April 21, 2014
Equity is the primary vehicle for compensating top executives and tying their interests to those of shareholders. While equity provides an attractive and often less costly non-cash compensation component for companies, it still carries a cost to shareholders in the form of dilution when options are exercised or shares are earned. Proxy advisors, institutional investors, and academics have a number of dilution measurements they consider when determining how prudently a company is administering its equity programs. Among the most heavily relied upon dilution tests is Shareholder Value Transfer (SVT), a metric created by Institutional Shareholder Services (ISS). Unlike other ways of measuring dilution, SVT calculates dilution on a cost basis rather than a share basis. The cost analysis requires valuing existing equity awards and projecting the cost of future equity awards either currently available for grant or being requested at an annual shareholder meeting. That overall cost is divided by market cap, and the resulting percentage is judged as either pass or fail based on proxy advisor standards.
Nearly half of sample technology companies had an SVT percentage between 10% and 15%.
The median company had 59% of its SVT attributable to total shares available and 41% of its SVT attributable to overhang.
Over half the sample technology companies used fungible equity pool designs to help mitigate SVT costs.
Results of share request votes are moderately correlated with SVT percentage.
In order to provide a detailed snapshot of SVT in an equity-intensive sector, Equilar analyzed the 79 technology companies in the S&P 1500 that requested shares between April 2013 and April 2014. Only share requests for primary equity plans were considered. In this article, SVT is broken down into its components, key equity plan features that drive the SVT formula are summarized, and voting results are compared to the SVT percentage.
For the 79 technology companies examined, the SVT percentage ranged from 2.8% to 25.0%.
The median SVT percentage was 11.2%.
More than one-third of the companies had an SVT percentage between 10.0% and 12.4%.
When requesting additional shares, companies must avoid exceeding an SVT cap in order to avoid a negative recommendation from ISS while also ensuring that they have enough shares to compensate all eligible employees for at least one year. The chart below summarizes company estimates of how many years each expects its share requests to satisfy company needs.
41 companies disclosed an estimated years-until-depletion number.
24 of these 41 companies aim to provide two to three years’ worth of shares with each share request.
The maximum number of years’ worth of shares requested was 5.5, indicating that requesting shares for more than 5.5 years may push the SVT percentage too high.
SVT comprises both overhang and shares available for grant. Furthermore, overhang is broken down into options and full-value shares outstanding. The shares-available component is broken down into shares requested and shares previously available. For the 79 S&P 1500 technology companies analyzed, the median breakdowns are shown below:
The company at the median had 59% of its SVT attributable to total shares available and 41% of its SVT attributable to overhang.
The value of shares requested for the company at the median was approximately 1.7 times the number of shares previously available.
Outstanding options represented about 1/6th of the SVT calculation for the median company and had the highest spread, ranging from 0% to 68%.
Equity Plan Features
Equity plans can include a variety of provisions and features. Three particular plan features—full-value award sublimits,fungible ratios, and liberal share recycling—have a direct impact on the SVT formula.
A full-value sublimit prevents a company from granting full-value shares in excess of the limit without further shareholder approval. If a plan has such a sublimit, shares available are valued as full-value awards up to the limit with the remainder valued as options.
A plan with a fungible ratio requires that full-value shares are counted at a higher rate than derivatives (e.g., one full-value share counts as two shares while an option counts as one for a fungible ratio of 2.0). The SVT formula will take into account the fungible ratio and value all awards as either full-value or derivative, based on which is more costly.
Finally, liberal share recycling is a provision that allows derivatives granted and exercised, under certain circumstances, to be added back to the plan for future grants. When those provisions are in place, the SVT formula will treat all awards as full-value awards.
Plans with liberal share recycling generally receive a more costly valuation, which is why few companies (2.5%) have this plan feature.
Slightly more than half of companies have a fungible ratio, which discounts the cost of full-value awards by the ratio.
The median fungible ratio was 1.94 with a minimum of 1.28 and a maximum of 3.00.
While both sublimits and fungible ratios help reduce SVT costs, fungible ratios have proven more popular due to the flexibility they give companies to grant the equity vehicles they prefer.
Cost Per Employee
When companies request shares, one of the main factors they consider is the current number of employees and how that figure is likely to change. In particular, a company expecting to make acquisitions that significantly grow headcount needs to factor the larger future employee base into its current request. Companies must also decide how much value to reserve per employee based on stock price expectations. Most companies design their primary equity plans for maximum flexibility and, accordingly, allow for all employees to be eligible for grants even when in reality a far narrower group of executives will actually receive awards. The table below breaks down SVT values both by employees and eligible employees as disclosed by sample companies.
79 companies (100%) disclosed their employee count, while 67 companies disclosed employees eligible under their equity plan.
49 of the 67 companies had 100% employee eligibility; 10 of the 67 companies had less than 50% eligibility.
Salesforce.com had the highest SVT per employee at $1,318,617 and the highest SVT per eligible employee at $2,393,046.
SVT per employee was $170,274 on average for companies above the 50th percentile, based on three-year TSR, and $81,050 for companies below.
Voting Results Compared to SVT Percentage
All share requests are subject to an SVT analysis from ISS and require a shareholder vote. In our sample of 79 companies, none failed to receive 50% approval, although results ranged from 52% to 98%. While many factors may affect a shareholder vote, we tested the correlation between SVT percentage and voting results. The resulting scatter plot is shown below, and a linear regression is observed:
Voting results correlated with SVT percentage with a coefficient of determination (R2 value) of 0.34, meaning that 34% of the variance in approval percentage is attributable to variance in SVT percentage.
The regression analysis shows that, for every percentage point increase in SVT, approval percentage will drop by approximately 1.46 percentage points.
The relationship between one- and three-year trailing TSR against SVT percentage was examined, but no strong correlation existed.
Voting results did not correlate with TSR, SVT per employee, or SVT of shares requested.
Equilar’s Shareholder Value Transfer (SVT) simulator allows you to project the cost of your equity plan using a transparent and straightforward methodology. Equilar’s SVT simulator goes beyond the limits of an arbitrary cap. Our SVT reports break down the cost of your equity plan in the context of your industry and peer group, providing the tools necessary to clearly communicate the structure of your plan to your shareholders.
Voting Results Compared to SVT Percentage
Value the cost of your equity plan while taking into account available shares, requested shares, fungible ratio, sublimits, and other plan features
Compare the cost of your equity plan to a customizable group of peers, including your GICS6 industry
Run what-if scenarios to analyze how adjustments to your shares requested or plan features impact the cost to shareholders
Please contact Dan Marcec at email@example.com for more information. Dan Marcec is the Director of Content & Marketing Communications at Equilar. The contributing authors of this paper are Andrew Gordon, Senior Project Manager, Felicia Wong, Associate Project Manager, and Dimitri Karahalios, Research Analyst.