that fail Say on Pay tend to have significantly lower support for their equity plan proposals, indicating that shareholders are assessing both proposals under similar lenses
A couple of final data points that seem to bring this all full circle are that ISS has recommended that shareholders vote “Against” Say-on-Pay at 10% of the companies it’s assessed so far in 2016, and, on top of that, shareholder support was 32% lower at companies with an ISS “Against” vote. This seems to suggest that companies looking for shareholder support in other areas, such as equity plan proposals, are more likely to gain shareholder support when ISS has recommended an affirmative Say-on-Pay vote. At minimum, there is an intertwining of all these factors and how they drive shareholder support.
For more interesting Say-on-Pay and equity plan proposal trends, view the full Semler Brossy report.
We’ve seen quite a bit of evolution in the mix of equity incentive compensation vehicles and terms over the last decade. The use of stock awards has surpassed that of stock options. Performance based compensation continues on its upward rise towards total prevalence. Another change that has slowly gained traction in the wake of Dodd-Frank, Say-on-Pay, and other measures is what I’m terming a slow death for the time based vesting of options and awards, or, as some call it, “pay for pulse.”
In a recent Equilar blog titled “Companies Just Say No to “Pay for Pulse,” the author cites a recent study of Equilar 100 companies that found 70% of the executive pay mix was “at risk.” In another report (Equilar’s 2015 Equity Trends Report), “nearly 70% of S&P 1500 companies used performance awards in 2014, up from about 50% in 2010.” This is consistent with the trends that we’ve observed as well.
Equilar also suggested that a closer look at LTIPs revealed that performance awards (in the form of units, stock, and options) comprised almost 80% of individual incentive plans. Equity awards that vest over time—or time-based awards—made up the remainder. Additionally, “slightly more than 10% of the Fortune 500—or 51 companies—used performance equity exclusively. The list varied by industry, but notably included multiple energy, retail and media companies.”
We really didn’t need more evidence to know that performance awards appear to have found a long term home in the equity compensation mix. What remains not entirely clear at this point is the fate of time based vesting for options and awards. There is an argument that while performance based incentives work well for executives – those with the most control over corporate decisions and strategy – there may still be benefit to offering time based vesting awards to those farther down in the ranks of the organization where some job functions may be more task oriented and less strategic in nature.
Time will tell whether time-based vesting is on its way out the door, or will stand the test of time (no pun intended) and remain a smaller, but still present, component of company stock plans. Is there still a home for “pay for pulse” in the equity compensation vesting mix?
We have a great webcast planned on the very relevant topic of performance awards and their evolution. On April 7th, Performance Awards: An Ever Changing Landscape will include Jillian Forusz from Adobe Systems Inc., Belen Gomez from Equilar, Dan Kapinos from Aon Hewitt and Robert Purser from E*TRADE. We’ve also got a podcast interview with Belen Gomez from Equilar going up on our website on Monday, March 28th. If you subscribe to the podcast now, you’ll get an email notification when Belen’s interview is up.
Does your company issue grants to outside directors out of the same plan that you issue grants to executives and other employees? If do you, does the plan expressly limit the number of shares that can be granted to directors over a specified period of time?
If it doesn’t, you aren’t alone. According to the NASPP/Deloitte Consulting 2014 Domestic Stock Plan Administration Survey, 77% of respondents’ plans don’t include a limit on grants to outside directors. But a recent spate of litigation, including a lawsuit that Facebook recently agreed to settle, suggest that maybe companies should rethink this practice.
What Litigation?
The lawsuits cover a range of issues related to stock and executive compensation. Some suits allege excessive compensation and some allege deficiencies over stock plan disclosures or proxy disclosures. In addition to Facebook, companies that have been targeted in these suits include Republic Services, Citrix Systems, Goldman Sachs, Cheniere Energy, and Unilife. One common denominator in all of these suits, however, is that the plaintiffs allege that because the company’s outside directors can receive unlimited awards under the plans, they aren’t disinterested administrators of the plan.
Why Is Disinterested Administration Important to these Lawsuits?
These lawsuits are all “derivative” actions (which are lawsuits brought by a shareholder on behalf of the corporation, usually alleging that management is doing something that is to the detriment of the corporation). In a derivative lawsuit, the plaintiff has to meet a “demand” requirement for the suit to proceed. Demand means that the plaintiff asked the company to investigate the matter and the company either refused to investigate or the shareholder doesn’t agree with the outcome of the investigation. In a lot of cases, these suits never get past the demand stage.
But, there is an exception to the demand requirement in lawsuits over stock compensation plans. Can you guess what it is? Yep, that’s right, the demand requirement is excused if a majority of the directors administering the plan lack independence. Plaintiffs are claiming that directors who can receive unlimited awards under a plan aren’t disinterested.
What Happened with Facebook?
Well, first of all, once a suit gets past the demand stage, it gets expensive. So the first thing is that Facebook had to spend a bunch of money on their own lawyers. That, in and of itself, is reason enough to want to keep any of these suits from getting past the demand stage.
The settlement Facebook agreed to includes the following provisions:
Corporate governance reforms, including (A) an annual review of all compensation (cash and equity) paid to outside directors, (B) engage a compensation consultant to advise the company on this review and on future compensation to be paid to outside directors, and (C) use the results of the review to make recommendations to the board on future compensation to outside directors.
Submit the 2013 grants to outside directors to shareholder vote (these grants were the subject of the lawsuit). Hopefully the shareholders approve them–I’m not sure what happens if they don’t (but I’m pretty sure it would make a good blog entry).
Submit an annual compensation program for directors to shareholders for approval. The program has to include specific amounts for equity grants and has to delineate annual retainer fees. As far as I can tell, this is a one-time requirement, for Facebook’s 2016 meeting; if I understand the settlement correctly, the board is allowed to make changes to the program in the future, commensurate with the results of the annual review required under #1 above.
Pay an award of attorneys’ fees and expenses to plaintiff’s counsel not to exceed $525,000 (this is, of course, in addition to whatever Facebook has paid to its own counsel).
A Simple Fix
The simple fix to avoid all of this is to have a limit on the awards that can be issued to outside directors in your plan. If your company is submitting a stock plan to shareholder vote this year, it is worth considering adding a limit like this to your plan.
Thanks to Mike Melbinger of Winston & Strawn for providing a handy summary of the Facebook settlement, as well as a number of the other lawsuits, in his blog on CompensationStandards.com (see “Follow-Up on Facebook Litigation Settlement,” January 29, 2016).
One area of ISS’s voting policy that you can count on changing every year are the burn rate benchmarks. ISS updates these benchmarks based on historical data. In theory, if granting practices haven’t changed, the burn rate benchmarks won’t change either. But, inevitably, practices change (in response to changes in the economic environment, the marketplace, and compensation practices, not too mention pressure to adhere to ISS’s burn rate benchmarks) and the burn rate benchmarks change as well.
Surprise, Surprise (Not!)—Burn Rate Benchmarks Lower in 2016
It seems like a self-fulfilling prophecy to me that if ISS sets a cap that burn rates can’t exceed and companies are forced to manage their grants to come in under that cap, burn rates are going to keep decreasing. This year, by my calculations, burn rate benchmarks dropped for 40% of industries in the S&P 500, 59% of industries in the Russell 3000, and 68% of industries in the Non-Russell 3000. ISS indicates that the median change across all industries/indices is a decline of .07%.
It’s a “Benchmark” Not a “Cap”
ISS calls the standard a “benchmark” not “cap.” When they made this change last year, I thought maybe this was because they thought the word “benchmark” sounded friendlier. This isn’t the case at all, however. It’s a “benchmark” because the cap is actually lower than the benchmark. To get full credit for the burn rate test in ISS’s Equity Plan Scorecard (EPSC), a company’s burn rate has to be less than 50% of the benchmark. In other words, the cap is 50% of the benchmark.
Burn Rate Scores Can Go Negative
Laura Wanlass of Aon Hewitt tells me that, just like the score for the SVT test (see “Update on the ISS Scorecard,” July 21, 2015), the burn rate score can also be negative.
Burn Rate Is Important
Burn rate is not quite as important as a plan’s SVT score, but it’s still significant—a negative score could be impossible to come back from in the EPSC. Laura tells me that it is the largest percentage of points in the Grant Practices pillar, which is worth less than Plan Cost (i.e., the SVT test) but more than the Plan Features pillar.
Before the EPSC, burn rates didn’t matter as much. If a company didn’t pass the burn rate test, they simply made a three-year commitment to stay under ISS’s cap in the future—no harm, no foul. But those three-year commitments are just a distant fond memory under the EPSC.
The Burn Rate Test Is Getting Harder
While the standard to earn full points for burn rate remains 50% of the benchmark, overall, the benchmarks have been lowered for most industries/indices. In addition, Laura tells me that ISS is recalibrating the test so that burn rates above 50% of the benchmark will earn fewer points and will go negative sooner than last year.
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.
There’s been a theme emerging in some of my recent blogs, covering a wave of companies finding creative ways to expand their equity compensation pool. Last week I talked about the move of Twitter’s CEO to give his own stock back to the company for use in the equity plans. Shortly before that, Apple announced it was giving RSUs to all employees. It seems more and more companies are trying to find ways to expand the equity offering to employees. It seems the Wall Street Journal has also taken notice of some of these efforts. In a recent article (Do Workers Want Shares or Cash?, October 27, 2015), the WSJ explored what do workers really want – stock or cash? The conclusion of the article seemed to be that stock is a tough sell. I’m not sure I fully agree. So in today’s blog, we’ll explore what’s on top? Shares or cash?
Value is in the Eye of the Beholder
Before I answer the question, we need to revisit the concept of perceived value. This, in my opinion, remains a widely underestimated component of truly comparing the merits of receiving cash over stock or vice versa. From the WSJ article, I gleaned some phrases that tell me that there is work to be done in elevating the perceived value of the equity plan. I read things like: [Employee X] “says his shares didn’t make him more likely to stay in his $60,000-a-year job, in part because he was unsure what his stake was worth.” Or, “‘Is this money real and am I really going to get it?’”
On the flip side, and I don’t have data to support it (someone should look into this!), there seem to be companies that have established, on a broad basis, that equity compensation has value – to the point where employees at all levels are requesting more of it. Interestingly, many of these companies offered broad based grants from the point of new hire. Do companies that offer broad based equity from hire do better at upping the perceived value of stock compensation? It’s hard to tell. Perhaps those companies are also more engaged in education and communication, two critical factors in raising the perceived value of equity awards.
From the WSJ article:
At MediaMath, a marketing software company, all employees—including customer-service reps and receptionists—are given stock options designed to equal the amount of their starting salary at the time the shares fully vest. Employees at all levels have requested more equity, and the company recently rolled out new performance incentives that include options.
“We would rather not have the haves and the have-nots,” chief people officer Peter Phelan says. The company is considering an IPO at some point in the future, a move that could bring windfalls for workers.
Online lender Avant Inc. is in the process of implementing policies giving hourly employees the chance to receive equity when they join the company as well as additional grants as part of an annual incentive program. Before, hourly employees were excluded from equity compensation. CEO Al Goldstein says he thinks it will take time before employees trust the perk is meaningful.
“I don’t think it’s a magical thing that happens right away,” he says. Of Avant employees who currently get equity, just 1% have left the company, according to Mr. Goldstein.
Which Wins? Cash or Stock?
Not all companies are valued the same, not all companies have the same stock growth potential, and stock compensation is not necessarily easy to understand if left to the employee to figure it out. For employees who are muddling through those considerations, stock can be a tough sell. Most people don’t want to give up cash to take on something they don’t understand. I think that’s where the key to answering the cash vs. stock question lies – it’s not necessarily that employees want only cash; I think in many cases they want both: cash and incentive compensation that they can understand and value.
Certainly cash may not be the top choice for every scenario. The same goes for stock. I think stock can absolutely be an easy sell to employees…if they are given the tools to appreciate what it means. Ultimately, companies need to pursue what works best for their employee demographics. For companies that are considering more broadly expanding equity programs in lieu of cash incentives, a key focus in mapping a strategic plan should include how to educate employees and raise the perception of the value of the award. And, to the point of one CEO mentioned above, if a company is expanding equity to a broader base of employees, it may take time for the employees to build up that perception of value. It may not magically happen overnight, but with a focus on supporting employees in their understanding and lots of persistence, companies can get there. So in my biased opinion, stock wins. After all, didn’t the turtle win the race?