ISS has published its burn rate tables for the 2014 proxy season and the news isn’t good. For most industries, the ISS burn rate caps have decreased for 2014. For today’s entry, I have a few fun facts about the new burn rate tables.
For Russell 3000 companies:
Burn rate caps decreased for 14 of the 22 industries in the Russell 3000 that ISS publishes caps for.
Caps increased for seven of the 22 industries (automobiles & components, banks, consumer services, insurance, retailing, semiconductor equipment, and transportation) and the cap stayed the same for the utilities industry.
The largest decrease was for the media industry, which dropped from 5.6% last year to 4.43% for this year (1.17 points). ISS did not decrease the caps for any other industries by more than 1 point.
The largest increase was for the automobiles & components industry, which increased from 3.28% last year to 3.81% this year (.53 points).
For non-Russell 3000 companies:
Burn rate caps decreased for 15 of the 22 non-Russell 3000 industries.
Just as for the Russell 3000 companies, ISS increased the caps for seven industries, but not the same seven. For non-Russell 3000 companies, the industries where the caps were increased are banks, capital goods, commercial & professional services, consumer durables & apparel, insurance, retailing, and technology hardware & equipment.
ISS did not leave the cap the same for any non-Russell 3000 companies.
The largest decrease was 2 points, which is the maximum change (either increase or decrease) ISS allows from one year to the next (yes, ISS puts a cap on the change in the cap).
There were two industries for which burn rates dropped by 2 pts: energy and diversified financials. For energy, the maximum burn rate dropped from 9.46% to 7.46%, but would have dropped to 6.26% without ISS’s cap on changes in maximum burn rates. For diversified financials, the maximum burn rate dropped from 9.56% to 7.56%, but would have dropped to 7.17% without the cap.
For just under half of the industries where the maximum burn rate decreased, the decrease was greater than 1 point. In addition to energy and diversified financials, these industries included automobiles & components, pharmaceuticals & biotechnology, telecommunication services, transportation, and utilities.
The largest increase was in capital goods, which went from 6.69 in 2013 to 8.16 in 2014 (1.47 points).
It’s Like We’ve Got a Good Set of Tarot Cards
For anyone that listened to the NASPP’s November webcast highlighting the results of our 2013 Domestic Stock Plan Design Survey (co-sponsored by Deloitte Consulting), this isn’t a surprise. The survey results foreshadowed this trend. Only 24% of respondents to the survey reported a three-year average burn rate of 2.5% or more (down from 31% in 2010) and, in the past year, almost one-fifth (19%) of respondents took action to reduce their burn rate. The ISS caps are extrapolated directly from actual burn rates (for each industry, the cap is generally the industry’s three-year average burn rate plus one standard deviation); ISS policy in this area simply reflects what is happening in practice.
But there’s one sound That no one knows What do the investors say?
Actually, What Do the Investors Say?
As we are heading into next year’s proxy season (and now that you have that horrible song in your head), I thought it might be a good time to look at what the investor hot buttons are likely to be with respect to executive and stock compensation. I listened to the recording of the session “Say-on-Pay Shareholder Engagement: The Investors Speak” at the 10th Annual Executive Compensation Conference and found a few recurring themes. The panelists were Aeisha Mastagni of CalSTRS, Karla Bos of ING, and Donna Anderson of T.Rowe Price; the panel was moderated by Pat McGurn of ISS.
The investor panelists take a rather dim view of retention grants. They also don’t like programs that grant the same value of stock to execs every year (so that when the stock price drops, execs get more shares).
They weren’t keen on TSR or EPS as performance metrics. They felt EPS is too easily manipulated and too short-term and they would rather see goals that drive TSR, not TSR goals themselves. Which is interesting because TSR and EPS are the two most popular performance metrics in our 2013 Domestic Stock Plan Design survey (co-sponsored by Deloitte).
They didn’t have a lot of use for supplemental proxy filings but opinions were mixed as to the value of realizable pay disclosures.
For next year’s proxy season, the main areas of focus that they generally agreed on were performance awards and metrics, CIC provisions, and employment contracts (e.g., retention bonuses). If you don’t have a good story to tell on those topics, you might want to get cracking.
They all thought the CEO pay-ratio disclosure was of dubious value.
They all also insisted that they were very open-minded about stock and executive compensation and that they don’t blindly follow ISS (it’s just that they happen to agree with ISS on most issues).
Another key takeaway for me was that all of the investors explained that they focus on “the outliers” when reviewing proxy statements. They have lots of proxies to review and can’t do an in-depth analysis of each one. But if something about your executive pay grabs their attention because it is outside the norm, they will look closer at your company. So make like a junior high student and try to blend in.
There aren’t any surprises, at least when it comes to executive and stock compensation. ISS didn’t make any changes specific to stock compensation and the only change that relates to executive compensation is that they’ve changed the Relative Degree of Alignment measure to be a three-year calculation only, rather than a weighted average of the one and three-year calculations.
Six Degrees of Kevin Bacon
The Relative Degree of Alignment measure doesn’t have anything to do with Kevin Bacon (although it might be argued that it would be a lot more interesting if it did). Instead, as I noted in my blog on ISS’s proposed changes (“ISS Policy Changes for 2014,” October 29, 2013), it simply compares the company’s TSR ranking among its peers to its CEO pay ranking. Ideally (from ISS’s perspective, that is–your CEO might feel differently), your company will have a high TSR ranking and a CEO pay ranking that is equal to or lower than its TSR ranking. A low TSR ranking and a high CEO pay ranking will result a negative RDA and probably a lot more attention from ISS than you’d like.
What’s Changed
The old calculation averaged the one-year RDA and the three-year RDA with a respective weighting of 40/60. The new calculation is just the three-year RDA.
Why Change?
Because the most recent year was included in both the one-year and three-year calculations, the prior RDA measure placed significant emphasis on this year. By eliminating the one-year RDA measure, the most recent year will be deemphasized in favor of the longer three-year period. As a result, short-term changes in TSR and CEO pay rankings will have a smaller impact on this aspect of ISS’s analysis. ISS also notes that the longer term calculation will help alleviate timing mismatches in pay for performance that result from equity awards being issued early in the fiscal year, before the corresponding performance year.
No Burn Rates Yet
The burn rate tables aren’t available yet. I expect them some time in mid to late December. Hmmm, maybe I’ll be able to get three blog entries out of this whole policy update.
Don’t Miss Your Chance to Update Your Peer Group with ISS
The companies that ISS considers to be your peers are critical for the RDA measure as well as numerous other analyses that ISS performs. ISS will consider your self-selected peers when constructing your peer group. You have until December 9 to let ISS know which companies are in your self-selected peer group. For more information see, ISS’s Peer Group Methodology FAQ. You can submit your peers and any other feedback you have for ISS on your peer group at http://www.issgovernance.com/PeerFeedbackUS.
ISS has proposed changes to its corporate governance policy for 2014. You have until November 4 to comment on the changes.
What’s Changed?
In terms of stock compensation, or even compensation in general, not much. So the good news is this maybe isn’t something you have to spend a lot of time on this year and I can have a short blog entry today. Of course that’s also the bad news–things aren’t going to get any better next year in terms of the restrictions ISS places on your stock compensation program.
Evaluating Alignment of Pay to Performance
The only proposal that relates directly to compensation that ISS is looking at changing is the Relative Degree of Alignment (RDA) measure, which compares the difference between a company’s TSR ranking and its CEO’s pay ranking among its peers. For example, if the company’s TSR ranks in the 25th percentile among its peers (meaning that the company’s TSR is better than only 25% of its peers) and its CEO’s pay is in the 75th percentile (i.e., the CEO’s pay is more than 75% of his/her peers), ISS might be concerned that there is a pay for performance misalignment. This is just one of several measures ISS uses to assess whether CEO pay aligns with company performance.
Currently ISS calculates RDA on a one-year and three-year basis. They are proposing to eliminate the one-year calculation and instead consider only three-year RDA. If your RDA score has been trending downwards, you are probably pleased as punch about this; if your RDA score has been trending upwards, you are probably a little less thrilled (but what goes up most come down and, under the proposed calculation, if you do have a down year, that year won’t impact your RDA score as much).
For today’s blog, I have another exciting smorgasbord of random stock plan related tidbits.
IRS Issues GLAM on Stock Compensation Deductions and CICs In January, the IRS issued general legal advice memorandum AM2012-010 clarifying that when NQSOs and SARs are cashed out due to a change in control, the tax deduction is attributable to the acquired company. This is because the obligation to make the payments became fixed and determinable at the closing and the payments were for services performed prior to the acquistion.
Two things to note here:
This is unfortunate because chances are the target company isn’t all that profitable, making the deduction less than useful.
The acronym for this type of IRS pronouncement is GLAM. That makes the whole thing sound way cooler than it actually is.
For more information see the WSGR alert we posted on this development.
ISS Theme Song: Coming Around Again? I’m sure you’ve heard about this by now, but just in case, ISS has announced that it will replace the GRId analysis system with a new system called “QuickScore,” which does have the advantage of sounding niftier and friendlier. If you are thinking “what the heck, didn’t they just switch to the GRId system,” time must be flying by for you just as fast as it does for me. ISS switched to GRId back in 2010 (I blogged about it, see “Will ISS Red Light Your Stock Compensation?” March 23, 2010). Still, it does feel like ISS is changing systems almost as often as they change their name.
Under QuickScore, companies will receive a relative ranking from 1 to 10 (1 is good, 10 is bad) by region and industry, instead of the color coded (red, yellow, green) score companies received under GRId. Which is similar to ISS’s Corporate Governance Quotient system that was replaced by GRId. Sort like how ISS changed to RiskMetrics and then changed back to ISS.
Backdating Bad for Your Career A recent academic study found that CFOs that lost their job as a result of option backdating have had a tough time re-entering the workforce. Only 18.7% found a comparable position (compared to 35.1% of CFOs that had lost their job for other reasons) and only 48.4% found any full-time corporate position (compared to 83.8% of other CFOs).
Which was a little surprising to me because how would a potential employer even know that’s how you lost your job? You wouldn’t exactly put “falsifying corporate records to reduce expense” under the skills listed on your resume and, in my experience, companies don’t give out that kind of information about former employees. But I guess a quick Google search these days can be very revealing about job candidates.
This week I have a couple of additional treats from the smorgasbord of topics related to stock compensation. Enjoy!
FAQs on ISS Peer Groups I guess I wasn’t the only one confused by ISS’s new peer group methodology; ISS has issued an FAQ to explain the new process.
There’s still a bunch of stuff about 8-digit, 6-digit, 4-digit, and 2-digit GICS codes that I don’t understand, but the gist that I came away with is that peers are selected first from within the company’s 8-digit code. ISS constrains which companies can be considered peers based on size (by revenue and market capitalization), so if there aren’t any 8-digit peers that fit within those constraints, then ISS moves to the 6-digit peers, and then to the four-digit peers. ISS will not select peers that match only based on the 2-digit code.
I finally googled “GICS Codes” to figure out what all these digits mean. Standard & Poor’s assigns companies to ten 2-digit industry groups (your 2-digit GICS code). Then within that 2-digit code, you are assigned to a more specific 4-digit code, and within that 4-digit code…all the way down to the 8-digit code. So the companies that share your 8-digit code should be those that most closely resemble you in terms of industry classification.
When selecting among those peers that meet your size constraints, ISS will give priority to companies that are in your self-selected peer group or that have been selected you as a peer, as well as companies that have been selected as peers by your peers or that have selected by your peers as their peers. This sort of feels like that game “Six Degrees of Kevin Bacon.” Note that if you’ve changed the companies in your self-selected peer group since last year, ISS has provided a special form that you can use to notify them of the change; you have until Dec 21 to do so.
What does all of this have to do with stock compensation you ask? Well, not much, because these peers have nothing to do with the burn rate tables published by ISS (those are based solely on 4-digit GICS codes). ISS uses these peer groups only for purposes of determining whether compensation paid to your CEO aligns with company performance. But it’s good to be aware of your ISS peer group because it probably differs from the peers you’ve identified for purposes of your performance awards and other LTI programs. Thus, even though your CEO has awards that vest based on performance, ISS could still find that his/her pay doesn’t align with company performance.
Top Ten Myths on Say-on-Pay A group of academics from Stanford and the University of Navarra have written a paper to debunk myths related to Say-on-Pay. Beside being an interesting topic, the paper has the advantages of being short (only 14 pages, including exhibits) and is written in fairly straightforward English (the word “sunspot” doesn’t appear in it anywhere).
My favorite myth is #6: “Plain-vanilla equity awards are not performance-based.”
Both ISS and Glass-Lewis have published updated corporate governance guidelines for the 2013 proxy season. The good news for my readers is that, in both cases, there aren’t a lot of changes in the policies specific to stock compensation; I think that Say-on-Pay is a much hotter issue for the proxy advisors right now than your stock compensation plan. Here is a quick summary of what’s changed with respect to stock compensation.
I don’t think ISS made any changes that directly apply to stock compensation, but there were some changes in their general policies on executive and CEO pay that may have an impact on your stock program:
Peer Groups: ISS assigns each company to a peer group for purposes of identifying pay-for-performance misalignments in CEO pay. The determination of company peer groups has been an ongoing source of much consternation; many companies disagree with the peers ISS assigns. In the past, peers have been determined based on GICS codes, market capitalization, and revenue. The new policy involves a lot of technical mumbo jumbo about 8-digit and 2-digit CICS groups that I don’t understand, but the gist that I came away with is that companies’ self-selected peers will somehow be considered in constructing peer groups. I’m not convinced this will be the panacea companies are looking for, but hopefully it will be an improvement.
Realizable Pay: Where ISS identifies a quantitative misalignment in pay-for-performance, a number of qualitative measures are taken into consideration before ISS finalizes a recommendation with respect to the company’s Say-on-Pay proposal. Under the 2013 policy, for large cap companies, these measures will include a comparison of realizable pay to grant date pay. For stock awards, realizable pay includes the value of awards earned during a specified performance period, plus the value as of the end of the period for unearned awards. Values of options and SARs will be based on the Black-Scholes value computed as of the performance period. If you work for a large-cap company, you should probably get ready to start figuring out this number.
Pledging and Hedging: Significant pledging and any amount of hedging of stock/awards by officers is considered a problematic pay practice that may result in a recommendation against directors. My guess, based on data the NASPP and others have collected, is that most of you don’t allow executives to pledge or hedge company stock. But if this is something your company allows, you may want to get an handle on the amounts of stock executives have pledged and consider reining in hedging altogether.
Say-on-Parachute Payments: When making recommendations on Say-for-Parachute Payment proposals, ISS will now focus on existing CIC arrangements with officers in addition to new or extended arrangements and will place further scrutiny on multiple legacy features that are considered problematic in CIC agreements. If you still have options or awards with single-trigger vesting acceleration upon a CIC (and, based on the NASPP and Deloitte 2010 Stock Plan Design Survey, many of you do), those may be a problem if you ever need to conduct a Say-on-Parachute Payments vote.
Glass Lewis Updates
Glass Lewis, in their tradition of providing as little information as possible, published their 2013 policy without noting what changed. I don’t have a copy of their 2012 policy, so I couldn’t compare the two but I’ve read reports from third-parties that highlight the changes.
As far as I can tell, the only change in their stock plan policy is that Glass Lewis will now be on the lookout for plans with a fungible share reserve where options and SARs count as less than one share (the idea is that full value awards count as one share, so options/SARs count as less than a share). It’s a clever idea for making your share reserve last as long as possible, but, to my knowledge, these plans are very rare (I’ve never seen one even in captivity, much less in the wild), so I suspect this isn’t a concern for most of you.
ISS has issued a draft of proposed updates to its corporate governance policies for the 2013 proxy season.
Speak Your Mind–But Be Quick About It
If you have an opinion on the draft that you’d like to express to ISS, you need to get your comments in by October 31. I know you’re thinking that maybe I could have mentioned this a little sooner, but actually, I couldn’t have. The draft was just released last week, after my blog was published. If you follow the NASPP on Twitter or Facebook, however, you at least knew about the draft by last Thursday, when we posted an NASPP alert on it.
You Probably Don’t Have a Lot to Say Anyway
The quick turnaround time for comments probably isn’t a problem because my guess is you aren’t going to have much to say about the proposed changes. ISS is proposing only three changes on their policies relating to executive compensation and only one of those changes relates directly to stock compensation. Here are the proposed changes:
New methodology for determining peer groups
Qualitative analysis will consider how “realizable pay” compares to grant date pay
Allowing executives to pledge company stock will be considered a problematic pay practice
Peer Groups
ISS’s determination of peer groups is critical to their analysis of whether CEO pay aligns with company performance. ISS puts together a peer group of around 14 to 24 companies (I have no idea why 14 to 24 and not, say, 15 to 25–that’s just what ISS says): if your CEO’s pay outpaces the peer group by more than the company’s performance, ISS perceives a possible pay-for-performance disconnect. As noted in my blog “Giving ISS an Earful” (August 14, 2012), the peer group methodology was already an anticipated target for change in this year’s policy.
Up to two years ago, ISS based peer groups solely on GICS codes. Last year, ISS updated it’s policy to base peer groups on revenue and market capitalization, in addition to GICS codes. This year, ISS is further refining peer identification to take into account the GICS codes of the company’s self-selected peers.
Realizable Pay vs. Grant Date Pay
If you follow Mark Borges’ Proxy Disclosure Blog on CompensationStandards.com, you know that a number of companies have been comparing the grant date pay disclosed in the Summary Compensation Table to “realizable pay.” Grant date pay, is, of course, the fair value of awards at grant. Realizable pay is a calculation of how much the executives could realize from their awards as of a specified point in time (usually the end of the year). As I’m sure my reader’s can imagine, the values are usually very diffferent.
Where ISS perceives a pay-for-performance disconnect, it will perform a more in-depth qualitative analysis of the CEO’s pay. In this year’s policy, ISS is proposing to include “realizable pay compared to grant pay” in that analysis.
ISS doesn’t provide any further information, such as what might be considered a favorable comparison or even how “realizable pay” will be determined. In taking a quick gander at the realizable pay disclosures Mark has highlighted recently in his blog, it seems that there is significant variation in practice as to how companies calculate this figure. Some look at pay realizable only from options and awards granted during the current year, others look at all outstanding options and awards, and others look at options and awards granted within a specified range (e.g., five years). I’m not sure whether ISS will perform its own realizable pay calculation (and whether it would have sufficient information to do so) or just accept the number disclosed by the company (assuming a company chooses to make this voluntary disclosure).
More Information
For more information on ISS’s proposed policy updates, including their discussion of the policy around pledging and proposed changes to their policy for Say-on-Parachute-Payment votes, see the NASPP alert “ISS Draft of 2013 Policy Updates.”
If you have concerns or comments that you’d like to voice to ISS about their policies, now is your chance. ISS’s policy survey, the responses to which will be used to formulate their corporate governance policies, is open through the end of this week (Friday, August 17). Speak now or forever hold your piece (well, not really “forever,” presumably they’ll do another survey next year).
This Year’s ISS Policy Survey
The only questions on the survey I noticed that directly address stock compensation were a couple of questions that ask about single-trigger acceleration of vesting of stock awards in the event of a change-in-control. A few other topics in the survey that could indirectly have an impact on stock compensation include:
ISS’s determination of peer groups
How pay should be measured (always a challenge for stock compensation)
Types of performance metrics (e.g., TSR vs. internal metrics)
A few last topics ISS focuses on in the survey that could have an even more indirect impact on stock compensation include director qualifications, director independence, and pledging (e.g., allowing executives to use company stock as collateral for margin accounts or other loans). There also were a bunch of topics that fall under the heading of “Things I Don’t Care About,” so I didn’t read those questions (e.g., corporate lobbying, proxy access, sustainability performance measures).
A Preview of Policy Changes to Come?
The issues covered in the survey are likely indicative of the areas where ISS is considering revising its corporate governance policies for next year–otherwise why would they be asking about these topics? ISS changed its peer group determinations as part of last year’s overhaul of the pay-for-performance analysis (see my blog entry “ISS Policy Updates for 2012,” November 29, 2011); now it looks like ISS may be considering further changes to peer groups. (But probably only for the pay-for-performance analysis; ISS didn’t change peer groups for burn rate purposes last year so I don’t think they’ll change burn rate peer groups for this year either.)
Next Steps
The ISS survey will close this Friday. ISS will hold round-table discussions of the topics covered in the survey during August and September and expects to release the survey results in September. ISS will then accept comments on the results until October and will release its final policy update in November.
For today’s blog, I have a couple of updates related to Glass Lewis and ISS.
Through a Glass (Lewis) Darkly While ISS has been somewhat forthright about its voting policies, the methodologies employed by Glass Lewis to evaluate management proposals have always been a black box. Recently, however, Glass Lewis launched a new “Issuer Engagement Portal” to provide insight into their decision-making process when making vote recommendations on proxy ballots.
The portal includes both “US Abridged Guidelines” and “Continental Europe Abridged Guidelines.” A few highlights from the US Abridged Guidelines relating to stock options:
Companies should seek additional shares only when needed and the number of shares requested should be small enough that the company will need an additional allocation of shares within three to four years (or less).
The annual cost of the plan should be reasonable as a percentage of financial results and the overall value of the company and in comparison to peers. Plans that are relatively expensive and that provide grants solely to senior executives and board members are a particular concern.
The intrinsic value received by option grantees in the past should be reasonable compared with the financial results of the business.
The portal also includes Issuer FAQs and a short summary of Glass Lewis’ Equity-Based Compensation Analysis, which discusses their analysis relating to program size, cost, and features.
While this is no where near the level of transparency provided by ISS and still leaves many questions unanswered, it is at least a step in the right direction.
ISS: Do as We Say, Not as We Do The disadvantage about disclosing your voting polices is that others can then apply them to you–or, in this case, to ISS’s parent company, MSCI. Exequity has prepared an in-depth analysis of how MSCI’s executive compensation programs would fare under ISS’s policies (ISS does not issue a report on MSCI due to the inherent conflict of interest in reporting on their own parent). Exequity found a number of areas where MSCI engages in practices that ISS criticizes:
Not splitting the CEO and Chairman of the Board roles;
Not having stock holding requirements, stock ownership guidelines, or a clawback policy;
Not using preset performance goals for the annual bonus plan (the plan is discretionary);
Not providing the specific performance goals for the performance-based equity awards until after the two-year performance period ends;
Aiming to compensate named executive officers at the “higher end of market practice”; and
Granting equity awards with single-trigger change-in-control provisions.
More at the NASPP Conference This year’s NASPP Conference will feature a session that will sort out fact from fiction on the proxy advisor policies and help you evaluate how critical it is for your company to comply with ISS and Glass Lewis policies. Look for more information when we announce the full program in a few weeks. The 20th Annual NASPP Conference will be held in New Orleans from Oct 8-11–register by May 31 for the early-bird rate.
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 we keep an ongoing “to do” list for you here in our blog.
Register for the 20th Annual NASPP Conference in New Orleans. Don’t wait, the early-bird rate is only available until May 31.
Register for the NASPP’s newly updated online Stock Plan Fundamentals program–it’s not too late to get into the course; all webcasts have been archived for you to listen to at your convenience.