The Advisors' Blog

This blog features wisdom from respected compensation consultants and lawyers

Monthly Archives: December 2024

December 3, 2024

Equity Awards: Maintaining Reasonable Dilution

This article from Meridian Compensation Partners addresses managing a company’s run rate — the number of shares granted from the incentive pool during the year divided by the average common shares outstanding used for basic EPS. The article notes that, last year, the ten top shareholder return performers in the S&P 500 increased their run rate by an average of approximately 5% year over year, while the bottom ten increased by about 40% on average. While the article discusses three approaches to comparing run rate relative to peers — gross shares granted at target, gross shares earned and net number of shares granted (excluding forfeitures and cancellations) — Meridian recommends using target number of shares granted for the best comparative assessment.

Going into 2025, for companies experiencing depressed stock prices, significant volatility or an otherwise high relative run rate, the post has this reminder of various options to reining in dilution:

Apply a long-term stock price average to derive the number of shares: Use a 6- or 12-month stock price average that may smooth out temporary dips.

– Below the executive level, grant a portion of the intended equity value in restricted cash: Maintains employee satisfaction and retention without diluting shareholders (at the expense of reducing alignment with shareholders).

– Reduce equity eligibility: Reserve equity for positions that are difficult/impossible to recruit and retain without equity awards.

– Reduce vesting period in connection with a lower grant date value: Annualized value delivered will feel similar to the employee despite a smaller number of total shares granted.

– RSUs in lieu of stock options: RSUs provide greater retention, cannot be underwater and use fewer shares for a given targeted dollar amount.

– Reduce dollar value of equity awarded: When a company’s share price decrease is precipitous (e.g., energy companies in 2020), companies may decrease the dollar value of equity awarded to manage both the run rate and upside leverage on share price rebound.

Meredith Ervine 

December 2, 2024

Equity Plan Proposals: The Glass Lewis Approach

Last week, Glass Lewis released this special report (available for download) on its approach to analyzing equity plan proposals. The report reviews the proxy advisor’s Equity Compensation Model — the tool used by its analysts to assess share request proposals put forth by U.S. companies — in detail and discusses equity plan proposal trends from the 2024 proxy season.

The model includes eleven quantitative and qualitative tests that gauge:

– The potential dilution and overall costs of the proposed plan,
– If the company already has enough shares for near-term granting,
– If the proposed share pool is excessively large, decreasing the frequency in which shareholders will have a say on the company’s equity compensation program, and
– If the company’s actual share usage aligns with shareholders’ values.

Glass Lewis’ four cost-based tests evaluate actual and projected costs to shareholders relative to industry peers. Potential dilution as measured by overhang is evaluated on both absolute and relative bases. The results of the remaining quantitative tests are compared to fixed benchmarks, adjusted to incorporate sector-specific considerations or changes to the size of the employee base at the company. Additional tests measure how well the qualitative features of the proposed plan follow best practices in pay governance.

For the 2024 proxy season, the “dilution exceeds peers” test was most commonly failed — though the report notes that a mere 6% of proposals that failed this test actually received an against recommendation after the full, holistic assessment. The next most failed test was the “pace of historical grants” test, which finds the ratio of the company’s net recent grants to its total shares outstanding and compares that to an industry benchmark. In terms of the test most correlated to against recommendations, the “expensed cost as a percentage of operating metrics” and “projected cost as a percentage of operating metrics” were most correlated. A majority of proposals that failed either test ultimately received an against recommendation.

Glass Lewis has recently been emphasizing how its approach to executive compensation is both “holistic” and “case-by-case,” and this is again reiterated in this report.

In some tests, the model uses historical practices to forecast future granting behavior. However, it may be the case that such historical data no longer apply to companies that have experienced significant transformations such as large mergers. As a result, each company that presents a proposal to Glass Lewis’ clients for vote is evaluated on a case-by-case basis to ensure that all tests used in the model are applicable. When a transformative event or a contravening factor is identified, Glass Lewis refrains from using the full model, though unimpacted tests remain part of our assessments.

Meredith Ervine