Now that the proxy season is winding down and I’ve had the chance to attend a couple of presentations on the new ISS Equity Plan Scorecard, I thought it would be a good time to provide an update on how the scorecard has worked out so far.
Most Plans Passed
Very few plans failed to obtain a favorable rating under the new EPSC. But I’m not sure this should come as a surprise. Of course, most plans passed; that’s why companies pay for the ISS Compass model and hire consultants certified in the use of this model—to ensure that they don’t undertake the expense of submitting a plan to a shareholder vote and not get the votes they need to pass. If a favorable ISS recommendation is key to ensuring the plan is approved, companies are going to do what it takes to get a favorable recommendation. But, how much did companies have to reduce their share requests (and how many of the scorecard factors did companies have to incorporate into their plans) to get favorable recommendations?
It’s Only Going to Get Harder
One thing that’s been clear from the beginning is that ISS is likely to tweak both the pass threshold and the points allotted to each test in the EPSC from year-to-year (this is how they operate scorecards they have created for other purposes). Ken Lockett of AST, Laura Wanlass of AON Hewitt, Scott McCloskey of Lincoln Financial, and Melinda Hanzel of D.F. King presented on the EPSC at the Philadephia/DC/VA/MD joint half-day meeting in June. Given that so few companies failed this year, they noted that they expect the EPSC to be harder to pass next year.
Negative Points Are Possible
Laura noted that on some of the tests, including the SVT, a company can score so poorly that the plan is awarded negative points. The Corporate Executive noted, in its January-February 2015 issue, that with the SVT worth 45% of the score for most companies, it is virtually impossible to achieve a favorable recommendation without earning at least some points for this test. Now it turns out that the plan could score so poorly on the SVT that it is actually impossible to make up enough points the elsewhere in the scorecard to pass.
Vesting Restrictions Unpopular; Post-Vest Holding Valuable
Where companies need to make up points under the scorecard, there are several provisions they can remove from (e.g., liberal share recycling, discretion to accelerate vesting) or add to (e.g., post-vesting holding periods, minimum vesting requirement) their plan to earn additional points.
I’ve heard from several practitioners that post-vest holding periods are worth more than expected under the scorecard. This is a nice break, since post-vest holding requirements aren’t necessarily a takeaway for execs when the company already has stock ownership guidelines in place (and what public company doesn’t have these already). To learn more about post-vesting holding periods, check out our podcast with Terry Adamson or our March webcast.
Peter Kimball of ISS Corporate Services presented on the scorecard at the Phoenix NASPP chapter meeting in May and noted that many companies were reluctant to remove discretion to accelerate vesting or to stipulate a minimum vesting period under the plan. I can understand this—there are perfectly legitimate reasons to accelerate vesting. And minimum vesting periods are a disaster waiting to happen. I’ve already encountered one company that had a minimum vesting requirement, and then granted RSUs that vested in under that time frame and did not discover the error until after the RSUs had vested and been paid out. I’m not sure how you fix that mistake; the lawyers I asked about it did not want to touch that question with a ten-foot pole (or without an attorney-client relationship to protect everyone involved).
Learn More at the NASPP Conference
The session “Demystifying the ISS Equity Plan Scorecard” at the 23rd Annual NASPP Conference will provide a full analysis of how companies fared under the scorecard this year and includes a case study from one company that has already navigated it. The Conference will be held in San Diego from October 27 to 30; register by August 7 to save!
– Barbara
Tags: EPSC, Equity Plan Scorecard, institutional investors, ISS, NASPP Conference, proxy advisors, proxy advisory firm, shareholder approval, shareholder value transfer
As I noted on October 21 (“ISS Changes Stock Plan Methodology“), ISS is changing how they evaluate stock plan proposals. Just before Christmas, ISS released additional information about their new Equity Plan Scorecard, including an FAQ. For today’s blog entry, I take a look at how the scorecard works.
What the Heck?
Historically, ISS has used a series of tests (Shareholder Value Transfer, burn rates, various plan features) to evaluate stock plan proposals. Many of these tests were deal-breakers. For example, fail the SVT test and ISS would recommend against the plan, regardless of how low your burn rate had been in the past or that fact that all the awards granted to your CEO vest based on performance.
Under the new Equity Plan Scorecard (known as “EPSC,” because what you need in your life right now is another acronym to remember), stock plans earn points in three areas (which ISS refers to as “pillars”): plan cost, grant practices, and plan features. Each pillar is worth a different amount of points, which vary based on how ISS categorizes your company. For example, S&P 500 and Russell 3000 companies can earn 45 points for the plan cost, 35 points for grant practices and 20 points for plan features. Plans need to score 53 points to receive a favorable recommendation. [I’m not sure how ISS came up with 53. Why not 42—the answer to life, the universe, and everything?] So an S&P 500 company could completely fail in the plan cost area and still squeak by with a passing score if the plan got close to 100% in both the grant practices and plan features area.
Plan Cost
Plan cost is our old friend, the SVT analysis but with a new twist. The SVT analysis is performed once with the shares requested, shares currently available under all plans, and awards outstanding, then performed a second time excluding the awards outstanding. Previously, ISS would carve out options that had been outstanding for longer than six years in certain circumstances. With the new SVT calculation that excludes outstanding options, this carve out is no longer necessary (at least, in ISS’s opinion–you might feel differently). The points awarded for the SVT analysis are scaled based on how the company scores against ISS’s benchmarks. Points are awarded for both analyses (with and without options outstanding), but the FAQ doesn’t say how many points you can get for each.
Grant Practices
The grant practices pillar includes our old friend, the burn rate analysis. But gone are the halcyon days when burn rates didn’t really matter because companies that failed the test could just make a burn rate commitment for the future. Now if companies fail the burn rate test, they have to hope they make the points up somewhere else. Burn rate scores are scaled, so partial credit is possible depending on how companies compare to the ISS’s benchmarks. This pillar also gives points for plan duration, which is how long the new share reserve is expected to last (full points for five years or less, no points for more than six years). S&P 500 and Russell 3000 companies can earn further points in this pillar for certain practices, such as clawback provisions, requiring shares to be held after exercise/vest, and making at least one-third of grants to the CEO subject to performance-based vesting).
Plan Features
This seems like the easiest pillar to accrue points in. Either a company/plan has the features specified, in which case the plan receives the full points, or it doesn’t, in which case, no points for you. There are also only four tests:
- Not having single-trigger vesting upon a CIC
- Not having liberal share counting
- Not granting the administrator broad discretionary authority to accelerate vesting
- Specifying a minimum vesting period of at least one year
That’s pretty simple. If willing to do all four of those things, S&P 500/Russell 3000 companies have an easy 20 points, non-Russell 3000 companies have an easy 30 points (more than halfway to the requisite 53 points), and IPO/bankruptcy companies have an easy 40 points (75% of the 53 points needed).
Alas, this does mean that companies no longer get a free pass on returning shares withheld for taxes on awards back to the plan. Previously, this practice simply caused the arrangement to be treated as a full value award in the SVT analysis. Since awards were already treated as full value awards in the SVT analysis, it didn’t matter what you did with the shares withheld for taxes. Now you need to be willing to forego full points in the plan features pillar if you want to return those shares to the plan.
Dealbreakers
Lastly, there are a few practices that result in a negative recommendation regardless of how many points the plan accrues under the various pillars. These include a liberal CIC definition, allowing repricing without shareholder approval, and a couple of catch-alls that boil down to essentially anything else that ISS doesn’t like.
For more information on the new Equity Plan Scorecard, see the NASPP alert “ISS Announces New Equity Plan Scorecard and Burn Rates.”
– Barbara
Tags: burn rate, EPSC, Equity Plan Scorecard, institutional investors, ISS, Plan Design, proxy, proxy advisors, proxy advisory firm, proxy voting, RiskMetrics, shareholder approval, shareholder value transfer, shareholder vote, SVT