Today [February 9, 2015], the Commission issued proposed rules on Disclosure of Hedging by Employees, Officers and Directors. These congressionally-mandated rules are designed to reveal whether company executive compensation policies are intended to align the executives’ or directors’ interests with shareholders. As required by Section 955 of the Dodd-Frank Act, these proposed rules attempt to accomplish this by adding new paragraph (i) to Item 407 of Regulation S-K, to require companies to disclose whether they permit employees and directors to hedge their companies’ securities.
Posts Tagged ‘Equity-based compensation’
1. What is the basis for ISS’ new scorecard approach for evaluating equity compensation proposals?
The new policy will allow more nuanced consideration of equity incentive programs, which are critical for motivating and aligning the interests of key employees with shareholders, but which also fuel the lion’s share of executive pay and may be costly without providing superior benefits to shareholders. While most plan proposals pass, they tend to get broader and deeper opposition than, for example, say-on-pay proposals (e.g., only 60% of Russell 3000 equity plan proposals garnered support of 90% or more of votes cast in 2014 proxy season, versus almost 80% of say-on-pay proposals that received that support level). The voting patterns indicate that most investors aren’t fully satisfied with many plans.
There is an important difference between the price paid for a business enterprise and the intrinsic value of that enterprise. As Benjamin Graham said, “Price is what you pay; value is what you get.” Warren Buffett has made himself and many others wealthy by understanding this difference and making investments accordingly.
Part I of this post looks briefly at the intrinsic value versus the market price (sometimes the latter is referred to as market value or market cap) of a publicly traded corporation. Part II looks at current design of long-term incentives awarded to the management of such corporations. These awards tend to be tied to short-term increase in the market price of the corporation’s stock. Part III suggests a way in which long-term incentive awards might be tied more to generators of long-term value of the corporations awarding them.
The use of long-term incentives, the principal delivery vehicle of executive compensation, has long been sensitive to external influences. A steady source of this influence has come under the guise of legislative reform with mixed results. In 1950, after Congress gave stock options capital gains tax treatment, the use of stock options surged as employers sought to avoid ordinary income tax rates as high as 91%. Some forty years later, Congress added Section 162(m) to the tax code in an attempt to rein in excessive executive pay by limiting the deduction on compensation over $1 million to certain executives. Stock options qualified for a performance-based exemption leading to a spike in stock option grants to CEOs at S&P 500 companies.
Fast forward twenty years and the form and magnitude of long-term incentives continues to be a hot button populist issue. The 2010 Dodd Frank Act introduced U.S. publicly-traded companies to Say on Pay giving shareholders a direct channel to voice their support or opposition for a company’s pay practices. Another legislative addition to the litany of unintended consequences, Say on Pay has magnified the growing number of interested parties, increased the influence of proxy advisory groups such as Institutional Shareholder Services (ISS) and Glass Lewis, heightened sensitivity to federal regulators, and provoked the increased interaction of activist investors.
Frederic W. Cook & Co. Inc.’s 2014 Director Compensation Report indicates that non-employee director compensation increased modestly since last year, with increases ranging from 4% to 7%. Although no new design trends were observed, the streamlining of director compensation continues through (1) replacing meeting fees with higher cash retainers implying that director attendance is a prerequisite of board service, (2) denominating equity grants as a dollar value rather than as a number of shares to mitigate year-over-year valuation changes, and (3) shifting from stock options to full-value shares to strengthen the alignment of directors’ and shareholders’ interests.
In our paper, Strategic News Releases in Equity Vesting Months, which was recently made publicly available on SSRN, we study the link between the equity vesting schedules of CEOs and the timing of corporate news releases. We show that, in months in which the CEO has equity vesting, the firm releases more news. This is an easy way to pump up the short-term stock price, as news attracts attention to the stock. This attention also increases trading volume, which allows the CEO to cash out his equity in a more liquid market. Indeed, we find that these news releases lead to significant increases in the stock price and trading volume in a 16-day window, but the effect dies down over 31 days, consistent with a temporary attention boost. The median CEO cashes out all of his vesting equity within seven days—within the window of price and volume inflation.
Publicly traded companies are required by the SEC and the stock exchanges to obtain shareholder approval when such companies seek to implement a new long‐term equity plan or increase the share reserve pursuant to such plans.
Companies comply with this requirement by seeking shareholder approval through the annual proxy process. Institutional Shareholder Services (ISS), the large proxy advisory firm retained by many institutional investors for proxy voting advice, offers its services to institutional clients by evaluating such proposals. One of the tools used by ISS in developing its voting advice is a financial model referred to as the Shareholder Value Transfer (SVT) Model that attempts to assign a cost to each company’s equity plan. ISS’ proprietary SVT model contains numerous hidden values and algorithms a company cannot readily replicate. If the SVT Model results in an assigned cost that falls outside the boundaries of what is acceptable to ISS, ISS will submit a negative vote recommendation.
On October 15, 2014, Institutional Shareholder Services (“ISS”) released proposed amendments to its proxy voting policies for the 2015 proxy season. ISS is seeking comments by 6:00 p.m. EDT on October 29, 2014.  ISS has stated that it expects to release its final 2015 policies on or around November 7, 2014. The policies as revised will apply to meetings held on or after February 1, 2015.
As issues around cost transparency and best practices in equity-based compensation have evolved in recent years, ISS proposes updates to its Equity Plans policy in order to provide for a more nuanced consideration of equity plan proposals. As an alternative to applying a series of standalone tests (focused on cost and certain egregious practices) to determine when a proposal warrants an “Against” recommendation, the proposed approach will incorporate a model that takes into account multiple factors, both positive and negative, related to plan features and historical grant practices.
Feedback from clients and corporate issuers in recent years, beginning with the 2011-2012 ISS policy cycle, indicates strong support for the proposed approach, which incorporates the following key goals:
Stock options have been a part of executive pay at major U.S. corporations for approximately 100 years. They have had an important role for approximately 70 years, starting in the 1950s. They have gone through periods of extraordinary popularity (e.g., the 1990s) and have been less popular during periods when the stock markets were in the doldrums. They survived the change in accounting rules (2006) that now require them to be a charge against earnings. This post examines this history and takes a look at where options are today.