The path to requesting additional shares from shareholders for equity incentive plans has been well defined, and with a success rate over 99%, companies are clearly very comfortable navigating that path. However, the landscape is changing and companies now have a longer list of items to consider in order to ensure a successful share authorization.
In the past, companies would develop a share authorization based on the number of shares needed for 3-4 years and test it against peer and industry overhang and run rate levels. If the proposal passed proxy advisor tests (primarily ISS’s Shareholder Value Transfer test) and the overall dilution was reasonable, then passage of the authorization was almost guaranteed.
However, that consensus is beginning to break down. Shareholders and proxy advisors, who have been focused largely on Say on Pay for the past several years, are turning their attention back to equity plans and challenging the status quo. ISS is working on a new ‘holistic’ approach to evaluating equity plans, looking beyond just the dilutive effects of the plan and focusing more on how the shares are going to be used. And plaintiffs’ lawyers are on the prowl, threatening lawsuits against companies that do not sufficiently disclose details on their share requirements.
In today’s world, ensuring the passage of new share authorization, and avoiding a lawsuit in the process, requires consideration of many additional factors, including:
1) Provide additional disclosure related to the dilution and expected life of the share authorization. Shareholders are increasingly focused on dilution in executive compensation programs, particularly as options have declined in prevalence and comparison of dilution across equity vehicles is more complicated. Disclosing supplemental information related to the company’s assumptions in modeling the appropriate authorization will also help head off potential litigation.
2) Do not rely solely on historical norms or proxy advisor guidelines. Large institutional investors are increasingly becoming more sophisticated and developing their own methodologies to evaluate dilution and share requests. Ensuring that the share authorization not only meets ISS’s tests, but also the guidelines of the company’s big institutional investors, is critical.
3) Time the request for a good performance year. Strong company performance generally lowers the level of shareholder scrutiny on the pay program and share requests. In some limited cases, shareholder concerns related to Say on Pay have carried over to the share authorization. Although certainly not always possible, timing the request to follow a year of strong performance will help increase the chances of an authorization passing.
Overall, navigating the path to a successful share request is still very achievable. However, doing so requires companies to be aware of more and more factors as the executive compensation environment continues to evolve.