ISS Updates How Stock Plan Proposals Are Evaluated
January 18, 2022
As we head into this year’s proxy season, it’s time to review the changes ISS has made to its voting policies for stock plan proposals.
See ISS’s FAQ on Equity Compensation Plans for more information.
No Changes to Equity Plan Scorecard
For the first time since the Equity Plan Scorecard was introduced, ISS made no changes to the EPSC factors, weightings or passing scores.
Clarification of Clawback Policy Factor
The EPSC has always included (and still includes) a factor relating to clawback policies. For the 2022 proxy season, however, ISS has clarified how it evaluates clawback policies, noting the following:
- The policy should authorize recovery of gains from equity awards in the event of a financial restatement.
- The policy should cover most or all equity compensation issued to all named executive officers.
ISS further notes that:
The company will not receive credit for a clawback policy that contains only the limited requirements under Sarbanes-Oxley, nor if the company discloses that it will establish a clawback policy only after the finalization of applicable rules under the Dodd-Frank Act.
New Burn Rate Calculation
Lastly, this year’s equity compensation voting policy introduces a new burn rate calculation which ISS refers to as the “value-adjusted burn rate” or “VABR.” For 2022, ISS will calculate VABR for informational purposes only but expects to use it to replace the existing burn rate calculation for the 2023 proxy season.
The existing burn rate calculation is adjusted for the volatility of the company’s stock. To calculate current burn rates, ISS completes the following steps:
- Multiplies the number of full value awards granted by a volatility factor.
- Adds the result obtained under step #1 to the number of stock options and SARs granted.
- Divides the total calculated in step #2 by the weighted average common shares outstanding.
Under the new value-adjusted burn rate, ISS will use the following process to calculate burn rates:
- Multiply the number of stock option and SARs granted by their Black-Scholes value per share.
- Multiply the number of full value awards granted by the per-share stock price on their date of grant.
- Add the totals from steps #1 and #2 together, then divide by the total stock price of the weighted average common shares outstanding.
This will change the burn rate analysis from a share calculation to a value calculation. In their memo summarizing the changes ISS announced this year, the consulting firm FW Cook notes the following:
ISS believes that a departure from the volatility-based calculation is warranted because the value-adjusted approach more accurately assesses the value of recently granted equity awards and the value of option grants. ISS also deems the value-adjusted approach as more closely reflecting the communication of equity value in the current market: the actual stock price for full-value awards, and a Black-Scholes adjusted value for options. Over time, this may have an unintended consequence of pushing companies with very high stock price volatility to grant more full-value awards in place of options, as options may be counted as nearly the same as RSUs for ISS burn rate purposes.
Updates to Burn Rate Tables
While the VABR won’t go into effect until 2023, ISS did make a number of changes to the burn rate tables for 2022. These tables establish the maximum burn rates that ISS deems acceptable by industry. The scoring for the burn rate factor in the EPSC is scaled based on how a company’s burn rate compares to the cap for its category and industry.
S&P 500: The burn rate caps remained the same for almost two-thirds of the industries in the S&P 500 and increased for four industries (consumer discretionary, health care, financials, and communication services). ISS did not decrease the burn rate caps for any S&P 500 industries.
Russell 3000: ISS increase the burn rate caps for nearly 60% of industries in the Russell 3000. The burn rate cap remained the same for the banking industry and decreased for nine industries (transportation; retailing; food, beverage & tobacco; household & personal goods; pharmaceuticals & biotechnology; software & services; technology hardware & equipment; semiconductor equipment; and telecommunication services).
Non-Russell 3000: ISS decreased the burn rate caps for just over half of industries for non-Russell 3000 companies (materials, capital goods, transportation, consumer services, consumer staples, health care equipment & services, pharmaceuticals & biotechnology, financials, software & services, and semiconductor equipment) and increased the burn rate caps for the remaining industries (energy, commercial & professional services, automobiles & components, consumer durables & apparel, retailing, technology hardware & equipment, telecom & media, utilities, and real estate).