Last week I spoke at meetings for the Western PA and Philadelphia chapters. Here are a few pics from the meeting.
We had a great turn-out for both meetings. Here are a few folks from PNC who attended the Western PA chapter meeting, which was held at Reed Smith’s offices in downtown Pittsburgh.
See more pics of the Western PA meeting on the NASPP’s Facebook page.
Pat Gentile of Reed Smith and Joe Steitz of Ansys. Joe is the new Western PA chapter president and has been hosting some great meetings. If you are in the Pittsburgh area, you should definitely check one out in the future.
A big thank-you to Pat for arranging for the meeting space and also big thanks to Joe and the rest of the board for hosting the meeting (and accommodating my travel schedule).
Attendees at the Philadelphia half-day meeting were invited to enter a raffle for four nifty prizes, including gift baskets and a restaurant gift certificate. Here are two attendees deciding how to allocate their raffle tickets.
Attendees listen intently at the Philadelphia half-day meeting. Emily Cervino of Fidelity and I presented on lessons we can learn from social media for employee communications and Brian Wydajewski from Baker McKenzie presented on complex stock plan issues.
Three-fourths of the CEP’s Accounting Curriculum Committee was in attendance in Philadelphia (Steve Tamsula of PNC, me, and Dan Kapinos of Aon)
The Philadelphia event was held at the Radnor Valley Country Club in Villanova. After the educational presentations, attendees enjoyed mingling and BBQ at a reception on the patio.
Kudos to chapter president Elena Thomas of Plan Management and the rest of the chapter board for hosting a fantastic event.
See more pics of the Philadelphia meeting on the NASPP’s Facebook page.
When I presented for the Western PA NASPP chapter last Wednesday, I told the group I expected the House to vote any day on the Financial CHOICE Act. And I was right—the House approved the Act the very next day. The CHOICE Act would repeal or weaken much of the Dodd-Frank Act, including repealing the CEO pay ratio disclosure.
Is It a Law Now?
No way; the Act still has miles to go before it becomes law. It has to be introduced in the Senate, pass through committee in the Senate, be voted on (and passed) by the full Senate, and then be signed into law. And the Act is very controversial; it is much broader than just the compensation-related provisions of Dodd-Frank, making significant changes to banking and financial regulation. To give you an idea of how broad it is, the Morrison & Foerster memo summarizing the Act is four pages long and doesn’t even mention repeal of the CEO pay ratio.
According to Morrison & Foerster, passing the Act as it stands now is likely to be an uphill battle:
Senate passage would require a 60 vote majority and Republicans control only 52 seats. There is no indication that any of the 46 Democrats, or 2 independents that caucus with the Democrats, will support the measure as passed by the House. As a result, it is likely that fundamental changes to the CHOICE Act would be required in order for it, or portions of it, to pass the Senate, be reconciled with the House bill and become law.
As reported by govtrack.us, Skopos Labs (a provider of predictions about legislation) is currently giving the Act a 25% chance of passing (but hey, that’s up from 1% the first time I looked at the prediction).
What Does It Do?
A lot of what the Act does is well outside the sphere of equity compensation. Here is what it does in the areas of Dodd-Frank that I am most interested in:
Repeals the CEO pay ratio disclosure
Limits Say-on-Pay votes to years in which substantial changes are made to exec pay packages (eliminating the Say-on-Pay-Frequency vote).
Repeals the hedging policy disclosure
Limits Dodd-Frank clawbacks to situations where the officer has control or authority over the financial reporting that triggered restatement
This Cooley memo provides a thorough list of all of the provisions of the Act.
Why CHOICE?
CHOICE stands for “Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs.” In the words of Matt Levine, a blogger for Bloomberg View:
The sheer art of naming something “Choice,” but “Choice” is an acronym that resolves to include “Hope”! Imagine if you could create hope by adjusting bank capital requirements. It is daring, inventive, impressive stuff. It’s no USA Patriot Act—what is?—but it is an achievement in acronyming that would make the financial industry proud.
Under ASU 2016-09, all windfall and shortfall tax effects of stock compensation will run through earnings in the P&L. When vesting in performance awards is tied to earnings per share, this could make it harder to set the targets in the future because it will be harder to forecast earnings. And, for awards that have already been granted, it might make the current targets easier to achieve (or harder to achieve if the company is experiencing tax shortfalls).
Adjusting EPS Targets
Companies might be tempted to adjust EPS targets for existing performance awards, to reflect the company’s new expectations in light of ASU 2016-09. But, unless the terms of the award already address what happens when there is a change in GAAP prior to the end of the performance period, this could be hard to do. Modifications of targets could cause the awards to no longer be exempt from Section 162(m) and could have other implications.
If the targets aren’t modified, companies will likely have to adjust their forfeiture estimate for the awards.
Non-GAAP EPS
Many companies use a non-GAAP calculation of EPS for purposes of their performance awards. Where the EPS calculation already excludes expense from stock compensation, it should also exclude any tax effects attributable to stock awards. And where this is the case, ASU 2016-09 won’t impact the likelihood of the targets being achieved.
Survey Says
In our May quick survey, we asked what companies plan to about their performance awards in which vesting is tied to EPS. Here’s what they said:
16% use a non-GAAP measure of EPS that already excludes stock compensation expense
2% are planning to adjust their EPS targets
35% are not planning to adjust their EPS targets
48% don’t know what they are going to do about their EPS targets
For today’s blog, we have a special guest entry from Terry Adamson of Aon Hewitt on three key considerations for relative TSR awards. Terry also invites readers to participate in Aon’s new Global Relative TSR Survey to find out how their plans compare to their peers’.
Three Factors That Impact Relative TSR Award Performance
By Terry Adamson of Aon Hewitt
I just finished reading over the March/April edition of The NASPP Advisor, and enjoyed reading the Q&A with Nell Minow, who will be the keynote address at the upcoming NASPP conference in October. One of her responses wished for more “indexed option grants so that they would only be in the money if the company outperforms its peers.” I love the idea and completely agree with the overarching philosophy of treating LTI as a profit sharing agreement between the employee and the investors. Unfortunately due to the tax code, indexed option grants create challenges. However, a similar payout function can be replicated with performance shares contingent on relative total shareholder return (RTSR), which is shares that vest based on the company’s stock price growth as compared to the stock price growth of defined peer companies.
RTSR has become a hot button with strong opinions weighing in from all sides. Some of the frequent criticisms are that relative TSR performance is not within management’s control, it is a “lottery ticket,” and simply rewards volatility. These criticisms are often misplaced to the discussion of whether relative TSR should be part of LTI. We know that relative TSR plans create incredibly strong shareholder alignment when properly designed, are completely transparent, and allow for objective multi-year performance measurement without the difficulty of long-term goal setting. The real challenge with relative TSR programs is designing a plan that is right for your organization and competes against a relevant group of comparators.
I’ve been thinking about these issues recently because Aon just formally launched our first ever Global Relative TSR Survey including firms from the United States, Europe, and Australia. I want to provide three recent thoughts that I have been playing with in my head:
Averaging Period—Our preliminary data show 92% of companies have averaging periods on TSR calculations ranging from 20 trading days to 90 calendar days. However, early returns show 41% of companies use a 20-trading day. I continue to think that a 90-calendar day is appealing as it would continue to smooth out short-term stock price aberrations, and also ensures that an SEC regulatory filing is always included within the averaging period.
Index vs. Custom Peers—A recent academic study, Relative Performance Benchmarks: Do Boards Follow the Informativeness Principle?, concluded that index-based peer groups perform 14% worse in their ability to explain performance than a customized peer group set. Interestingly enough, the study also has evidence that firms with poor governance are more likely to use an index rather than a bespoke group of peers. Our preliminary data show 56% of companies use an index for peer comparison within their relative TSR plans.
Percentile Rank Plans vs. Outperform Plans—Percentile rank plans currently make up 86% of the market in our preliminary data. For larger peer groups, percentile rank plans work great. However, for smaller peer groups, percentile rank plans can create situations that see small changes in TSR produce large changes in payout—which I would label as a governance risk. In these situations, I believe an outperform plan is an elegant way of mitigating risk and graduating the earnout. Learn more about percentile/outperform plans at www.RelativeTSR.com.
I’ve brought up these issues because there needs to be much more research on relative TSR designs. It is challenging to determine specific plan design nuances as the public disclosures from award agreements, proxies, and other regulatory filings are vague. For the good of the industry, we urge issuers to participate in this ten-minute survey at www.RTSRSurvey.com, in which all participants will be provided results, so we can all better understand what creates better alignment with pay and performance in your equity plans. Further, cross-correlated against our PeerTracker plan certifications, we may be able to determine what plan designs have strongest TSR performance. Look for the results to be discussed thoroughly at the 25th Annual NASPP Conference in DC!
Terry oversees Aon’s global Equity Consulting practice, with specific domain expertise in equity accounting, performance certification, and share management. Between consulting gigs though, Terry proudly serves on both the CEP Advisory Board and the NASPP Executive Advisory Board. Further, Terry was on the FASB Round Table on Employee Share Options, and is the Chairman of the Society of Actuaries task force on stock option valuation. The NASPP Conference is returning to Terry’s college town (let’s go Georgetown!), so he hopes to see you there.
Last Wednesday, Elizabeth Dodge of Equity Plan Solutions and I presented to the San Diego NASPP chapter. Here are a few pics from the meeting. More pics on the NASPP’s Facebook page.
Chapter president James Tozer of E*TRADE Financial and Lynn Goldacker of NuVasive wait to check in the meeting attendees. Kudos to James and the rest of the chapter board for hosting a fantastic meeting.
James is also the NASPP’s Regional Representative for the South and is a member of the NASPP’s Executive Advisory Committee.
A few of the early arrivals. The early-bird gets a seat at the table.
Board member Claudia Baranowski of Illumina and Theresa Lee of Qualcomm. Thanks to Claudia for making copies of the slide presentation for everyone.
Board member Thomas Welk of Cooley (and NASPP Individual Achievement Award recipient and member of the Executive Advisory Committee) chats with Ralph Barry of Compensia. The meeting was held at Cooley’s offices; we appreciate the great meeting space.
The folks who got a seat at the table.
In the background, a few folks who didn’t get a seat at the table. It was a great turnout for a 7:30 AM meeting. So great, I think the board might schedule a few more breakfast meetings.
One of the hottest questions I am hearing these days is whether to allow US employees to request additional federal tax withholding on their restricted stock, RSU, and performance awards. So, last week, we conducted a quick survey to find out what NASPP members are doing. Here are the results, in a nifty infographic:
P.S. NASPP members are awesome! We launched this survey on Thursday and by Saturday I had enough responses to close the survey and finalize the results. Thanks to all of you who participated so quickly! You rock! Check out the full survey results.
The glimmer of hope that the CEO Pay Ratio will be delayed or repealed continues to dim (although it hasn’t been completely snuffed out yet).
The SEC Delay
The comment letters submitted to the SEC about delaying the effective date were overwhelmingly opposed, although most were form letters and not nearly as many were received as on the proposed regs. More importantly, the SEC may not currently have enough commissioners to effect a delay. Although a new chair has been appointed, in his recent Equity Expert Podcast with us, Steve Seelig of Willis Towers Watson explains that three commissioners are needed for a quorum. The SEC currently has only three total commissioners (including the chair); a commissioner could prevent a matter from being voted on just by not showing up for the vote. One of the current commissioners is a Democrat (and even worked with Senator Dodd at one point) and may not be supportive of a delay.
Steve noted, however, that even if a delay can’t be effected, the SEC staff could issue interpretive relief that would make it easier to calculate the ratio). Steve had a lot of insightful things to say about the ratio; the podcast is definitely worth a listen.
The Financial Choice Act
The Financial Choice Act has already passed through the House Financial Services Committee, only a month after it was introduced by Jeb Hensarling (R-TX). This act would dismantle or weaken many provisions of the Dodd-Frank Act, including a full repeal of the CEO Pay Ratio. But even with the quick passage through committee, this act has a ways to go and the odds of it passing are still low.
The bill is close to 600 pages long and does a whole host of other things besides repealing the CEO pay ratio; a memo from Cooley, “It’s baaaack — the Financial CHOICE Act of 2017,” provides a rundown of the scope of the bill.
For today’s blog entry I have a couple of recent developments that don’t really warrant a blog entry of their own.
T+2: It’s Happening
The SEC has adopted an amendment to the Settlement Cycle Rule (Rule 15c6-1(a) of the Exchange Act) to move to T+2. The new settlement cycle will commence on September 5 (the day after Labor Day). I already blogged about this—twice—so I don’t really have any more to say on the topic (see “T+2: What’s It to You” and “Progress Towards T+2“). We hosted a great webcast on it in April (“Be Prepared for T+2“); if you aren’t up to date on this development, be sure to check it out.
FASB Issues Modification Accounting ASU
Yesterday the FASB issued ASU 2017-09 (not to be confused with ASU 2016-09—right, no one is going to get these confused), which redefines when modification accounting is required under ASC 718.
All companies have to adopt the ASU by their first fiscal year beginning after December 15, 2017. Early adoption is permitted. Once adopted the ASU applies prospectively. Unlike with ASU 2016-09, if ASU 2017-09 (yep, not confusing at all) is adopted in an interim period, prior interim periods in the same year are not adjusted.
The Trump Administration released its long-awaited tax reform proposal yesterday. The proposal is a long ways away from being final; legislation still has to be introduced into Congress and passed by both the House and the Senate, and the proposal, consisting of a single-page of short bullet points, is lacking in key details. The NY Times refers to it as “less a plan than a wish list” (“White House Proposes Slashing Tax Rates, Significantly Aiding Wealthy,” April 26, Julie Hirschfeld Davis and Alan Rappeport).
Here are six ways the proposal, if finalized, could impact equity compensation.
1. Lower Individual Tax Rates: The proposal would replace the current system of seven individual tax rates ranging from 10% to 39.6% with just three tax rates: 10%, 25%, and 35%. The plan doesn’t indicate the income brackets applicable to each rate, but it will clearly be a significant tax cut for many taxpayers (except those already in the lowest tax bracket).
Lower individual tax rates mean that employees take home a greater percentage of the income from their equity awards (and all other compensation). This will impact tax planning and may change employee behavior with respect to stock holdings and equity awards. Employees may be less inclined to hold stock to qualify for capital gains treatment and tax-qualified awards and deferral programs may be less attractive.
2. New Tax Withholding Rates: It’s not clear yet what would happen to the flat withholding rate that is available for supplemental payments. The rate for employees who have received $1 million or less in supplemental payments is currently pegged to the third lowest tax rate. But with only three tax rates, this procedure no longer makes sense.
The rate might stay at 25% or, with only three individual tax rates, the IRS might dispense with the supplemental flat rate altogether and simply require that companies withhold at the rate applicable to the individual. This could have the added benefit of resolving the question of whether to allow stock plan participants to request excess withholding on their transactions.
3. Lower Capital Gains Rate. The plan calls for elimination of the additional 3.8% Medicare tax imposed on investments that is used to fund Obamacare. This will increase the profit employees keep from their stock sales.
4. No More AMT. If you’ve been putting off learning about the AMT, maybe now you won’t have to. The plan would eliminate the AMT altogether (there aren’t any details, but I assume taxpayers would still be able to use AMT credits saved up from prior years). This would be a welcome relief for any companies that grant ISOs.
5. Elimination of the Estate Tax. With elimination of the estate tax, the strategy of gifting options to family members or trusts for estate-planning purposes would no longer be necessary.
6. Lower Corporate Tax Rate. The plan calls for the corporate tax rate to be reduced from 35% to 15%. A lower corporate tax will reduce corporate tax deductions for stock compensation, which will mitigate the impact of the FASB’s recent decision to require all tax effects for stock awards to be recorded in the P&L.
I was recently asked to comment on a premium priced option granted to IBM’s CEO for an article in Bloomberg (“IBM Says CEO Pay Is $33 Million. Others Say It Is Far Higher“). There are a number of things that I find interesting about the grant.
The Option Grant
The option was granted to IBM’s CEO and is for a total of 1.5 million shares, granted in four tranches. Each tranche cliff vests in three years and has a different exercise price, ranging from $129.08 to $153.66 (premiums ranging from 5% to 25% of FMV).
The option was granted in January of last year, about a month before IBM’s stock price hit its five-year low. IBM’s stock price recovered to the point where all four tranches were in the money around mid-July and the option has mostly been in-the-money since then. IBM’s stock is now trading at around $160 (down from a three-month high of around $180). Either the options were very effective at motivating IBM’s CEO or IBM didn’t set the premiums high enough (or both).
The option doesn’t vest until January 2019 and we all know what can happen to any company’s stock price in that period of time, so there’s no guarantee that the option will still be in-the-money when it vests. The option has a term of ten-years, however, so if it isn’t in-the-money, there’s still plenty of time for the stock price to recover before it expires.
A History of Premium-Priced Options
This isn’t IBM’s first foray into premium priced options. From 2004 to 2006, IBM granted a series of stock options to its executives that were priced at a 10% premium to the grant date market value. In 2007 they dropped the practice and granted at-the-money options, then they ceased granting options altogether. This is the first option IBM has granted since 2007.
The Valuation Mystery
The reason I was asked to comment on the option is that the value IBM reported for the option (which is also the expense IBM will recognize for it) is significantly less than amount that ISS determined the option was worth. IBM reported that the option has a grant date fair value of $12 million but, according to the Bloomberg article, ISS puts the value at $29 million.
It’s not unusual for there to be variations in option value from one calculation to the next, even when all calculations are using the same model and the same assumptions. But a variation this large is surprising. Both IBM and ISS say they are using the Black-Scholes model, so the difference must be attributable to their assumptions. If I were to guess which assumption is causing the discrepancy, my guess would be expected term. The dividend yield and interest rate aren’t likely to have that much of an impact and it seems unlikely that there would be significant disagreement as to the volatility of IBM’s stock.
Why Price Options at a Premium?
The idea behind premium-priced options is to require execs to deliver some minimum amount of return to investors (e.g., 10%) before they can benefit from their stock options. It’s an idea that never really caught on: only 3% of respondents to the NASPP/Deloitte Consulting 2016 Domestic Stock Plan Design Survey grant them.
I’ve never been a fan of premium-priced options. I suspect that most employees, including execs, assign a very low perceived value to them (or assign no value to them at all), so I doubt they are the incentive they are supposed to be. And the reduction in fair value for the premium is less than the amount by which the options are out-of-the money at grant and far less than the reduction to perceived value, which makes them a costly and inefficient form of compensation.
We had a great turn-out for both meetings. Here are a few folks from PNC who attended the Western PA chapter meeting, which was held at Reed Smith’s offices in downtown Pittsburgh.
Pat Gentile of Reed Smith and Joe Steitz of Ansys. Joe is the new Western PA chapter president and has been hosting some great meetings. If you are in the Pittsburgh area, you should definitely check one out in the future.
Attendees at the Philadelphia half-day meeting were invited to enter a raffle for four nifty prizes, including gift baskets and a restaurant gift certificate. Here are two attendees deciding how to allocate their raffle tickets.
Attendees listen intently at the Philadelphia half-day meeting. Emily Cervino of Fidelity and I presented on lessons we can learn from social media for employee communications and Brian Wydajewski from Baker McKenzie presented on complex stock plan issues.
Three-fourths of the CEP’s Accounting Curriculum Committee was in attendance in Philadelphia (Steve Tamsula of PNC, me, and Dan Kapinos of Aon)
The Philadelphia event was held at the Radnor Valley Country Club in Villanova. After the educational presentations, attendees enjoyed mingling and BBQ at a reception on the patio.
