Two of the leading shareholder proxy advisory firms, Institutional Shareholder Services (“ISS”) and Glass Lewis & Co. ("Glass Lewis"), released updates to their proxy voting guidelines for the 2015 proxy season. In sum, there is a new, “more nuanced” approach to evaluating equity incentive plan proposals, and a new focus on employee stock purchase plans and one-off awards granted outside an incentive plan.
- ISS guidelines for evaluating equity plans introduce a new “scorecard” approach that may promote more flexibility in designing equity compensation programs.
- Glass Lewis expresses a negative view of “one-off awards” granted outside of a company’s ordinary compensation programs and will look for enhanced and specific proxy statement disclosure relating to and justifying such awards.
- Glass Lewis adopts a methodology for reviewing ESPPs and will perform peer group analyses of ESPP practices.
ISS Updated Proxy Voting Guidelines for Equity Plan Proposals
Intending to better and more fairly address and recognize the range of equity compensation plan practices, ISS is changing its approach to evaluating equity plan proposals by introducing a scorecarding approach. The new approach will apply to proposals submitted at annual meetings held after February 1, 2015. Although much of the substance of the equity plan analysis remains the same, ISS’s new Equity Plan Scorecard (“EPSC”) is intended to provide a more nuanced approach for evaluating equity plan proposals by focusing on three general areas: plan cost (receiving a 45% weighting), grant practices (receiving a 35% weighting) and plan features (receiving a 20% weighting). ISS’s prior method for evaluating equity proposals was a pass-fail method under which a negative recommendation was very likely to be triggered by any one of a number of practices or characteristics that are, in the view of ISS, the hallmarks of expensive or inappropriate equity compensation practices (such as burn rates exceeding an industry cap, unreasonable total cost or shareholder value transfer, or expressly allowing option repricing without shareholder approval). ISS reiterated that while some egregious practices – such as allowing option repricing without shareholder approval – will continue to generate negative recommendations, other undesirable features of equity plans could be overcome to achieve a favorable recommendation if there are a sufficient number of positive factors.
With respect to plan cost, ISS focuses on the estimated value that equity plans transfer from shareholders to directors and employees, ie., so-called "shareholder value transfer" (“SVT”). Under the new approach, ISS will measure SVT in relation to peers, considering two SVT measures, one of which is based solely on the amount of new shares requested plus shares remaining under prior authorizations, with the other measure for SVT also incorporating all outstanding awards.
With respect to plan features and grant practices, ISS will continue to focus on many of the practices that have attracted scrutiny in the past. Such practices include automatic single-trigger vesting upon a change in control, liberal change in control definitions, discretionary vesting authority, liberal share recycling, lenient vesting requirements for CEO equity grants, short or no vesting periods for other equity plan grants, and a high burn rate relative to peer companies. Under the new EPSC approach, the presence of one or more of these practices may not trigger a negative recommendation.
To apply the scorecard approach across a broad range of companies in an appropriate manner, ISS will adopt separate scorecards for S&P500 companies, Russell 3000 companies (not in the S&P500), non-Russell 3000 companies, and companies that either recently emerged from bankruptcy or had an initial public offering.
The EPSC is intended to bring a more flexible scrutiny to equity plan features and reduce the prospect of negative recommendations triggered by one or more specific negative plan features. This may engender and support more custom-tailoring in the design of equity programs. ISS intends to release more information about the EPSC in December.
Glass Lewis Updates to Executive Compensation Guidelines
One-off Awards. While proxy advisory firms have for some time been wary of one-off awards and retention grants, Glass Lewis now specifically takes the position that grants outside of a company’s standard incentive schemes may not only undermine the integrity of established plans and the link between pay and performance, but are also evidence that the existing incentive plans do not provide appropriate incentives for executives. Glass Lewis believes that, in some cases, the appropriate solution may be to comprehensively redesign compensation programs, as opposed to making one-off awards. If a company believes that certain incentives outside of its established plans are appropriate, Glass Lewis will require that the awards be thoroughly described in the Proxy Statement, including explanations of why the one-off awards were necessary and why existing awards did not provide sufficient incentives.
One might question the need for this additional scrutiny and disclosure given the comparatively few instances of one-off grants, due to, for the most part, stock exchange listing requirements and the need to grant awards under a shareholder-approved plan to obtain exemption from the deduction limits of IRC section 162(m). In fact, significant-sized one-off equity grants are typically made in the executive recruitment and inducement context (an eminently valid reason and one recognized by NASDAQ and the NYSE). The irony here is that, in such equity grant cases, the one-off awards are usually the result of and driven by a lack of sufficient plan pool shares, or the need to preserve those shares, often because ISS or Glass Lewis (or both) recommended against (or threatened to recommend against) an adequate number of shares in connection with a previous shareholder plan pool approval.
ESPPs. Glass Lewis will now also perform peer group analyses of the shareholder cost of ESPPs. This cost analysis will take into consideration the expected purchase price discount under the ESPP, the purchase period, the anticipated purchase activity based upon prior employee purchase disclosures, whether the plan has a “lookback” feature, and the number of shares authorized under the plan. Although Glass Lewis is generally in favor of companies sponsoring ESPPs as a method for strengthening the alignment between employees and shareholders, concerns might still be raised if the aggregate number of shares requested for the ESPP results in significant overall dilution or if shareholders will not have the opportunity to reapprove the ESPP for an excessive period of time. Accordingly, Glass Lewis may recommend against an ESPP if it contains an “evergreen” share pool provision.