Russell 3000 equity plan proposals are facing historically low shareholder support and higher failure rates in 2023. These headwinds likely reflect both increased shareholder and proxy advisor expectations in equity plan sizing and increased share usage pressure at companies in depressed markets.
Companies will want to slightly adjust their playbook and engage with shareholders differently. The path forward will likely only get tougher as investors and proxy advisors continue to push for equity plans with a shorter expected life, creating more frequent equity plan votes.
What the Data Says
The failure rate of equity plan proposals consistently fell between 0.4% and 0.6% from 2014 to 2022, or typically 2-3 companies annually after passage of the Tax Cuts and Jobs Act (which impacted the frequency of equity plan votes). The difference between the years with the highest and lowest average vote support on proposals was only 200 basis points. Voting on these proposals in 2023 has been noticeably different:
Average vote support on equity plan proposals thus far in 2023 (86.9%) is 270 basis points lower than the average vote support observed in 2022 (89.6%) and 80 basis points lower than the lowest average support observed in the last 10 years (2014)
The significant decrease in support is coupled with seven failed proposals, or a 1.3% failure rate that is nearly double the next highest failure rate over the last 10 years
Breakdown of Say on Pay Vote Results
The ISS “Against” recommendation rate (28%) is the highest observed over the last 10 years, and the average impact of an ISS “Against” is greater than in recent years
What is Driving the Headwinds on Equity Plan Voting?
Investor voting preferences and the macroeconomic environment are likely the two biggest contributors to the increased headwinds on equity plan voting.
ISS advises investors on proxy ballot initiatives, including equity plan approvals. Its consulting arm offers the Equity Plan Scorecard (EPSC), which helps companies balance equity plan provisions and shares requested to obtain an ISS “For” recommendation. Many investors follow EPSC guidelines, making it a go-to resource for companies seeking shareholder support.
Importantly, the bar for passing ISS’ EPSC has meaningfully increased over the last decade, with a recent increase in 2023. S&P 500 companies needed a score of 53 in 2015, but now require a 59 in 2023. The threshold score for non-S&P 500 companies in the Russell 3000 is slightly lower than for S&P 500 companies, but the required threshold score has similarly increased over the last few years.
Average Vote Results After ISS “For” or “Against” Recommendation
The average vote result for companies that receive an ISS “Against” is 19% percentage points lower than those that receive an ISS “For” thus far in 2023.
ISS “Against” Recommendation Rate
The EPSC process has two other critical points. First, the number of shares requested under a proposal is the most meaningful input in driving the EPSC outcome. Second, ISS’ consulting arm suggests building in 5 points of “cushion” when working in the EPSC, meaning companies typically size their requests such that they leave some shares “on the table” as a cautionary measure. As a result, companies face pressure to reduce the size of their share requests (which in turn will, in theory, create more frequent share requests and thus touchpoints for shareholders to “weigh in” through voting).
Negative returns in the 2022 equity markets and increasing interest rates have also likely increased shareholders’ attention around a company’s burn rate. For companies with a depressed share price, more equity is needed to fulfill the dollar amount of equity promised to their employees. And, with higher interest rates, the cost of equity has risen for companies. These two external factors occurring simultaneously—alongside tightening EPSC guidelines—made 2023 a challenging year for equity plan requests.
How Should Companies Approach Their Next Equity Proposal?
Shareholders understand that a failed equity plan proposal strains a company’s ability to deliver fair compensation, and thus they have been remarkably consistent in approving nearly 99.5% of proposals over the last 10 years. Proposals that fail shareholder votes almost always fall well outside of the EPSC “passing” score—sometimes earning negative points on the EPSC—and frequently contain provisions that almost all investors dislike (e.g., evergreen provisions).
The good news is that passing ISS’ EPSC means there is very little risk of failing an equity plan vote. There are always benefits to conducting shareholder outreach, but this process will not be a “make or break” action if a share request is sized within EPSC guidelines. The downside to sizing a request within EPSC guidelines is that the next equity plan request could come sooner than wanted.
Companies can take following steps if a share request falls outside of investor or EPSC guidelines:
Understand the size of the share request versus shareholder guidelines. Many large investors have published burn rate and dilution “caps” similar to those found on the EPSC. Understand how far above (or below) the share request is versus these caps. Falling below investor burn rate/dilution “caps” (even if the proposal did not pass the EPSC) can prove to be valuable.
Develop talking points to secure investor support. Highlight responsible share use, good governance provisions (e.g., no repricing provisions, no evergreen provisions, etc.), the frequent benchmarking of equity-eligible roles to calibrate target spend, and that future equity grants will help create a competitive compensation program for a broader set of employees. Use facts and figures that demonstrate historical responsible share usage and consider adding in performance-based equity.
Engage investors in pre- and post-proxy filing discussions to gain insights on their perspectives and guide share request drafting. Share the talking points developed in step 2, particularly in the pre-filing discussion, but also listen to feedback. Investors will be familiar with the actions of other companies in similar situations and may offer valuable insights and perspectives that could guide how a share request is ultimately drafted. Use the follow-up calls to demonstrate responsiveness to the feedback received in the first round of outreach and further the discussion.
Use the proxy proposal to outline the entire case for the request, including prior and expected burn rates and any other elements that are additive to the overall “story” (e.g., impact of M&A or buybacks on share usage and burn rate, etc.).
While gaining support for equity plan proposals is becoming more challenging, companies that are diligent throughout the proposal process are likely to pass their vote. Using these steps to prepare for an upcoming equity proposal will ensure internal alignment around the plan sizing and features and build a stronger relationship with the company’s shareholders.
Austin is a founding member of Semler Brossy’s New York Office and is now located in North Carolina. He advises clients on strategic compensation issues, including during periods of transformative change. As a result, Austin’s client base covers a variety of industries–including fintech, biotech, and retail–and company performance contexts.