On October 18, ISS issued a preview of some of the policy changes it is considering for the 2012 proxy season. In today’s blog, I take a look at proposed policy changes relating to how ISS evaluates CEO pay and stock plans submitted for shareholder approval for Section 162(m) purposes.
ISS, CEO Pay, and Company Performance
ISS currently evaluates CEO pay and company performance by comparing the company’s TSR to that of its GICS industry group to identify underperformance, then applying a qualitative analysis of various other factors that relate the CEO’s pay to TSR.
Under the newly proposed policy, ISS will apply a relative measure that compares the company’s TSR to that of its peers, which will be determined based on market capitalization, revenue, and GICS industry group. ISS will compare the company’s TSR ranking within the group to that of its CEO pay ranking. ISS will also consider the multiple of the CEO’s pay to the peer-group median.
In addition to the relative measure, ISS will apply an absolute measure that tracks changes in the company’s TSR against changes in its CEO’s pay.
The results of ISS’s pay-for-performance evaluation can impact recommendations ISS issues for the company’s Say-on-Pay proposal and stock plan proposals (if a significant portion of the CEO’s misaligned pay is in the form of equity), as well as individual director nominations.
ISS and Section 162(m)
In the past, when stock plans have been submitted for shareholder approval solely for the purpose of qualifying for exemption under Section 162(m), ISS has generally recommended that shareholders approve the plans. Under the newly proposed policy, however, ISS states that they will complete a full analysis of future plans submitted to shareholder vote for this purposes.This will include consideration of the total shareholder value transfer, burn rate analysis (if applicable), and specific plan features (such as repricing and change-in-control provisions).
This may particularly be a concern for newly public companies that wish to qualify performance unit awards for exemption under Section 162(m). Under recently proposed rules, the IRS clarified that the Section 162(m) exemption for post-IPO grants of stock options, SARs, and restricted stock made during a transition period does not apply to RSUs. Thus, newly public companies that wish to grant exempt performance unit awards will need to submit their plans for shareholder approval, triggering a full analysis of the plan by ISS.
Comments and More Information
ISS accepted comments on the policy through the end of October. (We posted an NASPP alert on the policy changes shortly after ISS issued the proposal. If you follow the NASPP on Twitter or Facebook, then you knew about our alert in time to submit comments to ISS.)
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.
Today’s blog entry is guest authored by Jon Burg of Radford, who will be moderating a discussion on designing performance-based equity programs using market conditions at the 19th Annual NASPP Conference in November. The panel will include Gloria Estrada of Agilent Technologies, Susan Stemper of Biogen Idec, and Kathryn Neel of Frederic W. Cook & Co. We asked Jon to give us a sneak peak at what the panel will cover.
Taking the Difficulty Out of Setting Performance Goals By Jon Burg of Radford
Designing a performance-based equity plan can be one of the bigger compensation challenges companies face. Limited line of sight and unforeseen obstacles impacting financial results make choosing a metric and determining the appropriate target an uphill struggle.
With increased pressure to align shareholder and executive interests, I anticipate that market-based plans will continue to be implemented for the following reasons:
They do not depend on the ability to set long-term operational or financial goals;
The payouts are directly linked to stock price performance (absolute or relative) which allows for higher perceived alignment between shareholders and award recipients;
The accounting treatment is more predictable since the expense accrual is fixed at the time of grant and not adjusted, regardless of eventual outcome; and,
They are simpler to administer than plans with other internal performance conditions, and they are measurable at any time for regular and frequent communication to plan participants and the Board
Agilent Technologies was one of the early adopters of a relative total shareholder return program in 2004. In fact after a brief two-year experiment of using a combination of relative TSR and SAGE (must be present to understand) metrics, Agilent has since focused solely on relative TSR. Relative TSR plans come in many shapes and sizes, but the basic premise is the same–award holders receive a higher (or lower) level of payout for excess (or under) performance in TSR as compared to a peer group or benchmark. Gloria will share with us Agilent’s plan design, the continued evolution, and lessons learned over the past seven years.
But relative TSR is not necessarily the answer for all companies. Biogen Idec considered relative TSR as a primary metric for their performance-based plan before opting for a Market Stock Unit (“MSU”). An MSU is a unique equity instrument that effectively combines the upside opportunity of a stock option with a limited downside protection of a restricted stock. Given Biogen Idec’s business model and market position, MSUs were considered a more appropriate replacement of stock options, which are not viewed as performance-based by ISS. Susan will take us inside the compensation committee discussions as well as share a wealth of experience she has gained over the years from literally hundreds of one-on-one executive meetings about equity awards.
Kathryn has worked with numerous companies to perform an assessment of business strategies and performance in order to identify optimal performance metrics that drive sustainable performance. This often involves a balancing act of setting goals that are fair to executives and shareholders. While not always the end result, market-based performance metrics are always a central component of the discussion and the fastest growing area. Kathryn will share her perspective on why she believes the pace has quickened the past few years and possibly even prognosticate on where we are headed.
Collectively, this panel will demonstrate that a well-designed market-based program can both mitigate the most troublesome flaws with traditional equity vehicles, and provide better compensation delivery.
Learn Even More About Performance Awards Round out your knowledge of performance based awards by attending the pre-Conference program, “Practical Guide to Performance-Based Awards,” offered on Nov 1, in advance of the NASPP Conference. This intensive one-day program will cover everything you need to know to implement and administer this complex emerging form of compensation.
I recently attended a San Francisco NASPP chapter meeting that featured a presentation by Yana Plotkin of Towers Watson on trends in equity compensation. Yana included some data from the Towers Watson “2010/2011 Report on Long-Term Incentives, Policies and Practices.” Here are a few highlights:
Portfolio Approach
More companies are granting at least two types of awards–73% of respondents indicated this practice, an increase of 10% from 2009. Larger companies are more likely to utilize three types of awards than smaller companies.
Pay for Performance
Towers Watson is seeing a strong trend towards performance awards, which are now the second most common type of long-term incentive offered by survey respondents, ahead of stock options. Full value shares (RS/RSUs) were the most common type of LTI offered. In the NASPP’s 2010 Stock Plan Design and Administration Survey (co-sponsored by Deloitte), we also saw a strong trend towards performance awards, although we did not see them outpace the usage of stock options.
Full Value Awards
Towers Watson reports that full value awards have outpaced stock options for grants to employees at the manager/individual contributor level. In the NASPP survey, we also saw an increase in full value awards and even performance awards to employees at these levels, but many respondents were still granting stock options.
Award Sizes
For employees earning under $200,000, award sizes (as a percentage of salary) remained flat from 2009 to 2010 in the Towers Watson survey. But for employees at higher salary levels, award sizes increased, although not quite to 2008 levels.
Award Design
In terms of performance award design, Yana mentioned that they are seeing interest in awards with shorter performance periods, e.g., two years, and some sort of trailing service requirement after the performance goals have been met. I am a proponent of this design; for executives, it helps facilitate compliance with ownership requirements and clawback provisions and, for everyone, it can simplify tax withholding procedures.
Interestingly, Towers Watson reports that 35% of respondents to their survey measure performance relative to peers or a market index. For the NASPP survey, this was about the same (41% of respondents). Both surveys also agree on how commonly TSR is used as a performance metric (25% of respondents in the Towers Watson survey, 29% of respondents in the NASPP Survey). Yana indicated that Towers Watson is seeing more companies use TSR than in the past and that certainly aligns with the buzz I am hearing from compensation consultants, etc.
Performance Awards Are the Future
The biggest takeaway I got from Yana’s presentation is that the Say-on-Pay, the disclosures required under the Dodd-Frank Act, and shareholder expectations are making performance awards the hottest thing going today in terms of equity compensation. If you aren’t fully up to speed on them, don’t miss the pre-conference session, “Practical Guide to Performance-Based Awards,” to be held on November 1 in San Francisco, in advance of the NASPP Conference. Register by May 13 for the early-bird discount!
Online Fundamentals Starts in Two Weeks–Don’t Miss It! The NASPP’s acclaimed online program, “Stock Plan Fundamentals,” begins on 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.