Performance Stock Options in Broad-Based Plans

The analysis consists of both a quantitative and qualitative review. Some executive plans, however, use performance-based options. The Decision-Maker's Guide to Equity Compensation How to find and implement an equity compensation strategy that works for your company. A plan might provide that some of the options will vest at one price, while others will vest at a higher price. It appears that ISS is conducting a less rigorous review of the executive compensation programs of newly-public companies at least when it comes to their initial Say-on-Pay proposal which may be due, in large part, to insufficient data about long-term public company pay and stock price performance. Like price-vested options, they vest upon the attainment of an objective, except that some other measurement than stock price provides the trigger, such as revenues, profits, or return on investment. A nonprofit membership organization providing unbiased information and research on broad-based employee stock plans.

Nonetheless, if we accept the view that standard stock options are not performance-based pay, here is the conundrum: ISS also contends that stock price movement is a suitable measure of corporate performance.

The ISS CEO “Pay for Performance” Analysis

The Equity Plan Scorecard model will not apply to stand-alone nonemployee director plans, which will be evaluated based only on shareholder value transfer. However, shares under such plans will be incorporated into the Plan Cost calculation when plans subject to Equity Plan Scorecard are on the ballot. Even if a plan has a passing score, certain factors may nonetheless result in a negative recommendation:.

However, plans being presented for m approval for the first time following an IPO or bankruptcy will be subject to a full Equity Plan Scorecard review. If you have any questions regarding these new ISS updates or your compensation programs more generally, please do not hesitate to reach out to the attorneys listed on this mailing. This memorandum is considered advertising under applicable state laws. Equity Plan Scorecard The adoption of the Equity Plan Scorecard signals a significant change in the ISS approach to equity compensation plan proposals and is effective with respect to proposals included in annual shareholder meetings held on or after February 1, The Equity Plan Scorecard represents a shift to a more holistic analysis under which the plan can earn points based on the following three categories of factors: Scoring is not binary, but rather, is scaled, such that companies can receive a range of points.

Plan Features — penalizes the following plan features: In response to our inquiries, ISS has stated that a plan may carve out 5 percent of shares from the minimum vesting requirement and still receive full points. You can find many more articles on employee ownership and corporate performance in the articles section title Ownership Concepts and Research on our home page. These plans qualify for fixed price accounting, so they do not show up on the company's income statement at the time they are granted.

Some executive plans, however, use performance-based options. These plans provide that the option holder will not realize any value from the option unless specified conditions are met, such as the share price exceeding a certain value above the grant price or the company outperforming the industry.

Performance-based plans can require variable plan accounting, which requires companies to show on their income statement a value determined by calculating the difference between the grant price of the options and the stock's current fair market value, multiplied by the percentage of options vested, adjusted for the cumulative prior expense recorded. Any performance-based plan in which the measurement date the first date on which the number of shares and the exercise price are known occurs after the date of the grant triggers variable plan accounting.

This "hit to earnings" discourages most companies from using at least some kinds of performance options in a broad-based plan, even though an argument can be made that shareholders should be much happier with this approach. As long as shareholders remain in blissful accounting ignorance, however, the fixed approach appears better. Companies may also be concerned, however, that attaching a performance criterion to options may be inappropriate for non-executives because they have too little control over helping companies meet the targets.

Of course, they have no more control over whether the company's stock price increases above the grant price, but the layering on of conditions may make the options seem too uncertain. Advocates for performance-based plans counter that providing specific targets can help focus employee interest on company-specific goals, whereas employees can often benefit from options simply because the industry or broad market does well.

The plans may also be easier to sell to at least some shareholders, especially if they qualify for fixed plan accounting. If these or other arguments are persuasive, several types of performance options might be considered.

The plans described here are not the only choices; companies can impose all sorts of performance criteria and option terms. Whatever choice is made, however, care should be taken that it can be readily understood by employees, that it has a real chance of delivering meaningful value, that it fits with the company's culture, and that it will not cause recruitment or retention problems.

Plans That Allow Fixed Plan Accounting Performance Grants In the simplest of plans, the company grants options only on the achievement of certain specified targets, such as stock price or profits. Boeing announced such a plan a few years ago. Performance-Accelerated Vesting These plans grant options as usual, and have a normal vesting schedule. However, if specified targets are met, vesting accelerates. These plans normally get fixed plan accounting as long as the base vesting schedule does not exceed the company's normal option vesting schedule or, if it is the only kind of plan, what would be arguably normal in the industry.

Premium-Priced Options These options are granted at a strike price the price at which the shares can be exercised that exceeds the current price, so for them to have a value, the stock must increase to at least this higher target price.

Applying the “Pay for Performance” Analysis to Newly-Public Companies

In this context, strongly performance-based equity awards do not include standard time-based stock options or performance-accelerated grants. Instead, performance-based equity awards are performance-contingent grants, where the individual will not receive the equity grant if target performance is not achieved. The evidence to date does not suggest a significant shift to performance-contingent stock options, despite the pressure for companies to enhance the appearance of having performance-based pay. Yet there are circumstances where this vehicle may make good sense, and in this article we outline the benefits and risks of performance options, and. Home» Articles» Performance Stock Options in Broad-Based Plans [Editor's note: You can find many more articles on employee ownership and corporate performance in the articles section title Ownership Concepts and Research on our home page.].