Performance Awards and the ISS Burn Rate Calculation

For today’s blog entry, I continue my series on ways to count performance awards (for my last entry in this series, see “Ways to Count Performance Awards”). Because we are just at the start of proxy season, it seems like a good time to look at how performance awards are included in ISS’ calculation of burn rate.

Let’s Review

Before we talk about performance awards, let’s review the basics of the ISS burn rate calculation. The formula ISS uses to determine burn rate is simply shares granted (both options and awards) divided by weighted average common shares outstanding.  The award shares (i.e., shares issued at no cost to employees) are subject to multiplier based on the company’s stock price volatility.

What About Cancellations?

ISS doesn’t offset the shares granted by shares cancelled during the year. This become a key consideration for performance awards; if ISS counts your performance awards at their maximum payout, this could significantly overstate your burn rate (especially if your performance awards are full value awards and thus, subject to the multiplier).

Disclosure Is the Solution

The good news is that if you provide sufficient disclosure about your performance awards, ISS will only include them in your burn rate calculation in the year the awards are paid out. This ensures that performance awards are only counted at the maximum if they actually pay out at that level (which seems fair).

Last year, ISS updated their FAQ on Equity Compensation Plans to stipulate what they want your performance award disclosure to look like (see “ISS, Burn Rates, and Performance Awards”). It must be in a tabular format covering three years and must report the total shares granted, vested, and forfeited in each year. The disclosure has to cover all employees (not just NEOs) and you should disclose it every year, even in years in which your stock plans aren’t being acted on or there was no activity in your performance awards for that year.

The Loophole

There is, however, another way to ensure that ISS doesn’t count performance awards in your burn rate at the maximum payout: simply don’t report them at the maximum payout in your ASC 718 disclosures. The standard doesn’t stipulate how performance awards need to be reported for purposes of these disclosures. Many companies report grants of performance awards at the target payout in these disclosures. If the awards pay out above target, they report the additional shares paid out as grants in the year they are earned. ISS can’t count shares you haven’t disclosed.

While this approach gets around having to provide the additional disclosure for your performance awards, it does have a couple drawbacks. First, if your performance awards pay out below target, they’ll still be overcounted in ISS’ burn rate calculation. And second, ISS will count the performance awards earlier (at grant) than they would if you provide the disclosure they want.

- Barbara