Counting the shares underlying time-based awards is usually straightforward: one share granted equals one share issued. Performance awards, on the other hand, usually provide for a spectrum of possible payouts: one share granted might mean two shares issued, or .5 shares issued, or no shares issued. Given the many possible payout levels, how many shares should be considered granted for the various administrative and reporting purposes that are relevant to performance awards?
The last two issues of The Corporate Executive (January-February and May-June) took a look at this question and came up with 16 different purposes for which shares under performance awards are counted. In almost all cases the shares are counted differently. I thought it would be interesting to take a look a few of these purposes in the NASPP Blog. Now, 16 purposes is far too many to go through in one blog entry, so I’ll start with just one purpose and I’ll look at more in future entries. For today’s entry, we’ll look at counting the number of shares available in the plan.
Counting Performance Awards Against the Shares Available for Future Grants
There are no legal requirements that govern how performance awards must be counted against a plan’s reserve (other than those contained within the plan itself). Thus, for purposes of reducing the number of shares available in the plan as a result of performance awards, companies can make a policy decision as to whether to count the threshold, target, or maximum shares against the reserve.
Survey Says …
According to the NASPP’s Domestic Stock Plan Design Survey (cosponsored by Deloitte Consulting), practices in this area are split:
48% of respondents tracking awards against the plan reserve at the maximum payout
43% tracking them at the target payout
7% track awards at the expected payout
1% use some other approach
Best Practice (IMHO)
I feel pretty strongly that the best practice is to count performance awards against the plan reserve at the maximum possible payout. Where awards are counted at the target payout (or, worse, at the threshold payout), there is a risk that the company will not be able to meet its obligations should a higher level of performance be achieved. Once the performance period has closed, failing to have sufficient shares in the plan to cover the payout is problematic. At a minimum, allocating additional shares to the plan would require shareholder approval, which is not accomplished at the drop of a hat. There are likely to be accounting and securities law implications, as well.
Drawbacks
But this approach has its drawbacks. As evidenced by the NASPP survey, many companies are reluctant to earmark shares for a payout that isn’t expected (in some cases, not even remotely) to be achieved. In the current environment, where share usage by public companies is heavily scrutinized and restricted by proxy advisors and institutional investors, reducing the plan reserve by the maximum possible payout could prevent the company from making subsequent grants at the desired level or force the company to request shareholder approval for additional allocations to the plan earlier than would otherwise be necessary.
The full results from the 2016 Domestic Stock Plan Design Survey, which the NASPP co-sponsors with Deloitte Consulting LLP, are now available. Companies that participated in the survey (and service providers who weren’t eligible to participate) have access to the full results. And all NASPP members can hear highlights from the survey results by listening to the archive of the webcast “Top Trends in Equity Plan Design,” which we presented in early November.
For today’s blog entry, I highlight ten data points from the survey results that I think are worth noting:
Full Value Awards Still Rising. This survey saw yet another increase in the usage of full value awards at all employee levels. Overall, companies granting time-based restricted stock or units increased to 89% of respondents in 2016 (up from 81% in 2013). Most full value awards are now in the form of units; use of restricted stock has been declining over the past several survey cycles.
Performance Awards Are for Execs. We are continuing to see a lot of growth in the usage of performance awards for high-ranking employees. Companies granting performance awards to CEOs and NEOs increased to 80% in 2016 (up from 70% in 2013) and companies granting to other senior management increased to 69% (from 58% in 2013). But for middle management and below, use of performance award largely stagnated.
Stock Options Are Still in Decline. Usage of stock options dropped slightly at all employee levels and overall to 51% of respondents (down from 54% in 2013).
TSR Is Hot. As a performance metric, TSR has been on an upwards trajectory for the last several survey cycles. In 2016, 52% of respondents report using this metric (up from 43% in 2013). This is first time in the history of the NASPP’s survey that a single performance metric has been used by more than half of the respondents.
The Typical TSR Award. Most companies that grant TSR awards, use relative performance (92% of respondents that grant TSR awards), pay out the awards even when TSR is negative if the company outperformed its peers (81%), and cap the payout (69%).
Clawbacks on the Rise. Not surprisingly, implementation of clawback provisions is also increasing, with 68% of respondents indicating that their grants are subject to one (up from 60% in 2013). Enforcement of clawbacks remains spotty, however: 5% of respondents haven’t enforced their clawback for any violations, 8% have enforced it for only some violations, and only 3% of respondents have enforced their clawback for all violations (84% of respondents haven’t had a violation occur).
Dividend Trends. Payment of dividend equivalents in RSUs is increasing: 78% of respondents in 2016, up from 71% in 2013, 64% in 2010, and 61% in 2007. Payment of dividends on restricted stock increased slightly (75% of respondents, up from 73% in 2013) but the overall trend over the past four surveys (going back to 2007) appears to be a slight decline. For both restricted stock and RSUs, companies are moving away from paying dividends/equivalents on a current basis and are instead paying them out with the underlying award.
Payouts to Retirees Are Common. Around two-thirds of companies provide some type of automated accelerated or continued vesting upon retirement (60% of respondents for stock grants/awards; 68% for performance awards, and 60% for stock options). This is up slightly in all cases from 2013.
Post-Vesting Holding Periods are Still Catching On. This was the first year that we asked about post-vesting holding periods: usage is relatively low, with only 18% of companies implementing them for stock grants/awards and only 13% for performance awards.
ISOs, Your Days May be Numbered. Of the respondents that grant stock options, only 18% grant ISOs. This works out to about 10% of the total survey respondents, down from 62% back in 2000. In fact, to further demonstrate the amount by which option usage has declined, let me point out that the percentage of respondents granting stock options in 2016 (51%) is less than the percentage of respondents granting ISOs in 2000 (and 100% of respondents granted options in 2000—an achievement no other award has accomplished).
Next year, we will conduct the Domestic Stock Plan Administration Survey, which covers administration and communication of stock plans, ESPPs, insider trading compliance, stock ownership guidelines, and outside director plans. Look for the survey announcement in March and make sure you participate to have access to the full results!
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:
For today’s blog entry, I have a couple of follow-up tidbits related to the recent EITF decision on accounting for awards with performance periods that are longer than the time-based service period. I know you are thinking: “Yeesh, it was bad enough the first time, how much more could there be to say on this topic!” but you don’t write a blog.
Background
To refresh your memory, this applies to performance awards that provide a payout to retirees at the end of the performance period contingent on achieving a non-market condition target (in other words, just about any goal other than stock price or TSR targets). Where awards like this are held by retirement-eligible employees, the awards will not be forfeited in the event of the employees’ terminations but could still be forfeited due to failure to achieve the performance targets. The service component of the vesting requirements has been fulfilled but not the performance component.
This also applies to awards granted by private companies that vest based on both a time-based schedule and upon an IPO/CIC.
The EITF came to the same conclusion you probably would have come to on your own. Expense is adjusted for the likelihood that the performance conditions will be achieved; as this estimate changes throughout the performance period, the expense is adjusted commensurately until the end of the period, when the final amount of expense is trued up for the actual vesting outcome. (See “Performance Award Accounting,” April 15, for more information.)
The IASB Does It’s Own Thing
I thought it was just a few maverick practitioners that had taken an opposing position. The alternative approach (which the EITF rejected), is to bake the likelihood of the performance condition/IPO/CIC being achieved into the initial fair value, with no adjustments to expense for changes in estimates or outcome (akin to how market conditions are accounted for).
It turns out, however, that the IASB is one of the maverick practitioners that takes this position. Apparently, the IASB thinks that option pricing models can predict the likelihood of an IPO occurring or earnings targets or similar internal metrics being achieved. Which makes this another area were US GAAP diverges from IFRS. Just something to keep in your back pocket in case conversation lags at the next dinner party you attend.
Mid-Cycle Performance Grants
As I was reading Mercer’s “Grist Report” on the IASB’s decision, I noticed that they also had made a determination with respect to grants made in the middle of a performance cycle. These are typically grants made to new-hire employees. For example, the performance cycle starts in January and an executive is hired in February. All the other execs were granted awards in January at the start of cycle, but the newly hired exec’s award can’t be granted until February.
Under ASC 718, the grant to the newly hired exec is accounted for just like any other performance award. True, his award will have a different fair value than the awards granted in January and the expense of the award will be recorded over a shorter time period (by one month) than the other execs’ awards. But where the award is contingent on non-market conditions, the expense is adjusted based on the likelihood that the goals will be met and is trued up for the actual payout, just like any other performance-conditioned award.
The same treatment applies under IFRS 2, but only if the performance-conditioned award is granted shortly after the performance cycle has begun. Awards granted farther into the performance cycle (in my example, if the exec were hired in, say, June, rather than February) are accounted for in the manner applicable to market conditions (i.e., the vesting contingencies are baked into the initial grant date fair value, with no adjustment to expense for changes in estimates or outcome), even if the targets are internal metrics.
Hmmmm. I’m starting to wonder if discussions like this explain the dearth of dinner parties in my life.
Thanks to Susan Eichen at Mercer for bringing the IASB’s decision to my attention and for explaining the IASB’s positions with respect to mid-cycle performance grants.
The FASB recently ratified an EITF decision and approved issuance of an Accounting Standards Update on “Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period” (their words, not mine).
What the Heck?
I was completely baffled as to when an award would have a performance condition that could be met after the end of the service period. After all, isn’t the period over which the performance goals can be met the very definition of a service period? So I spoke with Ken Stoler of PwC, who translated this into English for me.
Turns out, it’s a situation where the award is no longer subject to forfeiture due to termination of employment but is still subject to some sort of performance condition. Here are two situations where we see this occur with some regularity:
Retirement-Eligible Employees: It is not uncommon for companies to provide that, to the extent the goals are met, performance awards will be paid out to retirees at the end of the performance period. Where this is the case, a retirement-eligible employee generally doesn’t have a substantial risk of forfeiture due to termination but could still forfeit the award if the performance goals aren’t met.
IPOs: Privately held companies sometimes grant options or awards that are exercisable/pay out only in the event of an IPO or CIC. The awards are still subject to a time-based vesting schedule and, once those vesting requirements have been fulfilled, are no longer subject to forfeiture upon termination. But employees could still forfeit the grants if the company never goes public nor is acquired by a publicly held company.
The EITF’s Decision
The accounting treatment that the EITF decided on is probably what you would have guessed. You estimate the likelihood that the goal will be met and recognize expense commensurate with that estimate. For retirement-eligible employees, the expense is based on the total award (whereas, for other employees, the expense is also commensurate with the portion of the service period that has elapsed and is haircut by the company’s estimate of forfeitures due to termination of employment).
For example, say that a company has issued a performance award with a grant date fair value of $10,000, three-fourths of the service period has elapsed, and the award is expected to pay out at 80% of target. In the case of a retirement-eligible employee, the total expense recognized to date should be $8,000 (80% of $10,000). In the case of an employee that isn’t yet eligible to retire, the to-date expense would be, at most, $6,000 ($80% of $10,000, then multiplied by 75% because only three-fourths of the service period has elapsed). Moreover, the expense for the non-retirement-eligible employee would be somewhat less than $6,000 because the company would further reduce it for the likelihood of forfeiture due to termination of employment.
The same concept applies in the case of the awards that are exercisable only in the event of an IPO/CIC, except that, in this situation, the IPO/CIC is considered to have a 0% chance of occurring until pretty much just before the event occurs. So the company doesn’t recognize any expense for the awards until just before the IPO/CIC and then recognizes all the expense all at once.
Doesn’t the EITF Have Anything Better to Do?
I had no idea that anyone thought any other approach was acceptable and was surprised that the EITF felt the need to address this. But Ken tells me that there were some practitioners (not PwC) suggesting that these situations could be accounted for in a manner akin to market conditions (e.g., haircut the grant date fair value for the likelihood of the performance condition being met and then no further adjustments).
I have no idea how you estimate the likelihood of an IPO/CIC occurring (it seems to me that if you could do that, you’d be getting paid big bucks by some venture capitalist rather than toiling away at stock plan accounting). And in the case of performance awards held by retirement-eligible employees, my understanding is that the reason ASC 718 differentiates between market conditions and other types of performance conditions is that it’s not really possible for today’s pricing models to assess the likelihood that targets that aren’t related to stock price will be achieved. Which I guess is why the EITF ended up where they did on the accounting treatment for these awards. You might not like the FASB/EITF but at least they are consistent.
Earlier this summer, Apple announced that CEO Tim Cook’s previously granted RSU for 1 million shares will be modified to vest contingent on relative TSR–per his own request. In today’s blog entry, I take a look at this development.
The Modification
Cook’s award was granted in 2011 and originally vested as to 500,000 shares in August 2016 and another 500,000 shares in August 2021. I’m sure you can guess what I thought of the original award, based on my prior entries covering Apple and mega grants (“Steve Jobs’ Affinity for Mega Grants,” April 28, 2009, and “And Another Thing,” May 5, 2009).
As modified, 100,000 shares still vest in August 2016 and 2021, regardless of performance. The remaining shares vests in increments of 80,000 per year, from 2012 to 2021, with the vesting in years 2014 to 2021 subject to a relative TSR goal (a small portion of the shares vesting in 2013 is also subject to a relative TSR goal). The TSR goal is applicable to 50% of each 80,000-share vesting tranche–so 40,000 shares vest every year regardless of Apple’s TSR and another 40,000 shares vest if specified TSR thresholds are achieved.
Why Do This?
What’s most interesting about this story is that the award was modified at the request of Cook. Past examples of companies modifying awards to vest contingent on performance conditions have been executed under threat of a failed Say-on-Pay or stock plan proposal or in response to a failed Say-on-Pay vote (“Eleven and Counting,” May 3, 2011). So why would Cook voluntary ask for his award to be modified? The stated reason (Apples’ Form 8-K, June 21, 2013) is that Apple is going to be granting performance awards to executives in the future and Cook wants to lead by example. Which could be true, but I’m a skeptic, especially when it comes to grants of stock currently worth close to $500 million. So I wondered, was the real reason:
To demonstrate confidence in Apple’s products and performance
To make other CEOs look bad
Because Cook is worried he won’t perform well if not properly motivated
Because Cook really wants his personal wealth to be better aligned with Apple’s shareholders’ wealth
After gestating on this question for a while, my suspicion is that it was a preemptive strike. In the 8-K announcing the change, Apple says:
“In outreach discussions this year with many of our largest shareholders, we heard that they believe it is appropriate to attach performance criteria to a portion of our future executive stock awards that have been entirely time-based (i.e., vesting for continued service) in the past.”
I think that Cook saw awards held by other CEO’s modified in response to shareholder pressure and thought it might be smart to get out ahead of any demands for the same thing from Apple’s shareholders. This way, he has more control over the modifications and was able to ensure that over 50% of the award still vests based solely on the passage of time.
More on Say-on-Pay and Performance Awards
Tune in tomorrow for the NASPP’s webcast “Performance Equity Design in Light of Say-on-Pay,” which will take a look at the pressure to grant performance awards that has resulted from Say-on-Pay votes and how this is changing long-term incentive programs.
Is it really 4th of July week already? Summer is in full swing and I know there are many people taking long awaited, hard earned vacations this week. What’s not to love about some relaxation, fireworks, watermelon and a good 4th of July BBQ? So keeping with a lighter theme for today’s blog, I’m going to share some photo highlights straight from our nation’s capital – capturing a recent DC/MD/VA NASPP chapter meeting in action.
We’ve been busy here in D.C. metro area, and not just preparing for independence day. Our recent NASPP chapter meeting had a record turnout!
Presenters Liz Stoudt of Radford and Don Gillotti of EASi presenting on Accounting for Performance Plans. They kept the audience attention the whole session – not an easy feat when you combine accounting and performance shares! Their presentation is available in the DC chapter events section of our NASPP website.
Meeting attendees concentrate on several scenarios in accounting for performance plans. Tricky stuff!
Lots of networking going on, and I mean serious networking. If you aren’t making it to your local chapter meetings, let me point out this is a HUGE benefit!
A big thank you to meeting host, Patty Drohan (center) of K12!
I HAD to throw this one in, because it proves that people actually reuse our annual conference bags for useful purposes after the conference! Chapter President Anu Saran was using hers to haul chapter handouts back and forth.
More networking!
And more!
Wishing everyone a safe and fun filled holiday weekend!