On December 16, 2022, Institutional Shareholder Services (“ISS”) released its updated FAQs on Equity Compensation Plans, which will apply to its “Equity Plan Scorecard” evaluation of equity plan proposals in shareholder meetings held on or after February 1, 2023. Under the Equity Plan Scorecard, ISS scores a proposed equity plan based on factors relating to (i) plan “cost” under a “Shareholder Value Transfer” model, (ii) plan features and (iii) company grant practices.
Although the only major update to the scorecard for 2023 relates to the burn rate factor, the threshold passing scores have also been increased and there is an interesting clarification on the clawback factor, as follows:
- New Value-Adjusted Burn Rate (VABR) Factor – As previewed in its updates for the 2022 proxy season, for 2023, ISS will calculate a company’s three-year average burn rate relative to its industry and index peers using a new “value-adjusted” model. According to ISS, the new methodology is intended to better approximate companies’ equity grant rates by using more accurate measures for the value of awards. Specifically, under the VABR method, options are valued based on a Black-Scholes model and full value awards are valued based on stock price, rather than using a multiplier based on the company’s historical stock price volatility. A company’s annual VABR will be calculated as follows:
((# of options * option’s $ value under Black-Scholes) + (# of full value awards * stock price))
(Weighted average common shares * stock price)
The impact of the new VABR methodology will vary based on a company’s circumstances. However, we have seen that it is having a material impact on the Equity Plan Scorecard results for some companies taking their plans for shareholder approval this year, affecting the number of plan shares for which ISS is likely to give a favorable vote recommendation.
- Increases to Threshold Scores – The threshold passing scores (out of a maximum of 100) under the Equity Plan Scorecard will increase as follows:
- S&P 500 model – from 57 points to 59 points
- Russell 3000 model – from 55 points to 57 points
- Non-Russell 3000 model – from 53 points to 55 points.
The threshold passing scores are unchanged for companies subject to ISS’s “Special Cases” models (applicable to recent IPOs, spinoffs, and certain bankruptcy-emergent companies).
- Clawback Policy must Apply to Time-Based Awards – Although ISS’s “Clawback Policy” factor has not changed for 2023, ISS has clarified that to qualify for Equity Plan Scorecard points under the factor, a company’s clawback policy should authorize recovery upon a financial restatement of both time- and performance-based equity awards. Therefore, a clawback policy in line with the minimum requirements of the SEC’s final clawback rule (Rule 10D-1) under Dodd-Frank will not receive points, because Rule 10D-1 generally exempts time-based equity awards from compensation that must be covered by the policy. However, as the clarifications do not impose prescriptive requirements on how the clawback should be applied to time-based equity awards, companies desiring to garner points on this factor should have some flexibility to determine which time-based awards would be subject to clawback and the portion of such awards to be recouped. Separately, because this factor is evaluated under the grant practices pillar of the Equity Plan Scorecard, it should not be necessary to hard-wire these clawback policy requirements into a company’s stock plan.
Companies seeking shareholder approval of their equity incentive plans this proxy season and desiring a favorable vote recommendation from ISS should consider the above changes and determine whether the new “value-adjusted” burn rate factor will impact their share request or require any associated revaluation of plan terms or other Equity Plan Scorecard factors to meet the increased threshold passing scores. Additionally, public companies preparing to adopt clawback policies compliant with the SEC’s new Rule 10D-1 and the pending listing standards should consider whether to expand their clawback policies to require recovery of time-based awards, as well as performance-based awards, in the event of a financial restatement.