It used to be that ISS would make only a few changes per year to its voting policies that affected stock compensation. Some years the changes didn’t even warrant a blog entry. But now ISS has the Equity Plan Scorecard and a scorecard requires constant tweaking. As a result, we now have a lengthy list of changes to review every year. Today’s blog entry is a summary of the ones I think are most significant.
It’s Harder for S&P 500 Companies to Earn a Passing Score
Big news for S&P 500 companies: your stock plans now have to earn an extra two points (a total of 55 pts) to receive a favorable recommendation. Everyone else’s plans still pass with only 53 pts.
The Burn Rate Test Gets a Little Easier for Acquirers
More big news: all companies can now request that ISS exclude restricted shares granted in consideration for an acquisition from their burn rate. Companies that want to request this must include a tabular disclosure reporting the number of restricted shares granted in this context for their most recent three fiscal years.
Partial Credit Eliminated for Some Factors
No more partial credit for CIC provisions, holding requirements, and CEO vesting requirements, and in some cases, the requirements to receive full credit have been relaxed.
To earn full credit for CIC provisions, the provisions must meet both of the following conditions (unless the company doesn’t grant time-based awards, in which case only the condition related to performance awards matters):
Performance awards can allow the following: (i) pay out based on actual performance, (ii) pro rata pay out of the target level (or a combination of i and ii), or (iii) forfeiture of awards.
Time based awards cannot provide for automatic single-trigger or discretionary acceleration of vesting.
To receive full points for the holding period requirement, shares must be required to be held for 12 months (down from 36 months in past years) or until the end of employment. No points for requiring shares to be held until ownership guidelines are satisfied.
To receive full points for the CEO vesting requirements, awards granted to the CEO in the past three years cannot vest in under three years (down from four years in the past). Still no points if no performance awards have been granted to the CEO in the past three years, but grants of time-based awards are no longer required to earn full credit.
Counting the shares underlying time-based awards is usually straightforward: one share granted equals one share issued. Performance awards, on the other hand, usually provide for a spectrum of possible payouts: one share granted might mean two shares issued, or .5 shares issued, or no shares issued. Given the many possible payout levels, how many shares should be considered granted for the various administrative and reporting purposes that are relevant to performance awards?
The last two issues of The Corporate Executive (January-February and May-June) took a look at this question and came up with 16 different purposes for which shares under performance awards are counted. In almost all cases the shares are counted differently. I thought it would be interesting to take a look a few of these purposes in the NASPP Blog. Now, 16 purposes is far too many to go through in one blog entry, so I’ll start with just one purpose and I’ll look at more in future entries. For today’s entry, we’ll look at counting the number of shares available in the plan.
Counting Performance Awards Against the Shares Available for Future Grants
There are no legal requirements that govern how performance awards must be counted against a plan’s reserve (other than those contained within the plan itself). Thus, for purposes of reducing the number of shares available in the plan as a result of performance awards, companies can make a policy decision as to whether to count the threshold, target, or maximum shares against the reserve.
Survey Says …
According to the NASPP’s Domestic Stock Plan Design Survey (cosponsored by Deloitte Consulting), practices in this area are split:
48% of respondents tracking awards against the plan reserve at the maximum payout
43% tracking them at the target payout
7% track awards at the expected payout
1% use some other approach
Best Practice (IMHO)
I feel pretty strongly that the best practice is to count performance awards against the plan reserve at the maximum possible payout. Where awards are counted at the target payout (or, worse, at the threshold payout), there is a risk that the company will not be able to meet its obligations should a higher level of performance be achieved. Once the performance period has closed, failing to have sufficient shares in the plan to cover the payout is problematic. At a minimum, allocating additional shares to the plan would require shareholder approval, which is not accomplished at the drop of a hat. There are likely to be accounting and securities law implications, as well.
But this approach has its drawbacks. As evidenced by the NASPP survey, many companies are reluctant to earmark shares for a payout that isn’t expected (in some cases, not even remotely) to be achieved. In the current environment, where share usage by public companies is heavily scrutinized and restricted by proxy advisors and institutional investors, reducing the plan reserve by the maximum possible payout could prevent the company from making subsequent grants at the desired level or force the company to request shareholder approval for additional allocations to the plan earlier than would otherwise be necessary.
Earlier this year, I presented five trends in restricted stock and unit awards. For today’s blog, I present a second installment in what I can now officially call a “series”: six trends in performance awards from the 2016 Domestic Stock Plan Design Survey cosponsored by the NASPP and Deloitte Consulting.
Trend #1: Performance awards are on the rise for executives.
Over the past four survey cycles, we’ve seen a more than 100% increase in the use of performance awards at the NEO and senior executive levels. For NEOs, usage has risen from 37% of respondents in 2007 to 80% in 2016. For senior execs, usage has risen from 32% of respondents in 2007 to 69% in 2016. Very few companies grant performance awards below the ranks of senior execs.
Trend #2: Performance-based options are not popular.
The vast majority of respondents (95%) issue full-value performance awards paid out in stock. Only 19% issue awards paid out in cash and only 8% issue performance-based options. I suspect this because when performance options are underwater, they don’t provide much of an incentive.
Trend #3: TSR is hot right now.
Usage of TSR as a performance metric has increased 80% since our 2010 survey, up from 29% to 52% of respondents. There is a lot of variation in practice when it comes to choosing performance metrics; this is the first time in the history of the survey that any performance metric is utilized by more than half of our respondents.
Trend #4: Three is the magic number when it comes to performance periods.
The majority of respondents (78%) measure performance over a three-year period. I suspect this is because ISS (and possibly other proxy advisors/investors) encourage use of a three-year performance period.
Trend #5: Multiple metrics are common.
Just over 60% of respondents report that their performance awards are subject to more than one metric: two metrics is most common but 19% use three or more.
Trend #6: Performance is typically measured at the corporate level.
Just under 90% of companies report that they measure performance at the corporate level only, rather than incorporating departmental, team, or individual goals. At 62% of respondents, the metrics for performance awards are different than those used for the company’s annual incentive plan (another 20% use a combination of annual incentive plan metrics and other metrics).
As part of its IPO last month, manufacturer Gardner Denver granted RSUs worth $100 million to its 6,000 employees, including hourly workers, customer service, and sales staff. According to Bloomberg, “As its executives rang the bell at the New York Stock Exchange, workers learned they would each get shares equal to about 40 percent of their annual salaries” (“KKR Gives Industrial Workers a Piece of the Action“).
There are three things that I find interesting/encouraging about this announcement.
Broad-based stock awards are common in the high-tech space. According to the NASPP/Deloitte Consulting 2016 Domestic Stock Plan Design Survey, 66% of high tech companies grant RSUs to exempt workers below middle management and 35% grant RSUs to nonexempt employees. In Silicon Valley, the numbers are even higher—77% grant RSUs to non-management exempt employees and 57% grant RSUs to nonexempt employees.
But outside of high-tech, grants of RSUs below middle management are a lot less common. Garner Denver makes gas compressors and vacuum systems and is headquartered in Wisconsin, putting it squarely outside of high-tech and about 2,000 miles from Silicon Valley. This makes their announcement blog-worthy in my book.
Even more surprising is that Gardner Denver is 75% owned by private equity firm KKR. After the grant, employees will own about 10% of the company. Private equity firms are not known for their generosity when it comes to stock compensation programs.
More Than a Token
What I find most interesting about this story, however, is the amount of stock delivered to employees. $100 million worth of stock to 6,000 employees works out to be an average of over $16,000 in stock delivered to each employee. At Gardner’s IPO price of $20, this is an average of over 800 shares per employee. As noted in the Bloomberg article, grants are 40% of employees’ annual salaries, making this more than just a ham sandwich. Each grant is likely to be meaningful to the employee who receives it.
This kind of investment positions an equity plan for success. If (and this is a big “if”) Gardner Denver can execute on the education necessary to help employees value the awards and understand how their efforts can improve the company’s stock price, this plan could be a win-win: improved results for the company and wealth creation for employees. The impetus for the plan came from the head of KKR’s industrials team, Pete Stavros, who is also the chairman of Gardner Denver. Bloomberg notes:
To Stavros, who wrote a paper while a student at Harvard Business School about employee share-ownership plans, manufacturers can make good prospects for employee ownership. In tech, for example, success often comes from betting on the right trend or on a single founder or chief executive officer, he says. By contrast, most manufacturers operate in a low-growth environment where they must do “a million things a little better” to excel, such as reduce scrap rates and improve plant productivity. Front-line workers know best where operational inefficiencies exist and how to fix them, and equity ownership lets them share in the fruits of their efforts.
Contrast Gardner Denver’s plan to Apple’s announcement of broad-based RSUs back in October 2015 (“Apple to Offer Broad Based RSUs“). Apple awarded grants of only $1,000 to $2,000 to employees, which, given Apple’s stock price at the time, likely worked out to be less than 10 to 20 shares per employee. Of course, Apple is subject to constraints that Gardner Denver isn’t: a lot more employees, proxy advisors, institutional investors, not 75%-owned by the investment firm that holds the chairman position on their board (who believes in employee ownership), over $100 million granted to their execs alone in 2016 and a history of mega-grants to execs. All of these things limit the number of shares available for grants to employees. But I still have to wonder how those RSUs are working out for them.
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.
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
The option was granted to IBM’s CEO and is for a total of 1.5 million shares, granted in four tranches. Each tranche cliff vests in three years and has a different exercise price, ranging from $129.08 to $153.66 (premiums ranging from 5% to 25% of FMV).
The option was granted in January of last year, about a month before IBM’s stock price hit its five-year low. IBM’s stock price recovered to the point where all four tranches were in the money around mid-July and the option has mostly been in-the-money since then. IBM’s stock is now trading at around $160 (down from a three-month high of around $180). Either the options were very effective at motivating IBM’s CEO or IBM didn’t set the premiums high enough (or both).
The option doesn’t vest until January 2019 and we all know what can happen to any company’s stock price in that period of time, so there’s no guarantee that the option will still be in-the-money when it vests. The option has a term of ten-years, however, so if it isn’t in-the-money, there’s still plenty of time for the stock price to recover before it expires.
A History of Premium-Priced Options
This isn’t IBM’s first foray into premium priced options. From 2004 to 2006, IBM granted a series of stock options to its executives that were priced at a 10% premium to the grant date market value. In 2007 they dropped the practice and granted at-the-money options, then they ceased granting options altogether. This is the first option IBM has granted since 2007.
The Valuation Mystery
The reason I was asked to comment on the option is that the value IBM reported for the option (which is also the expense IBM will recognize for it) is significantly less than amount that ISS determined the option was worth. IBM reported that the option has a grant date fair value of $12 million but, according to the Bloomberg article, ISS puts the value at $29 million.
It’s not unusual for there to be variations in option value from one calculation to the next, even when all calculations are using the same model and the same assumptions. But a variation this large is surprising. Both IBM and ISS say they are using the Black-Scholes model, so the difference must be attributable to their assumptions. If I were to guess which assumption is causing the discrepancy, my guess would be expected term. The dividend yield and interest rate aren’t likely to have that much of an impact and it seems unlikely that there would be significant disagreement as to the volatility of IBM’s stock.
Why Price Options at a Premium?
The idea behind premium-priced options is to require execs to deliver some minimum amount of return to investors (e.g., 10%) before they can benefit from their stock options. It’s an idea that never really caught on: only 3% of respondents to the NASPP/Deloitte Consulting 2016 Domestic Stock Plan Design Survey grant them.
I’ve never been a fan of premium-priced options. I suspect that most employees, including execs, assign a very low perceived value to them (or assign no value to them at all), so I doubt they are the incentive they are supposed to be. And the reduction in fair value for the premium is less than the amount by which the options are out-of-the money at grant and far less than the reduction to perceived value, which makes them a costly and inefficient form of compensation.
As announced yesterday, we’ve extended the deadline to participate in the Domestic Stock Plan Administration Survey that the NASPP co-sponsors with Deloitte Consulting. For today’s blog entry, I have six things I am excited about learning from this year’s survey.
Domestic Mobility Compliance: New this year, we’ve added questions on tax compliance for domestically mobile employees. This is an area of increasing risk and I’m curious to learn how far companies have come in their compliance procedures.
ESPP Trends: This survey takes an in-depth look at the design and administration of ESPP plans. I hear rumors of increased interest in ESPPs—both in terms of companies implementing new plans and enhancing the benefits in their existing plans; I’m excited to see if this plays out in the survey results.
Stock Plan Administration Staffing: This is the only survey I’m aware of that collects data on how stock plan administration teams are staffed, the department that stock plan administration reports up through, and how companies administer their plans. It is always intriguing to see the trends in this area.
Ownership Guidelines: The prevalence of ownership guidelines has increased dramatically in the last decade, with 80% of respondents to the 2014 survey reporting that they have these guidelines in place. Has this trend topped out or will we be reaching near universal adoption of ownership guidelines in this survey?
Rule 10b5-1 Plans: These trading plans have become de rigueur for public company executives, with 84% of respondents to the 2014 survey allowing or requiring them. We’ve expanded this area of the survey to capture more data on policies and practices with respect to these plans.
Director Pay: The survey reports the latest trends in the use of equity in compensating outside directors. I’m particularly interested in seeing what percentage of respondents indicate that they have imposed a limit on the number of shares that can be granted to directors. This is a best practice to avoid shareholder litigation but adoption of it was low in the 2014 survey—have we made progress on this in the past three years?
If you are interested in these trends, too, you’re going to want to participate in the survey so that you’ll have access to the results. It’s not too late to participate, but you have to do so by the end of this week. We’ve already extended the deadline once; we can’t extend it again. Register to participate today!
* Only issuers can participate in the survey. Service providers who are NASPP members and who aren’t eligible to participate will receive full access to the published results.
It’s restricted stock and unit week here at the NASPP. For today’s blog, I have five trends in the usage of restricted stock and units, from the 2016 Domestic Stock Plan Design Survey, co-sponsored by the NASPP and Deloitte Consulting.
Trend #1: Use of time-based stock grants and awards is still on the rise.
The percentage of companies issuing stock grants and awards increased by 10 percent since our last survey (up from 81 percent in our 2013 survey to 89 percent in 2016). In addition, among those companies that use restricted stock and unit awards, close to 40 percent of respondents report that their usage of these vehicles has increased at some level of their organization over the past three years, while only 18 percent report decreased usage over the same time period. Overall, that nets out to greater usage of restricted stock and units by more companies than in past surveys.
Trend #2: Time-based stock grants and awards are the equity vehicle most frequently granted to lower-ranking employees.
Stock grants and awards are the equity vehicles most commonly granted to lower-ranking employees, with 77 percent of respondents granting awards to middle management (approximately three times the percentage of respondents that grant either stock options or performance awards at this employee rank). Fifty-two percent of respondents grant restricted stock/units to other exempt employees (compared to 13 percent for stock options and 11 percent for performance awards) and 19 percent grant these awards to nonexempt employees (compared to 7 percent for stock options and 3 percent for performance awards).
Trend #3: Time-based stock grants and awards are also common at the top of the house.
Stock grants and awards are even more common for senior-level employees with 79 percent of respondents granting awards to the CEO, CFO, and named executives, and 84 percent granting awards to other senior management. The five-point drop in usage of restricted stock/units at the CEO, CFO, and NEO level as compared to other senior management is likely due to the increased usage of performance awards in the C-suite.
Trend #4: Restricted stock units are the vehicle of choice among various types of time-based full-value awards.
The 2016 survey saw a continuation in the shift away from restricted stock awards toward restricted stock units. Respondents reporting that they currently grant restricted stock awards* dropped from 44 percent in 2013 to 31 percent in 2016, while respondents currently granting restricted stock units* increased from 77 percent in 2013 to 83 percent in 2016.
* Awards not in lieu of cash.
Trend #5: Awards are most commonly granted on an annual frequency.
The overwhelming majority of companies that make grants of stock and units do so on an annual basis (ranging from 95 percent of respondents for CEOs, CFOs, and named executives to 75 percent of respondents for nonexempt employees). In addition to annual grants, stock/units are most frequently awarded upon hire, promotion, and for retention purposes.
The treatment of equity compensation in a change-in-control is complicated and perhaps the most complicated of all is the spin-off. We recently posted an article by Michael Gorski of Semler Brossy that looks at various ways outstanding stock grants are handled in a spinoff (“Keeping Your Equity Strategy in Balance Through a Corporate Spin‐Off,” originally published in workspan).
Gorski explains that, to minimize concerns over employee relations, companies should seek an outcome in which the pre-spin equity value is preserved. He breaks the approaches into various types, including the following two most common methods:
Shareholder (or Portfolio) Approach: Equity holdings are treated the same as those of a company shareholder in that they are divided into equity in both the remaining company and the spun-off entity on a one-for-one basis. For options, the exercise prices are converted, but the number of options remains the same.
Employee (or Concentration) Approach: Equity holdings are entirely in either the remaining company or the spun-off entity. This is the approach used most often as it ensures employees are aligned directly with the success of the company they are working for post-spin. For options, both the number of options and the exercise prices are translated to maintain the existing value.
Gorski provides a few examples from high-profile deals. For instance, when PayPal was spun off from eBay, it used the “employee approach” for employees staying with eBay or shifting to PayPal, but for executives in charge of a smooth transition, it used the “shareholder approach.”
When Kraft Foods spun off from Mondelez International, Gorksi notes that the transaction used the “shareholder approach” for options, SARs, restricted stock, and deferred stock units to encourage a collaborative environment between the companies. However, for performance shares, it used an “employee approach” to align directly with each company’s post-spin goals.