March 9, 2016
Featuring Commentary from and
Featuring Commentary from Semler Brossy and Equity Methods
Since boards of directors are responsible for aligning company affairs with shareholder interests, companies often implement director stock ownership guidelines to ensure that board members are invested in the company’s current and future performance. These guidelines typically require that directors own at least some specified amount of company equity and that they hold equity granted as compensation for a minimum period before selling those shares.
In recent years, investor activism has brought increasing attention to director ownership guidelines and compliance, and shareholders increasingly want to see that directors have an incentive to ensure the company is performing well, both in the short-term and the long-term. Company ownership is increasingly concentrated in public and private pension funds and with other institutional investors, which have gained support from federal legislative and regulatory initiatives. The degree that directors are monetarily invested in a company’s long-term growth can significantly impact shareholder support of the proposals directors bring to them.
In this report, Equilar examined trends in design and prevalence of director stock ownership guidelines disclosed by Fortune 100 companies for fiscal years 2012, 2013 and 2014. The data included covers changes in prevalence of ownership guidelines for directors, common ownership policy designs implemented, changes in value of target director stock ownership amounts, and use of holding period requirements within ownership guidelines.
Equilar’s Director Stock Ownership Guidelines report details the prevalence and features of stock ownership guidelines and holding requirements applied to board members by Fortune 100 companies, as disclosed in their annual proxy statements. The prevalence of features is the percentage of Fortune 100 companies disclosing them for fiscal years 2014, 2013 and 2012. The study samples include 97 companies in fiscal 2014, 96 companies in fiscal 2013 and 94 in companies in fiscal 2012. Years are defined as fiscal year ends between August 1st and July 31st.
Requiring non-employee directors to fulfill ownership guidelines standards is common practice. Over the past three fiscal years, the percentage of Fortune 100 companies with publicly disclosed director stock ownership guidelines has remained high—nearly 90%—indicating that companies prioritize this policy as a way to align directors with company performance and shareholder interest.
In that time frame, the number of companies including holding requirements in addition to ownership guidelines has increased from 25.5% to 30.9%, while the percentage of companies that implement only ownership guidelines for directors fell to 49.5%, a decrease from 56.4% two years prior. Just 6.2% of companies had holding requirements only.
Along with ownership guidelines, many companies institute an accumulation period to ensure directors are meeting their ownership guidelines by an appropriate time. In 2014, 89.7% of the companies that implemented director ownership guidelines disclosed an accumulation period. This is a small decrease from 91.0% in 2013. These stock ownership accumulation periods ranged from one to 10 years, but 84.3% required directors to fulfill their stock ownership guidelines within five years of becoming appointed.
“Compensation and incentives for executives and board members are heavily scrutinized from all angles: regulatory agencies, media, investors and governance groups,” said David Outlaw of Equity Methods. “The general rise in ownership targets is a clear response to outbursts for more skin in the game.”
Ownership guidelines typically specify the conditions that directors must meet to show they have a financial investment in the company. Typically, directors must own stock that’s equal in value to a multiple of their annual retainer, a fixed dollar value of shares or a fixed number of shares. Companies most commonly defined the minimum amount of equity a director must own as a multiple of their annual retainer, and a decreasing number of Fortune 100 companies are using a fixed number of shares to define the minimum director ownership requirement. Specifically, the percentage of companies using a fixed number of shares fell to 11.5% in 2014, down from 16.9% two years earlier. Conversely, the percentage of companies with disclosed ownership policies that used a fixed dollar value of shares increased from 7.7% in 2013 to 10.3% in 2014.
“While the median multiple may be similar between the board and CEO, that surface number hides a couple of important points,” noted Outlaw. “CEOs rarely have required multiples below 5x, whereas many directors have lower requirements at 3x. Further, since CEOs or other executives typically have salaries well in excess of a director’s retainer, the same multiple for a board member actually results in a lower number of shares required to be held.”
Among companies that utilized a retainer multiple in 2014, 60.0% required board members to hold five times their annual retainer. The second-most common multiple was three, with 24.0% of those companies using that requirement.
Companies disclose target ownership to show how much stock ownership amounts are worth in simplified dollar amounts. Since stock changes in value, this is a way to examine ownership more tangibly. Target ownership amounts vary, but the median values for multiples of annual retainers, number of shares, and value of shares required to fulfill director stock ownership guidelines have all increased over the past three years. The median value of director stock ownership targets overall for Fortune 100 companies grew from $400,000 in 2012 to $500,000 in 2014, which indicates that companies are requiring a greater financial investment from directors, and that board members shouldn’t be shielded from potentially negative financial consequences of poor company performance.
Directors who are required to own a certain number of shares of company stock not only had the highest target value of ownership, but also saw the most substantial increase in value of stock ownership targets during the study period, growing from a target amount of $353,690 in 2012 to a target worth of $550,480 in 2014.
* Assumes fiscal 2014, 2013, 2012 corresponding annual retainer.
** Assumes year-end stock price for corresponding fiscal year 2014, 2013, 2012.
*** As stated by company.
“Companies often give executives the opportunity to earn a significant amount of value through ongoing compensation and annual equity grants, and it’s rare that an executive would need to enter the open market to meet normal ownership guidelines,” said Seamus O’Toole of Semler Brossy Consulting Group. “But if necessary, they usually have the assets and wealth to do so. With directors, the dynamics can be very different. The cash portion of director pay is relatively moderate and the risk of falling out of compliance may be higher at times of poor stock price performance. This issue is as important now as ever as companies are looking to bring in more viewpoints. Aggressive director ownership guidelines could be a burden for new directors or candidates that are not independently wealthy.”
Typically, directors are able to sell shares upon meeting vesting requirements, eliminating their financial stake in a company. To prevent this, companies are increasingly implementing holding requirements, in which directors are unable to transfer shares until either a specified period of time or their ownership guidelines are met. Overall, 37.1% of the companies in our study had some form of holding requirements in 2014.
Holding requirements are a share retention tool that can be implemented with or without stock ownership requirements. There are different types of holding requirements, the most common being pre-ownership or post-ownership, in which directors must retain a certain amount of company stock they acquire through exercised stock-based awards before or after they reach their ownership guidelines.
“There is simply more variation available in structuring holding requirements for executives vs. directors,” said Outlaw. “For instance, many companies institute both an absolute ownership requirement and share retention provisions, but because directors’ remuneration packages are smaller and simpler, they will tend to have a more vanilla framework applied.”
Companies primarily maintain pre-guideline holding requirements or general holding requirements, together accounting for 77.8% of the companies that had any such requirements in place. Very few Fortune 100 companies had both pre- and post- holding requirements, decreasing slightly from 3.2% in 2012 and 2013 to 2.8% in 2014.
"For executives, stock ownership policies are one of the only levers that reinforce a long-term focus and orientation, and each element of an executive compensation program—base salary, bonus, and performance-based equity—is designed to encourage certain behaviors and create alignment,” said O’Toole. “But for directors, ownership guidelines and holding requirements take on additional weight. This is particularly true in light of changes to director pay programs over recent years, including a greater emphasis on full value shares and a move toward shorter vesting periods. Ensuring a longer-term alignment and focus from the directors is critical given their role as the fiduciary governance oversight.”
Seamus O’Toole has served as a trusted advisor on compensation and incentive design issues for both public and private companies for over 12 years. Working with companies of all sizes and across all industries, he helps companies execute their strategy through appropriate performance measurement and incentive design, including annual and long-term programs. He can be contacted at SOToole@semlerbrossy.com.
David is a Manager at Equity Methods, specializing in compensation design and modeling, as well as fair value measurement and accounting under ASC 718. In addition to managing many of the practice’s most complex projects, David plays a leadership role in internal training and mentoring programs and is one of Equity Methods’ most prolific authors and presenters. He can be contacted at firstname.lastname@example.org.
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For more information on Equilar’s research and reports, please contact Dan Marcec, Director of Content & Marketing Communications at email@example.com contributing authors of this report were Heather Kerr and Dylan Lennard, Research Analysts, and Matthew Goforth, Equilar Research and Content Specialist.