Quick Survey on Stock Plan Education
The NASPP and Fidelity Stock Plan Services are pleased to announce a joint survey on stock plan education programs. Take this quick survey today to find out how your education program compares to your peers’. The survey includes fewer than 25 questions; you can complete it in less than ten minutes—do it today, before you forget. The deadline to complete the survey is Friday, December 11.
New Studies
We’ve posted the following new studies to the NASPP website:
Today’s blog entry is guest authored by Jon Burg of Radford, who will be moderating a discussion on designing performance-based equity programs using market conditions at the 19th Annual NASPP Conference in November. The panel will include Gloria Estrada of Agilent Technologies, Susan Stemper of Biogen Idec, and Kathryn Neel of Frederic W. Cook & Co. We asked Jon to give us a sneak peak at what the panel will cover.
Taking the Difficulty Out of Setting Performance Goals By Jon Burg of Radford
Designing a performance-based equity plan can be one of the bigger compensation challenges companies face. Limited line of sight and unforeseen obstacles impacting financial results make choosing a metric and determining the appropriate target an uphill struggle.
With increased pressure to align shareholder and executive interests, I anticipate that market-based plans will continue to be implemented for the following reasons:
They do not depend on the ability to set long-term operational or financial goals;
The payouts are directly linked to stock price performance (absolute or relative) which allows for higher perceived alignment between shareholders and award recipients;
The accounting treatment is more predictable since the expense accrual is fixed at the time of grant and not adjusted, regardless of eventual outcome; and,
They are simpler to administer than plans with other internal performance conditions, and they are measurable at any time for regular and frequent communication to plan participants and the Board
Agilent Technologies was one of the early adopters of a relative total shareholder return program in 2004. In fact after a brief two-year experiment of using a combination of relative TSR and SAGE (must be present to understand) metrics, Agilent has since focused solely on relative TSR. Relative TSR plans come in many shapes and sizes, but the basic premise is the same–award holders receive a higher (or lower) level of payout for excess (or under) performance in TSR as compared to a peer group or benchmark. Gloria will share with us Agilent’s plan design, the continued evolution, and lessons learned over the past seven years.
But relative TSR is not necessarily the answer for all companies. Biogen Idec considered relative TSR as a primary metric for their performance-based plan before opting for a Market Stock Unit (“MSU”). An MSU is a unique equity instrument that effectively combines the upside opportunity of a stock option with a limited downside protection of a restricted stock. Given Biogen Idec’s business model and market position, MSUs were considered a more appropriate replacement of stock options, which are not viewed as performance-based by ISS. Susan will take us inside the compensation committee discussions as well as share a wealth of experience she has gained over the years from literally hundreds of one-on-one executive meetings about equity awards.
Kathryn has worked with numerous companies to perform an assessment of business strategies and performance in order to identify optimal performance metrics that drive sustainable performance. This often involves a balancing act of setting goals that are fair to executives and shareholders. While not always the end result, market-based performance metrics are always a central component of the discussion and the fastest growing area. Kathryn will share her perspective on why she believes the pace has quickened the past few years and possibly even prognosticate on where we are headed.
Collectively, this panel will demonstrate that a well-designed market-based program can both mitigate the most troublesome flaws with traditional equity vehicles, and provide better compensation delivery.
Learn Even More About Performance Awards Round out your knowledge of performance based awards by attending the pre-Conference program, “Practical Guide to Performance-Based Awards,” offered on Nov 1, in advance of the NASPP Conference. This intensive one-day program will cover everything you need to know to implement and administer this complex emerging form of compensation.
This week I write about how stock compensation can introduce volatility into the P&L and why this is a problem.
The Problem with Liability Treatment
The recent article “Higher Stock Price Triggers First-Quarter Loss for Barnwell” (Honolulu Star Advertiser, May 12, 2011, Andrew Gomes) highlighted for me the exact problem with stock compensation that is subject to liability treatment. The article explains that Honolulu-based Barnwell Industries experienced a $1.5 million loss this quarter–a reversal of a $1.5 million profit for the same quarter last year. The reason for the loss is that their stock price doubled during the quarter.
How can a stock price increase cause the company to recognize a loss? The answer is that Barnwell has granted options that can be paid out in cash (the options include a cash SAR component) and are therefore subject to liability treatment. Thus, the increase in their stock price had a very significant impact on their stock compensation expense. Although they haven’t granted options since 2009, Barnwell’s stock option expense went from $46,000 for the comparable quarter last year to $1,677,000 for the current quarter. That’s an increase of 3,546%–kind of hard to explain to shareholders, who, for the most part, probably don’t have the foggiest understanding of liability vs. equity treatment.
Performance Awards Too
While performance awards receive equity treatment under ASC 718, they can also introduce the potential for similar volatility to the P&L. When performance awards are contingent on non-market based goals (e.g., revenue, earnings, and other internal metrics), the likelihood of forfeiture is estimated and expense is recorded based on this estimate. If the company does well, the likelihood of forfeiture will be lower and the expense for the awards will increase.
It’s important to keep this in mind when designing performance award programs and to set appropriate caps on payouts as a means of controlling stock plan expense (not to mention, how do you handle a situation where awards vest based on earnings, the earnings target is hit, and this decreases the forfeiture estimate to the point where the additional expense for the awards reduces earnings below the target). This is also a reason to consider market-based awards–i.e., awards that vest based on stock price targets or total shareholder return. For these awards, the likelihood of meeting the targets is baked into the initial fair value estimate and there are no further adjustments if the likelihood that the targets will be achieved changes.
Need to know more about the accounting treatment and design considerations for performance awards? Don’t miss the NASPP’s pre-conference program, “Practical Guide to Performance-Based Awards” at this year’s NASPP Conference.
IFRS 2
If ever required for US companies (see last week’s blog entry, “IFRS 2: The Saga Drags On“), there are three requirements under IFRS 2 that could introduce significant volatility to the P&L:
Tax Accounting: IFRS 2 requires all tax shortfalls to run through the P&L and, moreover, requires companies to estimate their tax benefit/shortfall each accounting period and adjust tax expense accordingly. This is the opposite of Barnwell’s problem. Here, an increase in stock price wouldn’t be a problem, but a decrease that causes options and awards to be underwater (i.e., the current intrinsic value of the award is less than the expense) could result in significant increases in tax expense, which would reduce earnings for the period. Sort of rubbing salt into the wound–reduced earnings is not going to help get the stock price back up.
Share Withholding: Share withholding on either options or awards triggers liability treatment (for the portion of the award that will be withheld to cover taxes) under IFRS 2. As the company’s stock price increases, this liablity–and associated P&L expense–will increase.
Payroll Taxes: The company’s matching tax liability for payroll taxes (Social Security and Medicare in the US) is also treated as a liability that must be estimated and expensed each accounting period. Again, as the company’s stock price increases, this liability and expense will also increase.
See the NASPP’s IFRS 2 Portal for articles on these IFRS 2 requirements.
Last Chance to Qualify for Survey Results This is the last week to participate in the NASPP’s 2011 Domestic Stock Plan Administration Survey (co-sponsored by Deloitte). Issuers must complete the survey by this Friday, May 20, to qualify to receive the full survey results. Register to complete the survey today.
New “Early-Bird” Rate for the NASPP Conference If you missed last Friday’s early-bird deadline for the 19th Annual NASPP Conference, you can still save $200 on the Conference if you register by June 24.This deadline will not be extended–register for the Conference today, so you don’t miss out.
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.
Register for 19th Annual NASPP Conference (November 1-4 in San Francisco). Don’t wait; the new early-bird rate is only available until June 24.
Participate in the NASPP’s 2011 Domestic Stock Plan Administration Survey (co-sponsored by Deloitte, with survey systems support provided by the CEP Institute). Don’t wait–this week is your last chance to participate.
The popularity of performance-based equity compensation is growing. If your company is adopting a new performance plan, these are the top 5 things you’ll need to know in order to administer and communicate it to participants.
Performance criteria
Companies can spend a lot of time hammering out the best performance criteria to motivate employees as there are seemingly endless possibilities. The stock plan management team needs to have a very clear understanding of the performance measures being tracked for the grant (e.g., target EPS, milestones, or relative TSR) and how performance will impact the grant (e.g., will it determine the payout date, payout amount, or strike price).
These unique parameters determine how performance-based grants should be valued and how their expense is amortized. For example, if the performance goals are considered market-based, then the valuation takes the likelihood of vesting based on those conditions into consideration. Expense for awards that are not paid out due to not achieving the market condition is not reversed. You can find more on the valuation and amortization of performance-based grants in the article “Accounting for Performance and Market Awards” from Equity Methods.
Performance period(s)
With performance-based grants, the vesting period and the performance period may not be the same (in fact, it’s recommended that the vesting date be far enough after the end of the performance period to allow for approval of performance goal achievement). Some grants even have multiple performance periods within one grant. If the performance and vesting schedules differ, it is important that each is well-documented and tracked. It may not be possible to track separate periods within the same database, so detailed documentation is essential.
Performance attainment
It will also need to be very clear when performance measurement will take place and who will be responsible for determining the degree to which performance targets have been achieved. In order to qualify as “performance based” grants under 162(m), the compensation committee will need to certify that the performance targets have been met. To facilitate a smooth certification process, the other groups and individuals involved must be ready to report to the compensation committee as cohesively and promptly as possible. It may be just one group or person who can verify the performance target(s); in which case the company should develop a process to insure that that group or individual is prepared to evaluate performance at the end of the performance period. On the other hand, the evaluation may require multiple groups; in which case there should be a process in place to coordinate.
Terminations (and other details)
There are many important grant parameters that are not necessarily unique to performance-based grants. For example, the inclusion of dividends or dividend equivalents, the details of change of control provisions, and how terminations will impact the grants. I highlight terminations because there are additional considerations for performance grants, and because they are the most likely scenario to consider.
The trickiest termination consideration is what to do about grants where one or more performance periods have been met prior to termination; particularly for termination due to death, disability, or retirement.
Grant input and tracking
After all the details of a performance plan are in place and understood by everyone involved, there is still the challenge of how to get as much of the specifics of plan into the stock plan administration software. Many stock plan administration databases have some degree of tracking and reporting capabilities for performance-based grants. However, due to the amount of variation among existing performance plans, it is likely that there will be some degree of “outside the box” thinking around how to input each company’s performance plan.
If you are getting ready to input performance grants into your stock plan administration software, be sure to meet with your software provider to determine what can be entered in the database and what must be tracked outside the database or otherwise customized. You’ll need to be sure that you’ve found the best balance between the way the grant reflects in the participant interface, on expensing reports, and even how it impacts plan reserves.
Planning
Of course, the best way to have a manageable performance plan is to have the stock plan management team be an integral part of the planning process! The best way for the stock plan management team to get invited to the planning table is to be knowledgeable regarding performance plans prior to the adoption of a new plan.
Whether you’ve just been asked to manage a performance plan or your company is exploring the possibility, we have a fantastic program designed to get you prepared. Offered for the first time this year as a one-day intensive program preceding the 18th Annual NASPP Conference, “Practical Guide to Performance-Based Awards” will give you the substantive knowledge necessary to implement or administer this unique and emerging form of equity compensation.
Early bird rates for the pre-Conference sessions end on April 15th. If you are planning to attend both the Conference and the “Practical Guide to Performance-Based Awards”, you get a double-discount if you register before the early-bird rates for both end on April 15th. Register today!