ISS 2017 Equity Compensation Plan FAQ notes that where companies want ISS to include performance awards in their burn rate when the awards are earned, ISS now requires specific disclosures with respect to the performance awards.
A Quick Primer on ISS, Burn Rates, and Performance Awards
ISS includes performance awards in a company’s burn rate when the awards are earned, if the company includes this information in the disclosures related to its stock plan. If this information isn’t disclosed, ISS includes the performance awards in the burn rate calculation when they are granted.
The problem with including the performance awards when they are granted is that ISS doesn’t reduce the burn rate for subsequent forfeitures (due to either termination of employment or failure to meet the performance goals). Consequently, it is generally preferable to have performance awards included in the burn rate when they are earned. This will result in a more accurate (and possibly lower) burn rate, because only the shares that are actually earned and paid out will be included in the calculation.
What’s Changed?
In the past, ISS simply required companies to clearly and consistently disclose how many shares were granted and earned under performance awards, without defining what the disclosure should have looked like. In its 2017 Equity Compensation Plans FAQ, however, ISS has stipulated the following requirements for the disclosure:
Table format
Separate from the disclosure for time-based awards
Aggregate of all performance awards granted to all employees (providing the disclosure only for awards held by NEOs is insufficient)
Covering three years
Included every year going forward, even if the plan will not be acted on in a particular year
Included even if no performance awards were granted or earned in a particular year
ISS has also said that they generally won’t calculate the number of shares earned under performance awards, even if it would be possible for them to do this from information presented in narrative format.
The FAQs include a sample disclosure that looks remarkably like the old roll-forward tables companies used to include for all of their stock compensation under the original FAS 123.
Is This Legally Required?
The disclosure isn’t legally required or required under ASC 718. But if you want ISS to include your performance awards in your burn rate when they are earned, rather than when they are granted, the disclosure is necessary.
One area of ISS’s voting policy that you can count on changing every year are the burn rate benchmarks. ISS updates these benchmarks based on historical data. In theory, if granting practices haven’t changed, the burn rate benchmarks won’t change either. But, inevitably, practices change (in response to changes in the economic environment, the marketplace, and compensation practices, not too mention pressure to adhere to ISS’s burn rate benchmarks) and the burn rate benchmarks change as well.
Surprise, Surprise (Not!)—Burn Rate Benchmarks Lower in 2016
It seems like a self-fulfilling prophecy to me that if ISS sets a cap that burn rates can’t exceed and companies are forced to manage their grants to come in under that cap, burn rates are going to keep decreasing. This year, by my calculations, burn rate benchmarks dropped for 40% of industries in the S&P 500, 59% of industries in the Russell 3000, and 68% of industries in the Non-Russell 3000. ISS indicates that the median change across all industries/indices is a decline of .07%.
It’s a “Benchmark” Not a “Cap”
ISS calls the standard a “benchmark” not “cap.” When they made this change last year, I thought maybe this was because they thought the word “benchmark” sounded friendlier. This isn’t the case at all, however. It’s a “benchmark” because the cap is actually lower than the benchmark. To get full credit for the burn rate test in ISS’s Equity Plan Scorecard (EPSC), a company’s burn rate has to be less than 50% of the benchmark. In other words, the cap is 50% of the benchmark.
Burn Rate Scores Can Go Negative
Laura Wanlass of Aon Hewitt tells me that, just like the score for the SVT test (see “Update on the ISS Scorecard,” July 21, 2015), the burn rate score can also be negative.
Burn Rate Is Important
Burn rate is not quite as important as a plan’s SVT score, but it’s still significant—a negative score could be impossible to come back from in the EPSC. Laura tells me that it is the largest percentage of points in the Grant Practices pillar, which is worth less than Plan Cost (i.e., the SVT test) but more than the Plan Features pillar.
Before the EPSC, burn rates didn’t matter as much. If a company didn’t pass the burn rate test, they simply made a three-year commitment to stay under ISS’s cap in the future—no harm, no foul. But those three-year commitments are just a distant fond memory under the EPSC.
The Burn Rate Test Is Getting Harder
While the standard to earn full points for burn rate remains 50% of the benchmark, overall, the benchmarks have been lowered for most industries/indices. In addition, Laura tells me that ISS is recalibrating the test so that burn rates above 50% of the benchmark will earn fewer points and will go negative sooner than last year.
I was thinking that we might be dealing with a shutdown government this, which, while otherwise not such a good thing, would have provided some interesting fodder for my blog. But it appears to be business as usual at the IRS and SEC, so today I blog about something completely different: burn rate guidelines.
Burning the Candle at Both Ends: Burn Rates and Stock Compensation “Burn rate,” also referred to as “run rate,” is a mechanism for measuring how much equity a company grants to employees on an annual basis as compared to the equity held by shareholders. It’s a way for shareholders to guage how much their equity is being diluted annually through stock programs in a worst-case scenario (i.e., ignoring any offsets to that dilution, such as forfeitures and repurchase programs).
There’s no legal definition of burn rate, so every investor, proxy advisor, and survey has their own calculation, but the basic formula is the number of shares granted during the year divided by the total shares of common stock outstanding.
Fidelity Investments Announces Use of Burn Rates
Fidelity Investments, a large institutional investor with holdings in many public companies, has announced that it will begin using a burn rate analysis in determining whether to vote for stock plan proposals. The policy establishes the following acceptable maximum burn rates:
1.5% for a large-cap company
2.5% for a small-cap company
3.5% for a micro-cap company
Fidelity will vote against new stock plans and share authorizations if a company’s three-year burn rate exceeds the relevant maximum, unless Fidelity believes there is a compelling justifcation for the high burn rate.
ISS (formerly RiskMetrics, formerly ISS–how many times can one company change their name) has used a burn rate analysis for as long as I can remember. (I confess, these days, that time period isn’t as long as it used to be, but, in this case at least, is many, many years. 10 points to anyone who knows when ISS first started using their burn rate analysis in evaluating stock plan proposals.)
There are a few key differences between the ISS burn rate analysis and Fidelity’s new policy:
ISS burn rates are published by industry and by whether or not the company is in the Russell 3000 index, so ISS has a more than just three burn rate categories.
ISS applies a multiplier to full value awards, so one award share granted counts as greater than one share in the burn rate calculation. The multiplier is based on the volatility of the company’s stock.
Where a company’s burn rate exceeds ISS’s guideline, the company can still get ISS to recommend voting for their stock plan proposal by making a commitment to keep their average burn rate for the next three years within the higher of: a) 2% of the company’s common shares outstanding or b) the mean plus one standard deviation of its applicable industry burn rate.
Higher Burn Rates Equals More Generous Grants? Not So Fast
ISS’s acceptable burn rates were generally higher this year than last year, so companies may be feeling like they can be a little more generous with this year’s grants. Keep in mind, however, that ISS uses a three-year average in its analysis. Granting more shares this year means that, three years down the road, your average will be higher and, by then, the ISS guidelines for burn rates may be lower.
Online Fundamentals Starts on Thursday–Don’t Miss It! The NASPP’s acclaimed online program, “Stock Plan Fundamentals,” begins this Thursday, April 14. This multi-webcast course covers the regulatory framework and administrative best practices that apply to stock compensation; it’s a great program for anyone new to the industry or anyone preparing for the CEP exam. Register today.
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 early-bird rate is only available until May 13.
Attend your local NASPP chapter meetings in Denver, NY/NJ, and San Francisco. I will be at the Denver and San Francisco chapter meetings (that’s two out of three this week); I hope to see you there!