It’s not uncommon for public companies that grant stock compensation widely to report non-GAAP earnings that back out the expense for their stock compensation programs. This is a supplement to their reported GAAP earnings (which they are required to report) of course. The practice arose after the adoption of ASC 718, before which companies rarely recognized any expense for their stock compensation programs. But, though the transition to ASC 718 has long been complete, the practice continues.
Earlier this year, Google decided to stop backing stock compensation expense out of its earnings. Ruth Porat, Alphabet’s chief financial officer, explained the decision during an analyst conference call:
SBC [stock-based compensation] has always been an important part of how we reward our employees in a way that aligns their interests with those of all shareholders. Although it’s not a cash expense, we consider it to be a real cost of running our business because SBC is critical to our ability to attract and retain the best talent in the world. Starting with our first quarter results for 2017, we will no longer regularly exclude stock-based compensation expense from non-GAAP results. Noncash stock-based compensation will continue to be reported on our cash flow statement, but we will no longer be providing a reconciliation from GAAP to non-GAAP measures that reflects SBC and related tax benefits.
Will Other Companies Follow Suit?
A Bloomberg article urges more companies to take a similar approach (“Shame on Silicon Valley’s Stock Expense Stragglers”) and praises tech companies such as Facebook, Amazon, Google, and Electronic Arts, which are all either starting or planning to move away from excluding stock compensation expense from earnings.
Likewise, the Financial Times, calls this move a “watershed moment in Google’s financial maturity and the evolution of the Valley” (“Alphabet Opts to Spell Out Its Stock Options”). The article notes, however, that while Google’s consistent growth and profitability make this a “smooth transition,” it will be harder for other tech companies that need to back out this expense in their non-GAAP earnings to appear profitable.
And profitability is the name of the game. As noted in the Bloomberg article, many tech companies would be significantly less profitable (and some would report a loss) if they include stock compensation expense in earnings. These companies are probably pretty attached to their non-GAAP reports.
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Members sometimes ask me whether it is common for companies to adjust equity grants when employees go out on leave. The short answer is no; according to the NASPP’s surveys, this practice is rare.
I understand why this question comes up. Awards are earned by working and employees who are on leave aren’t working, so it seems reasonable to adjust vesting in their awards. It might even feel unfair to employees who aren’t on leave if vesting isn’t adjusted for employees who are on leave. But there’s more to this question than meets the eye. There are both practical and philosophical reasons to think twice about these adjustments. For today’s blog entry, I have four reasons why you should not adjust vesting for leaves of absence.
1. You can’t get the data. Let’s face it, sometimes it’s best to know your own limitations and this is one of those times. It’s hard enough to get HR and payroll to forward timely reports of terminated employees, getting accurate updates as to leaves of absence is an uphill struggle. If you can’t get the data, you aren’t going to be able to enter the adjustments on a timely basis. This will inevitably result in transactions that later have to be unwound.
2. No one else does it. In most cases, over 90% of respondents to the NASPP/Deloitte Consulting 2016 Domestic Stock Plan Design Survey report that they do not adjust options or awards for leaves of absence. We ask about statutory leaves and nonstatutory leaves (both paid and unpaid) separately for options and awards. In all but one situation, less than 10% of respondents adjust vesting for a leave. The one exception is vesting in awards (restricted stock and units) for an unpaid leave, but even there, 86% of respondents don’t adjust vesting.
3. It’s a hot mess globally. If your stock plan is multinational, you have to worry about compliance with the laws in all countries where stock plan participants are located. At the Philadelphia chapter half-day meeting, Brian Wydajewski of Baker McKenzie presented on the challenges of implementing a global leave policy. He noted that many countries are more protective of employee rights than the United States and this includes restricting the adjustments that can be made to their compensation and benefits while on leave. I can think of more productive ways to spend your time than trying keep track of all these laws.
4. Women are more likely to be impacted than men. Probably the most common leave of absence is maternity leave. Thus, tolling or adjusting vesting during leaves is likely to apply to more women than men and arguably penalizes women for being caretakers. This policy also discourages men from taking paternity leave, further encouraging women to take on more childcare responsibilities than their partners.
Tags: Leave of Absence
Last week I spoke at meetings for the Western PA and Philadelphia chapters. Here are a few pics from the meeting.
We had a great turn-out for both meetings. Here are a few folks from PNC who attended the Western PA chapter meeting, which was held at Reed Smith’s offices in downtown Pittsburgh.
See more pics of the Western PA meeting on the NASPP’s Facebook page.
Pat Gentile of Reed Smith and Joe Steitz of Ansys. Joe is the new Western PA chapter president and has been hosting some great meetings. If you are in the Pittsburgh area, you should definitely check one out in the future.
A big thank-you to Pat for arranging for the meeting space and also big thanks to Joe and the rest of the board for hosting the meeting (and accommodating my travel schedule).
Attendees at the Philadelphia half-day meeting were invited to enter a raffle for four nifty prizes, including gift baskets and a restaurant gift certificate. Here are two attendees deciding how to allocate their raffle tickets.
Attendees listen intently at the Philadelphia half-day meeting. Emily Cervino of Fidelity and I presented on lessons we can learn from social media for employee communications and Brian Wydajewski from Baker McKenzie presented on complex stock plan issues.
Three-fourths of the CEP’s Accounting Curriculum Committee was in attendance in Philadelphia (Steve Tamsula of PNC, me, and Dan Kapinos of Aon)
The Philadelphia event was held at the Radnor Valley Country Club in Villanova. After the educational presentations, attendees enjoyed mingling and BBQ at a reception on the patio.
Kudos to chapter president Elena Thomas of Plan Management and the rest of the chapter board for hosting a fantastic event.
See more pics of the Philadelphia meeting on the NASPP’s Facebook page.
Tags: NASPP chapter meetings
When I presented for the Western PA NASPP chapter last Wednesday, I told the group I expected the House to vote any day on the Financial CHOICE Act. And I was right—the House approved the Act the very next day. The CHOICE Act would repeal or weaken much of the Dodd-Frank Act, including repealing the CEO pay ratio disclosure.
Is It a Law Now?
No way; the Act still has miles to go before it becomes law. It has to be introduced in the Senate, pass through committee in the Senate, be voted on (and passed) by the full Senate, and then be signed into law. And the Act is very controversial; it is much broader than just the compensation-related provisions of Dodd-Frank, making significant changes to banking and financial regulation. To give you an idea of how broad it is, the Morrison & Foerster memo summarizing the Act is four pages long and doesn’t even mention repeal of the CEO pay ratio.
According to Morrison & Foerster, passing the Act as it stands now is likely to be an uphill battle:
Senate passage would require a 60 vote majority and Republicans control only 52 seats. There is no indication that any of the 46 Democrats, or 2 independents that caucus with the Democrats, will support the measure as passed by the House. As a result, it is likely that fundamental changes to the CHOICE Act would be required in order for it, or portions of it, to pass the Senate, be reconciled with the House bill and become law.
As reported by govtrack.us, Skopos Labs (a provider of predictions about legislation) is currently giving the Act a 25% chance of passing (but hey, that’s up from 1% the first time I looked at the prediction).
What Does It Do?
A lot of what the Act does is well outside the sphere of equity compensation. Here is what it does in the areas of Dodd-Frank that I am most interested in:
- Repeals the CEO pay ratio disclosure
- Limits Say-on-Pay votes to years in which substantial changes are made to exec pay packages (eliminating the Say-on-Pay-Frequency vote).
- Repeals the hedging policy disclosure
- Limits Dodd-Frank clawbacks to situations where the officer has control or authority over the financial reporting that triggered restatement
This Cooley memo provides a thorough list of all of the provisions of the Act.
CHOICE stands for “Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs.” In the words of Matt Levine, a blogger for Bloomberg View:
The sheer art of naming something “Choice,” but “Choice” is an acronym that resolves to include “Hope”! Imagine if you could create hope by adjusting bank capital requirements. It is daring, inventive, impressive stuff. It’s no USA Patriot Act—what is?—but it is an achievement in acronyming that would make the financial industry proud.
Tags: CEO Pay Ratio, Dodd-Frank Act, Financial Choice Act
Under ASU 2016-09, all windfall and shortfall tax effects of stock compensation will run through earnings in the P&L. When vesting in performance awards is tied to earnings per share, this could make it harder to set the targets in the future because it will be harder to forecast earnings. And, for awards that have already been granted, it might make the current targets easier to achieve (or harder to achieve if the company is experiencing tax shortfalls).
Adjusting EPS Targets
Companies might be tempted to adjust EPS targets for existing performance awards, to reflect the company’s new expectations in light of ASU 2016-09. But, unless the terms of the award already address what happens when there is a change in GAAP prior to the end of the performance period, this could be hard to do. Modifications of targets could cause the awards to no longer be exempt from Section 162(m) and could have other implications.
If the targets aren’t modified, companies will likely have to adjust their forfeiture estimate for the awards.
Many companies use a non-GAAP calculation of EPS for purposes of their performance awards. Where the EPS calculation already excludes expense from stock compensation, it should also exclude any tax effects attributable to stock awards. And where this is the case, ASU 2016-09 won’t impact the likelihood of the targets being achieved.
In our May quick survey, we asked what companies plan to about their performance awards in which vesting is tied to EPS. Here’s what they said:
- 16% use a non-GAAP measure of EPS that already excludes stock compensation expense
- 2% are planning to adjust their EPS targets
- 35% are not planning to adjust their EPS targets
- 48% don’t know what they are going to do about their EPS targets
Tags: ASU 2016-09, earnings-per-share, EPS, performance awards, performance target
For today’s blog, we have a special guest entry from Terry Adamson of Aon Hewitt on three key considerations for relative TSR awards. Terry also invites readers to participate in Aon’s new Global Relative TSR Survey to find out how their plans compare to their peers’.
Three Factors That Impact Relative TSR Award Performance
By Terry Adamson of Aon Hewitt
I just finished reading over the March/April edition of The NASPP Advisor, and enjoyed reading the Q&A with Nell Minow, who will be the keynote address at the upcoming NASPP conference in October. One of her responses wished for more “indexed option grants so that they would only be in the money if the company outperforms its peers.” I love the idea and completely agree with the overarching philosophy of treating LTI as a profit sharing agreement between the employee and the investors. Unfortunately due to the tax code, indexed option grants create challenges. However, a similar payout function can be replicated with performance shares contingent on relative total shareholder return (RTSR), which is shares that vest based on the company’s stock price growth as compared to the stock price growth of defined peer companies.
RTSR has become a hot button with strong opinions weighing in from all sides. Some of the frequent criticisms are that relative TSR performance is not within management’s control, it is a “lottery ticket,” and simply rewards volatility. These criticisms are often misplaced to the discussion of whether relative TSR should be part of LTI. We know that relative TSR plans create incredibly strong shareholder alignment when properly designed, are completely transparent, and allow for objective multi-year performance measurement without the difficulty of long-term goal setting. The real challenge with relative TSR programs is designing a plan that is right for your organization and competes against a relevant group of comparators.
I’ve been thinking about these issues recently because Aon just formally launched our first ever Global Relative TSR Survey including firms from the United States, Europe, and Australia. I want to provide three recent thoughts that I have been playing with in my head:
- Averaging Period—Our preliminary data show 92% of companies have averaging periods on TSR calculations ranging from 20 trading days to 90 calendar days. However, early returns show 41% of companies use a 20-trading day. I continue to think that a 90-calendar day is appealing as it would continue to smooth out short-term stock price aberrations, and also ensures that an SEC regulatory filing is always included within the averaging period.
- Index vs. Custom Peers—A recent academic study, Relative Performance Benchmarks: Do Boards Follow the Informativeness Principle?, concluded that index-based peer groups perform 14% worse in their ability to explain performance than a customized peer group set. Interestingly enough, the study also has evidence that firms with poor governance are more likely to use an index rather than a bespoke group of peers. Our preliminary data show 56% of companies use an index for peer comparison within their relative TSR plans.
- Percentile Rank Plans vs. Outperform Plans—Percentile rank plans currently make up 86% of the market in our preliminary data. For larger peer groups, percentile rank plans work great. However, for smaller peer groups, percentile rank plans can create situations that see small changes in TSR produce large changes in payout—which I would label as a governance risk. In these situations, I believe an outperform plan is an elegant way of mitigating risk and graduating the earnout. Learn more about percentile/outperform plans at www.RelativeTSR.com.
I’ve brought up these issues because there needs to be much more research on relative TSR designs. It is challenging to determine specific plan design nuances as the public disclosures from award agreements, proxies, and other regulatory filings are vague. For the good of the industry, we urge issuers to participate in this ten-minute survey at www.RTSRSurvey.com, in which all participants will be provided results, so we can all better understand what creates better alignment with pay and performance in your equity plans. Further, cross-correlated against our PeerTracker plan certifications, we may be able to determine what plan designs have strongest TSR performance. Look for the results to be discussed thoroughly at the 25th Annual NASPP Conference in DC!
Terry oversees Aon’s global Equity Consulting practice, with specific domain expertise in equity accounting, performance certification, and share management. Between consulting gigs though, Terry proudly serves on both the CEP Advisory Board and the NASPP Executive Advisory Board. Further, Terry was on the FASB Round Table on Employee Share Options, and is the Chairman of the Society of Actuaries task force on stock option valuation. The NASPP Conference is returning to Terry’s college town (let’s go Georgetown!), so he hopes to see you there.
Last Wednesday, Elizabeth Dodge of Equity Plan Solutions and I presented to the San Diego NASPP chapter. Here are a few pics from the meeting. More pics on the NASPP’s Facebook page.
Chapter president James Tozer of E*TRADE Financial and Lynn Goldacker of NuVasive wait to check in the meeting attendees. Kudos to James and the rest of the chapter board for hosting a fantastic meeting.
James is also the NASPP’s Regional Representative for the South and is a member of the NASPP’s Executive Advisory Committee.
A few of the early arrivals. The early-bird gets a seat at the table.
Board member Claudia Baranowski of Illumina and Theresa Lee of Qualcomm. Thanks to Claudia for making copies of the slide presentation for everyone.
Board member Thomas Welk of Cooley (and NASPP Individual Achievement Award recipient and member of the Executive Advisory Committee) chats with Ralph Barry of Compensia. The meeting was held at Cooley’s offices; we appreciate the great meeting space.
The folks who got a seat at the table.
In the background, a few folks who didn’t get a seat at the table. It was a great turnout for a 7:30 AM meeting. So great, I think the board might schedule a few more breakfast meetings.
Tags: NASPP chapter meetings
It was standing room only at when I presented to the Nashville chapter this past Tuesday. Here are a few pics from the event:
As you can see from this photo, we had a full house for the meeting. Every seat was filled. I heard rumors of it being a record number of attendees. Nashville is one of the newest NASPP chapters and it’s great to see this level of interest from our members in the area.
I chatted with Catrice Cooke of Discovery Communications and Tami Phillips of UBS before the meeting.
A number of attendees arrived early to catch up with their friends and colleagues before the meeting. It’s always smart to take a little extra time out of your day to make a few connections while you attending your local NASPP chapter meetings.
Pictured here is the new chapter president, Tommy Swindle of UBS and board member Ron Marx of Tractor Supply, along with James Hockaday from Brookdale Senior Living. A big thank-you to Tommy, Ron, and the rest of the chapter board for accommodating my travel schedule and hosting a fantastic meeting!
There were even a few attendees from out of town. Melissa Sims and Dennis Lanham of the CEP Institute were in town for a conference and stopped by for the meeting.
One of the hottest questions I am hearing these days is whether to allow US employees to request additional federal tax withholding on their restricted stock, RSU, and performance awards. So, last week, we conducted a quick survey to find out what NASPP members are doing. Here are the results, in a nifty infographic:
Can’t see the infographic? View it on a separate web page.
P.S. NASPP members are awesome! We launched this survey on Thursday and by Saturday I had enough responses to close the survey and finalize the results. Thanks to all of you who participated so quickly! You rock! Check out the full survey results.
Tags: ASU 2016-09, excess withholding, tax withholding, W-4
This past Tuesday I presented at the Boston NASPP chapter. Here are a few pics from the meeting (see more pics on the NASPP’s Facebook page).
Kudos to chapter president Mike Albert of Fidelity Stock Plan Services and the chapter board for hosting a great meeting in a great location and also for accommodating my travel schedule. Pictured here with Mike is Ben Gibbons and Art Meyers of Choate Hall & Stewart.
Attending chapter meetings is a great way to catch up with your friends in the stock compensation community and to make some new friends (oh, and also to learn stuff).
The meeting was held at Tripadvisor’s headquarters in Needham, MA, which are pretty spiffy. This might look like a living room, but it’s actually the lobby.
A big thank-you to Kevin Kirby of Tripadvisor for arranging for such a fabulous meeting space. Joining Kevin in this picture is Yoon Park of Yoon Park Advisors.
Pamela Murphy of Charles River Laboratories and Hal Lorton of Fidelity chat after my presentation.
This was possibly the most interesting meeting room I’ve ever presented in. There were comfy sofas, and coffee table, a book shelf filed with travel souvenirs, and even a fireplace (well, technically it was the back of a pizza oven).
Tags: NASPP chapter meetings