Realizable pay has quickly emerged as a hot topic for this proxy season. In today’s blog, I offer a few thoughts on realizable pay as it relates to stock compensation.
Why Realizable Pay?
Realizable pay has emerged as a method for evaluating whether executive pay aligns with company performance. It’s an alternative to comparing company performance to total pay as disclosed in the Summary Compensation Table. For equity awards, pay is disclosed in the SCT at grant and is based on the grant date fair value. Arguably, the pay disclosed in this table is for future performance, not current performance. Also, the grant date fair value is not necessarily a predictor of how much compensation execs will actually receive under the arrangement.
Realizable pay, however, is based not on grant date fair value but on the current value of the company’s stock. Thus, where equity awards are a significant component of executive pay, realizable pay can make for a more compelling story for shareholders: high levels of realizable pay are likely the result of an elevated stock price, which in turn probably means that the company is performing well. On the other hand, poorly performing companies have lower stock prices, resulting in underwater stock options and low levels of realizable pay.
What Is Realizable Pay?
Realizable pay is not a mandated disclosure, so there is no standard definition for it. Generally, it can be expected to include cash compensation paid during the year, plus the intrinsic value of options and awards held by the executive. But, of course, it’s more complicated than that.
- Which awards/options? Awards typically vest and pay out in three to four years, but options can be outstanding for up to ten years. The standard that is emerging seems to be to include only options and awards granted within a specified period (e.g., three years). The idea is that the grants that are generating the company’s current performance are the ones made in recent years; grants made earlier generated performance in an earlier time frame.
- Vested and Unvested? Technically, executives can really only realize the value of options and awards that are vested. Most companies, however, seem to include both vested and unvested options and awards in realizable pay.
- Performance Awards? Where execs hold performance awards, a decision also need to be made as to whether to include these awards at threshold, target, or maximum. These awards could also be included at the level at which they are currently expected to pay out, but companies may be uncomfortable with this approach as it potentially signals management’s expectations as to future company performance.
When Is Realizable Pay Not Realizable?
When ISS calculates it, of course. ISS includes the current Black-Scholes value of options in realizable pay, rather than just their intrinsic value (see “Proxy Advisor Policies for 2013,” November 27, 2012). The Black-Scholes value is generally always going to be higher than the intrinsic value (think fast: ten points if you can name two situations where the Black-Scholes value would not be significantly higher than intrinsic value), so this has the effect of increasing the pressure to outperform peers.
– Barbara
Tags: disclosures, executive compensation, executive compensation disclosures, pay-for-performance, proxy, realizable pay
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.
For more on the ISS and Glass Lewis updates, see the NASPP alert “ISS and Glass Lewis Issue Policy Updates for 2013.”
ISS Updates
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.
– Barbara
Tags: Glass Lewis, hedging policies, ISS, peer groups, performance awards, Plan Design, pledging policies, proxy advisors, proxy voting, realizable pay, RiskMetrics, say on parachutes, Say-on-Pay, shareholder approval