Last week, I discussed ISS’s new Equity Plan Scorecard. If you were hoping that the scorecard gave you a free pass on your burn rate, I have some disappointing news. The scorecard doesn’t eliminate the burn rate caps—the caps are a component of a plan’s overall scorecard rating.
The Word “Cap” Is So Limiting
One interesting change I noticed is that ISS is no longer calling them “caps”; now they are “benchmarks.” I’m not sure if this is to make them seem less restrictive or to make companies feel worse about exceeding them because the caps aren’t an arbitrary limit but a benchmark established by their peers.
According to ISS’s FAQ on the Scorecard, a plan gets max points when the company’s burn rate is 50% or less of the benchmark for its industry. The FAQs say that the burn rate score is “scaled,” so I assume this means that partial credit is available if the company’s burn rate is more than 50% of the benchmark but still below it. (If burn rates follow the pattern established in other areas, companies will get half credit if they are in this range. But don’t quote me on that; I didn’t find anything in the FAQs about this–I’m totally guessing). I’m also guessing that if you are over the benchmark, no points for you.
Good News for (Most) Russell 3000 Companies; Not So Good News for S&P 500 Companies
The most significant change is that ISS has broken out S&P 500 companies from other Russell 3000 companies for purposes of determining the burn rate benchmarks. For S&P 500 companies, this results in significantly lower burn rate benchmarks. In a number of industries (energy, commercial & professional services, health care equipment & services, pharmaceuticals & biotechnology, diversified financials, software & services, and telecommunication services), the benchmark dropped more than two points below the cap that S&P 500 companies in these industries were subject to last year.
For most of the Russell 3000 companies that aren’t in the S&P 500, ISS increased the burn rate benchmark slightly. For non-Russell 3000 companies, burn rate benchmarks dropped for the most part (only seven out of 22 industries didn’t see a drop), so I’m guessing that the benchmarks for the Russell 3000 would be lower if the S&P 500 companies hadn’t been removed.
How Does This Play Into the Scorecard?
Burn rate is just one part of one pillar in the scorecard, the grant practices pillar, which is worth 35 points for S&P 500/Russell 3000 companies (25 points for non-Russell 3000 companies). All three types of companies can also earn points in this pillar for the duration of their plan (shorter duration=more points). S&P 500/Russell 3000 companies also earn points in this pillar for specified grant practices. Thus, even if a company completely blows their burn rate benchmark, the plan can still earn partial credit in the grant practices pillar.
In a worst-case scenario, where a plan receives no points at all for grant practices, there’s still hope in the form of the plan cost and plan features pillars. For S&P 500/Russell 3000 companies, plan cost is worth 45 points and the plan features pillar is worth 20 points. That’s a potential 65 points, well over the 53 required to receive a favorable recommendation.
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.
I had planned to blog about some pretty big and exciting news from the FASB, but on October 15, ISS announced their new methodogy for analysing stock plan proposals. You only have until October 29 to submit commits, so this anouncement trumps the FASB announcement.
My first thought upon reading the ISS announcement was “Seriously? People only have 14 days to read this and comment on it?” I don’t know, it kind of makes me think they don’t care about your comments.
Balanced Scorecard
Historically, ISS has employed a number of mechanisms to evaluate stock plan proposals, including 1) plan cost (e.g.’ the Shareholder Value Transfer test), 2) historical burn rates, and 3) a review of specific plan features. Each of these factors were evaluated as a series of pass/fail tests and a plan had to pass all three to receive a positive recommendation.
The proposed approach will still consider the three areas noted above (with a number of significant changes), but will look at them on a holistic basis, rather than as a series of separate tests. So plans that fail one test may still receive a favorable recommendation if the results of the other analyses are positive enough to outweigh the failure. I also suspect that means that plans that pass all three tests but with a low score on each could end up receiving a negative recommendation.
SVT Test Gets an Update
The SVT test will be performed not just on the shares requested for the plan but instead on 1) shares requested, shares currently available for grant, and shares outstanding, and 2) shares requested and shares currently available for grant.
Bad News for RSUs
Historically, allowing shares withheld for taxes to return to the plan just caused the award to be treated as a full value award in the SVT test. Which meant that it didn’t matter if you allowed this for full value awards becauuse they were already counted as full value awards in the SVT test.
Now “liberal” share counting features (e.g., returning shares withheld for taxes to the plan reserve) will no longer be part of the SVT test but will instead be considered separately as a plan feature. So it could be a problem to do this for both RSUs.
Burn Rate Commitments Are a Defunct
My understanding is that up until now, companies didn’t really worry about the burn rate test because if they failed it, they could fix the failure by simply making a burn rate commitment for the future. But the new methodology eliminates the ability to correct burn rate failures by committing to a burn rate cap.
Now, if you fail the burn rate test, you’ll have to hope that the plan cost is low enough and you have enough positive plan features (e.g., clawbacks, ownership guidelines) to outweigh the failure.
Be sure to tune in next week for my big FASB announcement (see the alert on the NASPP home page for a preview).
I’ve told you to complete the ISS policy surveys in the past and I’m sure a lot of you have scoffed. But this year is different; this year, you might want to think twice about blowing off the survey. ISS has announced that they are considering a significant shift in how they evaluate stock compensation plans. The ISS Policy Survey is your opportunity to give ISS some feedback about how you think they should be analyzing your stock plans.
New ISS Policy on Equity Plans?
According to a recent posting in Tower Watson’s Executive Pay Matters blog (“ISS 2015 Policy Survey — Expanded Focus on Executive Compensation,” July 21), ISS has stated that it is considering using a more “holistic, ‘balanced scorecard’ approach” to evaluate equity plans. The good news is that this might allow for a more flexible analysis, rather than the very rule-based, SVT and burn rate analysis ISS uses today. But, as the Towers Watson blogs points out, it also might result in a less transparent process. Less transparency equates to less confidence in how ISS will come out on your plan when you put it to a vote (and perhaps also more business for ISS’s consulting group).
The 2015 Policy Survey
ISS uses policy surveys to collect opinions from various interested parties as to its governance policies. Corporate issuers are one of the many entities that are encouraged to participate in the survey. This year’s survey includes several questions on equity plans, including what factors should carry the most weight in ISS’s analysis: plan cost and dilution, plan features, or historical grant practices.
There’s a good chance your institutional investors are participating in the survey; don’t you want ISS to also hear your views on how your equity plans should be evaluated?
What Do You Think?
Say-on-Pay and CEO Pay
The survey also includes several questions on CEO pay (that ultimately relate to ISS analysis of Say-on-Pay proposals), including questions on the relationship between goal setting and award values and when CEO pay should warrant concern.
Completing the Survey
You have until August 29 to complete the survey. There may be questions in the survey that you don’t have an opinion on or that aren’t really applicable to you as an issuer–you can skip those questions. But don’t wait to complete the survey, because I’m pretty sure the deadline won’t be extended. On the positive side, however, the survey is a heck of a lot shorter than the NASPP’s Stock Plan Design and Administration Surveys.
It’s once again proxy season and many companies will be asking their shareholders to vote on proposals relating to their stock plan. Most of these proposals probably add more shares to the plan, but there are a number of other plan amendments companies might seek shareholder approval for, including:
To add a new type of award that can be granted under the plan
To change the employees eligible to participate in the plan
To increase the limit on the number of shares that can be granted to one employee or some other plan limit
To extend the term of the plan
In some cases, companies aren’t making any changes at all to the plan, but are merely seeking shareholder approval to preserve the plan’s exempt status under Section 162(m) (where a plan doesn’t state the specific performance conditions that awards will be subject to, the plan has to be approved by shareholders every five years).
To Bundle or Not Bundle
It is not unusual for a company to have two or more changes to their stock plan that they are asking shareholders to approve. Where this is the case, the company can bundle all the changes into one proposal or can present each change as a separate proposal subject to a separate vote.
Bundling presents shareholders with an all-or-nothing proposition; they either approve all the changes or they approve none of them. It seems to me that this could go either way for the company. If shareholders are a little opposed to some of the changes but mostly supportive, they might overlook their niggling doubts and vote for the proposal. On the other hand, if shareholders strongly oppose one of the changes, they might vote against the entire proposal and the company doesn’t get any of the changes that it wanted.
Shareholders Wanting Their Cake and Eating It Too
Mike notes in his blog that there have been some recent lawsuits alleging improper bundling of changes (and expresses hope that the SEC’s new CDI will help resolve/prevent these suits), particularly where one of the changes is beneficial to shareholders. This is interesting to me because my guess is that where a company bundles a shareholder-friendly change with another change, the shareholder-friendly change is probably included solely to pave the way for shareholders to approve the other change.
For example, a company might bundle a proposal allocating new shares to the plan with an amendment to restrict the company from repricing options without shareholder approval. The repricing restriction is likely included because the company has received negative feedback from shareholders on this issue (repricing without shareholder approval is considered a poor compensation practice by ISS) and is afraid the share allocation won’t be approved without it. The two proposals have a symbiotic relationship: the company isn’t willing to agree to the repricing amendment unless shareholders agree to the share allocation. Forcing companies to unbundle the two amendments means the company could end up having to implement the shareholder-friendly amending without getting the other change that it wanted.
A Poll
I conclude this blog with a short poll on how you are handling your shareholder proposals this year.
I have another grab bag of topics for you this week.
2013 Say-on-Pay Results Just in time for the 2014 proxy season, Steven Hall & Partners has published a quick summary of the Say-on-Pay vote results for last year’s proxy season. Here are a few facts of interest.
73 companies failed (out of a total of 3,363 companies that held votes. This seems to be up from 2012. Oddly, even with a Google search, I could not find an apples-to-apples comparison, but it seems like just over 60 companies had failing votes in 2012. It’s possible the increase is partly due to more companies having held Say-on-Pay votes.
In the category of “Not Getting the Message,” 15 of the companies with failing votes had failures in prior years.
At one company, Looksmart, 100% of the votes on their Say-on-Pay proposal were against it (which makes them look not so smart). That’s right, even the board voted against their own Say-on-Pay proposal. Apparently there was a complete board turnover, all the executives were fired, and the new execs didn’t own any stock.
New HSR Act Filing Thresholds New HSR Act filing thresholds have been announced for 2014. Under the new thresholds, executives can own up to $75.9 million of stock before potentially having to make the HSR filings. See this memo from Morrison & Foerster for more information. If you have no idea what the HSR Act is, see the NASPP’s excellent HSR Act Portal.
NASDAQ Amends Rules on Compensation Committee Independence NASDAQ has amended its rules on compensation committee independence to provide that compensatory fees (consulting, advisory, et. al.) paid by the company to board members should be considered when evaluating eligibility to serve on this committee, rather than prohibiting these fees outright. The NYSE has always imposed the more lenient standard and apparently NASDAQ received feedback that their more stringent standard might make them less popular. This alert from Cooley has more information.
Today I have a grab bag of short topics for you, each worth mentioning but none are really long enough for their own blog.
The Most Ridiculous Section 162(m) Lawsuit Ever Last year, a Delaware federal court ruled in favor of a company that was the subject of lawsuit alleging that their incentive plan had not been properly approved by shareholders for Section 162(m) purposes. The plaintiff argued that because Section 162(m) requires the plan to be approved by the company’s shareholders, all shareholders–even those holding non-voting shares–should have been allowed to vote on it. Shareholder votes are governed by state law but the plaintiff attorney argued that the tax code preempted state law on this matter. Luckily the judge did not agree.
The plaintiff also argued that the company’s board violated their fiduciary duties because they used discretion to reduce the payments made pursuant to awards allowed under the plan. The plaintiff stipulated that this violates the Section 162(m) requirement that payments be based solely on objective factors. In a suit like this, the plaintiff attorney represents a shareholder of the company; it seems surprising that a shareholder would be upset about award payments being reduced–go figure. In any event, it’s fairly well established that negative discretion is permissible under Section 162(m) and the judge dismissed this claim.
Glass Lewis Policy Update Glass Lewis has posted their updated policy for 2014. For US companies, the policy was updated to discuss hedging by execs (spoiler alert: Glass Lewis doesn’t like it) and pledging (they could go either way on this). With respect to pledging, Glass Lewis identifies 12–count ’em, that’s 12–different factors they will consider when evaluating pledging by execs.
The policy was also updated to discuss the SEC’s new rules related to director independence and how the new rules impact Glass Lewis’s analysis in this area. Although we now have three perfectly good standards for director independence (Section 16, Section 162(m), and the NYSE/NASDAQ listing standards), Glass Lewis has developed their own standards and they’re sticking to ’em. I’m sure I’ve asked this before, but really, how many different standards for independence do we need? I’m not sure director independence is the problem here.
Should Your Plan Limit Awards to Directors? As you are getting this year’s stock plan proposal ready for a shareholder vote, one thing to consider is whether to include a limit on awards to directors. In 2012, a court refused to dismiss one of the plaintiff’s claims in Seinfeld v. Slager because the plan did not place sufficient limits on the grants directors could make to themselves and, thus, were not disinterested in administration of the plan, at least with respect to their own grants.
ISS has published its burn rate tables for the 2014 proxy season and the news isn’t good. For most industries, the ISS burn rate caps have decreased for 2014. For today’s entry, I have a few fun facts about the new burn rate tables.
For Russell 3000 companies:
Burn rate caps decreased for 14 of the 22 industries in the Russell 3000 that ISS publishes caps for.
Caps increased for seven of the 22 industries (automobiles & components, banks, consumer services, insurance, retailing, semiconductor equipment, and transportation) and the cap stayed the same for the utilities industry.
The largest decrease was for the media industry, which dropped from 5.6% last year to 4.43% for this year (1.17 points). ISS did not decrease the caps for any other industries by more than 1 point.
The largest increase was for the automobiles & components industry, which increased from 3.28% last year to 3.81% this year (.53 points).
For non-Russell 3000 companies:
Burn rate caps decreased for 15 of the 22 non-Russell 3000 industries.
Just as for the Russell 3000 companies, ISS increased the caps for seven industries, but not the same seven. For non-Russell 3000 companies, the industries where the caps were increased are banks, capital goods, commercial & professional services, consumer durables & apparel, insurance, retailing, and technology hardware & equipment.
ISS did not leave the cap the same for any non-Russell 3000 companies.
The largest decrease was 2 points, which is the maximum change (either increase or decrease) ISS allows from one year to the next (yes, ISS puts a cap on the change in the cap).
There were two industries for which burn rates dropped by 2 pts: energy and diversified financials. For energy, the maximum burn rate dropped from 9.46% to 7.46%, but would have dropped to 6.26% without ISS’s cap on changes in maximum burn rates. For diversified financials, the maximum burn rate dropped from 9.56% to 7.56%, but would have dropped to 7.17% without the cap.
For just under half of the industries where the maximum burn rate decreased, the decrease was greater than 1 point. In addition to energy and diversified financials, these industries included automobiles & components, pharmaceuticals & biotechnology, telecommunication services, transportation, and utilities.
The largest increase was in capital goods, which went from 6.69 in 2013 to 8.16 in 2014 (1.47 points).
It’s Like We’ve Got a Good Set of Tarot Cards
For anyone that listened to the NASPP’s November webcast highlighting the results of our 2013 Domestic Stock Plan Design Survey (co-sponsored by Deloitte Consulting), this isn’t a surprise. The survey results foreshadowed this trend. Only 24% of respondents to the survey reported a three-year average burn rate of 2.5% or more (down from 31% in 2010) and, in the past year, almost one-fifth (19%) of respondents took action to reduce their burn rate. The ISS caps are extrapolated directly from actual burn rates (for each industry, the cap is generally the industry’s three-year average burn rate plus one standard deviation); ISS policy in this area simply reflects what is happening in practice.
But there’s one sound That no one knows What do the investors say?
Actually, What Do the Investors Say?
As we are heading into next year’s proxy season (and now that you have that horrible song in your head), I thought it might be a good time to look at what the investor hot buttons are likely to be with respect to executive and stock compensation. I listened to the recording of the session “Say-on-Pay Shareholder Engagement: The Investors Speak” at the 10th Annual Executive Compensation Conference and found a few recurring themes. The panelists were Aeisha Mastagni of CalSTRS, Karla Bos of ING, and Donna Anderson of T.Rowe Price; the panel was moderated by Pat McGurn of ISS.
The investor panelists take a rather dim view of retention grants. They also don’t like programs that grant the same value of stock to execs every year (so that when the stock price drops, execs get more shares).
They weren’t keen on TSR or EPS as performance metrics. They felt EPS is too easily manipulated and too short-term and they would rather see goals that drive TSR, not TSR goals themselves. Which is interesting because TSR and EPS are the two most popular performance metrics in our 2013 Domestic Stock Plan Design survey (co-sponsored by Deloitte).
They didn’t have a lot of use for supplemental proxy filings but opinions were mixed as to the value of realizable pay disclosures.
For next year’s proxy season, the main areas of focus that they generally agreed on were performance awards and metrics, CIC provisions, and employment contracts (e.g., retention bonuses). If you don’t have a good story to tell on those topics, you might want to get cracking.
They all thought the CEO pay-ratio disclosure was of dubious value.
They all also insisted that they were very open-minded about stock and executive compensation and that they don’t blindly follow ISS (it’s just that they happen to agree with ISS on most issues).
Another key takeaway for me was that all of the investors explained that they focus on “the outliers” when reviewing proxy statements. They have lots of proxies to review and can’t do an in-depth analysis of each one. But if something about your executive pay grabs their attention because it is outside the norm, they will look closer at your company. So make like a junior high student and try to blend in.
There aren’t any surprises, at least when it comes to executive and stock compensation. ISS didn’t make any changes specific to stock compensation and the only change that relates to executive compensation is that they’ve changed the Relative Degree of Alignment measure to be a three-year calculation only, rather than a weighted average of the one and three-year calculations.
Six Degrees of Kevin Bacon
The Relative Degree of Alignment measure doesn’t have anything to do with Kevin Bacon (although it might be argued that it would be a lot more interesting if it did). Instead, as I noted in my blog on ISS’s proposed changes (“ISS Policy Changes for 2014,” October 29, 2013), it simply compares the company’s TSR ranking among its peers to its CEO pay ranking. Ideally (from ISS’s perspective, that is–your CEO might feel differently), your company will have a high TSR ranking and a CEO pay ranking that is equal to or lower than its TSR ranking. A low TSR ranking and a high CEO pay ranking will result a negative RDA and probably a lot more attention from ISS than you’d like.
What’s Changed
The old calculation averaged the one-year RDA and the three-year RDA with a respective weighting of 40/60. The new calculation is just the three-year RDA.
Why Change?
Because the most recent year was included in both the one-year and three-year calculations, the prior RDA measure placed significant emphasis on this year. By eliminating the one-year RDA measure, the most recent year will be deemphasized in favor of the longer three-year period. As a result, short-term changes in TSR and CEO pay rankings will have a smaller impact on this aspect of ISS’s analysis. ISS also notes that the longer term calculation will help alleviate timing mismatches in pay for performance that result from equity awards being issued early in the fiscal year, before the corresponding performance year.
No Burn Rates Yet
The burn rate tables aren’t available yet. I expect them some time in mid to late December. Hmmm, maybe I’ll be able to get three blog entries out of this whole policy update.
Don’t Miss Your Chance to Update Your Peer Group with ISS
The companies that ISS considers to be your peers are critical for the RDA measure as well as numerous other analyses that ISS performs. ISS will consider your self-selected peers when constructing your peer group. You have until December 9 to let ISS know which companies are in your self-selected peer group. For more information see, ISS’s Peer Group Methodology FAQ. You can submit your peers and any other feedback you have for ISS on your peer group at http://www.issgovernance.com/PeerFeedbackUS.