In my blog entry this week titled “Other ISS Policy Amendments,” I said that ISS no longer permits the 5% carve-out with respect to minimum vesting requirements. This statement was not correct. ISS will still permit up to 5% of shares granted under a stock plan to vest quicker than required under the plan’s minimum vesting requirements. I apologize for my error and any confusion it created; I have corrected my original entry.
On November 29, I discussed ISS’s amendments related to dividends paid on awards (ISS Targets Dividends on Unvested Awards), but that’s not the only amendment to their 2017 Proxy Voting Guidelines that impacts stock compensation programs. For today’s blog entry, I discuss the other amendments.
Minimum Vesting Requirements
The plan must specify a minimum vesting period of one year for all awards to receive full points for this test under the Equity Plan Scorecard. In addition, no points will be earned if the plan allows individual award agreements to reduce or eliminate this vesting requirement (note, however, that ISS still permits an exception for up to 5% of shares awarded).
Anyone who listened to my podcast “Five Things Barbara Baksa Learned About the ISS Equity Plan Scorecard” knows that I’m not a fan of this test in the EPSC because I’m convinced it is just a compliance disaster waiting to happen. And now that the plan can’t allow any exceptions to it all, I like it even less.
Plan Amendments
Although ISS didn’t deem this change significant enough to include it in the Executive Summary, the policy with respect to how plan amendments are evaluated has also been updated. For most types of substantive amendments (i.e., amendments that aren’t purely administrative or that aren’t solely for purposes of Section 162(m)), the plan will be reevaluated under the EPSC and ISS will assess the amendments on a qualitative basis.
It isn’t clear to me why the EPSC isn’t enough by itself (since it would be enough for a new plan). Apparently ISS just doesn’t like some stuff that companies do with their equity plans and they want to be able to recommend that shareholders vote against amendments that would add those features to your plan, even if they would be allowed under the EPSC.
Where private companies are submitting a plan to shareholders for the first time, the plan will have to pass the EPSC even if no new shares are being requested (e.g., if the plan is submitted solely for Section 162(m) purposes) and ISS will make a qualitative assessment of any amendments.
We’ve seen quite a bit of evolution in the mix of equity incentive compensation vehicles and terms over the last decade. The use of stock awards has surpassed that of stock options. Performance based compensation continues on its upward rise towards total prevalence. Another change that has slowly gained traction in the wake of Dodd-Frank, Say-on-Pay, and other measures is what I’m terming a slow death for the time based vesting of options and awards, or, as some call it, “pay for pulse.”
In a recent Equilar blog titled “Companies Just Say No to “Pay for Pulse,” the author cites a recent study of Equilar 100 companies that found 70% of the executive pay mix was “at risk.” In another report (Equilar’s 2015 Equity Trends Report), “nearly 70% of S&P 1500 companies used performance awards in 2014, up from about 50% in 2010.” This is consistent with the trends that we’ve observed as well.
Equilar also suggested that a closer look at LTIPs revealed that performance awards (in the form of units, stock, and options) comprised almost 80% of individual incentive plans. Equity awards that vest over time—or time-based awards—made up the remainder. Additionally, “slightly more than 10% of the Fortune 500—or 51 companies—used performance equity exclusively. The list varied by industry, but notably included multiple energy, retail and media companies.”
We really didn’t need more evidence to know that performance awards appear to have found a long term home in the equity compensation mix. What remains not entirely clear at this point is the fate of time based vesting for options and awards. There is an argument that while performance based incentives work well for executives – those with the most control over corporate decisions and strategy – there may still be benefit to offering time based vesting awards to those farther down in the ranks of the organization where some job functions may be more task oriented and less strategic in nature.
Time will tell whether time-based vesting is on its way out the door, or will stand the test of time (no pun intended) and remain a smaller, but still present, component of company stock plans. Is there still a home for “pay for pulse” in the equity compensation vesting mix?
We have a great webcast planned on the very relevant topic of performance awards and their evolution. On April 7th, Performance Awards: An Ever Changing Landscape will include Jillian Forusz from Adobe Systems Inc., Belen Gomez from Equilar, Dan Kapinos from Aon Hewitt and Robert Purser from E*TRADE. We’ve also got a podcast interview with Belen Gomez from Equilar going up on our website on Monday, March 28th. If you subscribe to the podcast now, you’ll get an email notification when Belen’s interview is up.
Free lunches (not too mention breakfasts, dinners, and snacks), open offices, games and nap rooms, shuttle services for commuting employees—we all know Silicon Valley operates a little differently than the rest of corporate America. But just how different is the Valley when it comes to stock compensation?
Last week, I attended a presentation hosted by the Silicon Valley NASPP chapter on how Silicon Valley differs from the rest of the United States when it comes to stock compensation. Tara Tays of Deloitte Consulting ran special northern California cuts of the results of the NASPP’s 2013 and 2014 Domestic Stock Plan Design and Administration Surveys and compared them to the national results. She was joined by Sue Berry of Infoblox and Patti Hoffman-Friedes of Seagate Technology, who provided color commentary.
As it turns out, not as different as you might think. In many areas, the northern CA data aligned fairly closely with the national data. These areas included the use of full value and performance awards, overhang levels, timing of grants, termination and forfeiture provisions, and performance metrics. But here are five areas where Silicon Valley does its own thing:
Burn Rates
This probably isn’t a big surprise to anyone, but burn rates are higher in Silicon Valley. Nationally, 77% of respondents report a burn rate of less than 2.5%. In northern California, only 56% of respondents report burn rates below this level. Interestingly, however, the higher burn rates did not translate to higher overhang; in this area the northern California numbers align closely with the national data.
Clawbacks
In the national data, 60% of respondents report that equity awards are subject to a clawback provisions, representing an almost 90% increase in the use of these provisions since our 2010 survey. But this trend doesn’t appear to have taken hold yet in Silicon Valley; only 34% of companies in northern California report that their awards are subject to clawbacks.
RSUs
While usage of full value awards (vs. stock options) in northern California aligns with the national data, practices vary with respect to the type of award granted. Just over 90% of northern California respondents grant RSUs but, nationally, RSUs are granted by only 77% of respondents. Restricted stock is granted by only 26% of northern California respondents but 44% of national respondents.
Vesting Schedules
For full value awards, graded vesting is more common in northern California (88% of respondents) than it is nationally (65% of respondents). But vesting schedules for full value awards appear to be slightly longer in Silicon Valley. 57% of northern California respondents report a four-year schedule and 37% report a three-year schedule, whereas this trend is flipped at the national level. There, 60% of respondent report a three-year schedule and 30% report a four-year schedule.
For stock options, monthly vesting is far more common in Silicon Valley than nationally. 53% of northern California companies report that options vesting with a one-year cliff and monthly thereafter; only 11% of respondents report this in the national data (27% for high-tech companies).
ESPP Participation
When it comes to ESPP participation, Silicon Valley comes out on top. Close to 60% of northern California companies report that their participation rate is between 61% to 90% of employees; nationally only 20% of companies were able to achieve this. ESPPs are also more generous in northern California, with more companies reporting that their plans offer a look-back and 24-month offering than nationally. This may account for some of the increase in participation but I’m not sure it accounts for all of it (note to self: must do quick survey on this).
What do you do when someone has inadvertently been omitted from the grant approval process? You really can’t just slip the grant into the approval documentation, fully disclosed or clandestinely, and write it off to an “administrative error.” The bad news is that each situation has the potential to be unique, which makes it unlikely that you can create a standard response to a missed grant. For this reason, your grant policy probably can’t (even shouldn’t) attempt to address every potential circumstance surrounding a missed grant. The good news is that you can prepare yourself to evaluate the responses available to you in the event you do find a missed grant. These are my top five considerations:
Vesting
If a grant is left out of the approval process and needs to be approved at a later date, you need to know if the delay in approval will impact vesting. If your plan or grant policy already bases the vesting off a date other than the approval date or is flexible on the issue, it is possible that the grant can maintain the intended vesting dates.
Approval
It’s important to have a solid understanding of your plan and approval process under any circumstance, but when it comes to a missed grant, there are additional considerations. If the delayed approval will result in a grant that is different from your typical grants either in size or vesting schedule, you need to know who has the authority to approve the grant. If standard grants are approved by an officer, such as the CEO, it’s likely that a modification to standard terms will cause the grant to fall outside the parameters of the officer’s approval authority and may need to be referred to the compensation committee for approval.
Stock Price
If the grant in question is an option, then the stock price has likely moved on since the original approval date. If the price has dropped, it is easy to sell your employee on a grant of equal size and vesting with a better exercise price, but it may not be advisable to provide a disproportionately advantageous position to just one employee. Provided your plan permits it, it is possible to approve the option with the intended (i.e., higher) grant price.
If the stock price has increased, you have the opposite issue to contend with–the employee really shouldn’t be penalized for an administrative error. However, approving the grant at the lower exercise price would most likely result in a discounted option, making it subject to 409A. You can, however, develop a policy on how the company may compensate for this change in FMV such as increasing the number of shares or providing a cash payment to make up the difference.
If an RSU has slipped through the cracks in your approval process, making up for lost time can be less of a burden provided you have the flexibility in your plan to keep the intended vesting schedule. But, make sure that if your grant policy doesn’t lock in grant size based on the date of approval (e.g.; a value of $1,000 based on the FVM on date of approval).
Timing
Ideally, you never have to deal with a missed grant. Hopefully, if you do encounter one, the error is discovered virtually immediately. However, it is a good idea to think about what the company can do if a significant amount of time has passed between the date the grant should have been approved and the discovery.
One possible issue is vesting; if the grant should have already vested by the time the error is discovered. Like compensating for a higher exercise price, the company could choose to increase the number of shares or provide a cash payment to compensate for a missed sale opportunity. This is risky business because you are using counterfactual history–there is no way to know at what point the employee would have sold the shares.
Another issue comes up for companies that use a “total rewards” type compensation standard and one or more annual grants have been approved before the original missed grant is discovered. In a total rewards model, annual grant size would typically be based on a target total equity value or total compensation level. If the missed grant is not included in the calculations, then an annual grant approved after the error is likely to be larger to accommodate the value “missing” from that employee’s total equity value or compensation level.
Communication
Regardless of the circumstances leading up to a missed grant, communication is going to be key. No matter how you cut it, employees don’t appreciate being left out and bristle at the idea of being penalized for an administrative error, whether that idea is well-founded or not. This might sound a little like running a customer service call center, but it’s not a bad idea to have some apology verbiage ready that can fit most administrative issues; something that can help to reassure the employee that the company will “make it right” without actually obligating the company to provide recompense it isn’t prepared or able to accommodate. Whatever your response is to a missed grant, keep the employee abreast of the process as much as possible. Also, it’s probably best to avoid detailing the circumstances of the oversight even if you are trying to reassure the employee.
It may seem obvious that when an employee moves from full-time to part-time status, his or her salary changes to a part-time amount as well. The impact to equity compensation, however, isn’t so obvious.
Philosophical Differences
A company’s stock plan philosophy should be a pivotal component of all decisions around equity compensation to provide a cohesive stock plans program. Employees who get a consistent message regarding their equity compensation are more likely to understand and value it. When it comes to full-time employees changing to a part-time status, consider how equity compensation is promoted to employees. Is it a reward for past performance, part of compensation, or incentive for future performance? Also consider what outcomes the company is looking for (and, no, you don’t need to pick just one). It could be that the company wants to create an employee ownership environment, improve retention, align employees with shareholder interests, reduce cash salaries; whatever the desired outcomes are, the policy around part-time employee grants should be in alignment with that goal.
Weighing the Options
Most companies are not in a position where modifying vesting because of a move to part-time status makes sense. First, consider the consequences to the company for continuing vesting. It’s unlikely that enough employees will choose to go part-time holding enough unvested to create a material negative impact. Also, it’s possible to limit the impact from part-time employees by considering part-time employees ineligible for new grants. There are also minimal advantages to having a move to part-time status impact grant vesting; again because there shouldn’t be a huge number of employees making that move.
Then, take a good look at what the costs could be to cancelling grants or suspending vesting because of a move to part-time status. There’s the issue of employee morale. If grants are impacted by a move to part-time, it could feel punitive to the employee, especially if grants are promoted to employees as a reward for past services. Most likely, if an employee is eligible for equity compensation and is approved to move to part-time status, then the company truly wants to retain that employee keep him or her engaged in the success of the company. There’s also the issue of tracking and administering vesting changes, which can be time-consuming and involve a high level of manual adjustments in the stock plan administration database. With any manual data changes comes additional risk of error.
Managing Your Policy
If your company already has a policy in place to cancel, suspend, or modify grants due to a move to part-time status, it may be worth a thorough review. It’s good to understand why the policy is in place and examine if it still aligns with corporate and equity compensation philosophy. If it does, or you company is just not ready to make a change, here are some ways to make that policy successful.
First, work with your legal team to make sure that it is very clear which circumstances will be impacted. Like leaves of absence, there may be situations in the U.S., and especially internationally, where a move to part time either can’t impact vesting or where it is a grey area that could expose the company to risk if existing grants are impacted. Then, get your HR and IT involved to solidify how changes in status are tracked in the HRIS database and communicated to stock plan management. If there are situations where vesting won’t be impacted, it’s important that those employees are easily identified. Also, meet with your service provider to fully understand your policy can best be managed in the stock plan administration software. As with other areas of stock plan management, don’t assume that the process currently in place is the most efficient and effective one.
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