How institutions REALLY vote ...
Danny, you said "to convince the institutional investors to vote 'no'". C'mon, with all your WS experience, you must know that institutions are sophisticated investors that do extensive due diligence on their investments AND their proxy votes, making fact-based decisions.
You must know that ISS (Insititutional Shareholder Services) is a proxy analysis firm that makes proxy voting recommendations to instituions.
And, ISS has in fact done a proxy analysis on IDCC for the upcoming ASM and provided voting recommendations to its institutional clients.
Danny, can you please use your institutional contacts to obtain ISS' voting recommedations and report back to this board what you learn about their recommended vote on measure #2 ???
FYI, below are the calculations that ISS uses to make its proxy voting recommendation as to "Executive Compensation". It may surprise you that there is no criteria about reviewing individual shareholder recommendations for these calculations. There are however caps based on industry data and comparables, such data as I have posted previously.
Regards,
Corp_Buyer
From ISS US Proxy Voting Manual:
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"Executive and Director Compensation
Stock-based incentive plans are among the most economically significant issues upon which shareholders are entitled to vote. Approval of these plans may result in large transfers of shareholder equity out of the company to plan participants as awards vest and are exercised. The cost associated with such transfers must be measured if incentive plans are to be managed properly.
Decisions regarding the types of awards to be granted under a plan, the timing of grants, and the participants eligible to receive grants are ones best left to the plan administrator, typically the board compensation committee. Leaving such discretion in the hands of the board enables directors to structure the company's overall compensation program to provide incentives that meet the needs of individual plan participants and recognize a company's unique corporate culture.
These proposals should be analyzed on a case by case basis. ISS has developed a proprietary, quantitative approach to evaluating compensation proposals that is unique in the industry, utilizing a binomial option pricing model to estimate the cost of a company's stock-based incentive programs. The estimated plan cost is compared to an allowable cap. This methodology revolves around two basic questions:
How much will the plan cost?
Is the cost reasonable?
Cost: Our approach measures two primary costs: Shareholder Value Transfer (SVT) and Voting Power Dilution (VPD).
SVT is measured using a binomial model which assesses the amount of shareholders' equity flowing out of the company to executives as options are exercised. An estimated dollar value for each award is determined by factoring award features into an option pricing model to determine the potential plan cost. No award types are deemed negative, rather some award types are more costly and use up the company's allowable budget faster. This approach affords the board flexibility to structure its incentive programs, while shareholders are ensured that plan costs are linked to performance.
VPD is measured using a division equation which assesses the relative reduction in voting power as options are exercised and existing shareholders' proportional ownership is diluted. For instance,
(A+B+C)/(A+B+C+D), where:
A = shares reserved for new plan/amendment
B = shares available under continuing plans
C = granted but unexercised shares, all plans
D = shares outstanding, plus convertible debt, convertible equity and warrants
These two costs are combined by assigning a 95 percent weight to SVT and a 5 percent weight to VPD.
Equity analysts typically value voting rights at approximately five percent of the company's market value.
Proposals to approve or amend stock-based incentive plans are evaluated in conjunction with all previously adopted plans to provide an overall snapshot of the company's compensation system. Therefore, shares reserved under a new plan or amendment are valued together with shares available for grant under all continuing plans and shares granted but unexercised. An integrated approach enables shareholders to evaluate a new request in conjunction with management's prior actions as well as costs to be incurred when awards are exercised.
Reasonableness: After determining how much the plan will cost, ISS evaluates whether the cost is reasonable by comparing the cost to an allowable cap. The allowable cap is industry-specific, market cap based, and pegged to the average amount paid by companies performing in the top quartile of their peer groupings. Such a benchmark suggests that if the top performing companies in a given industry are able to attract and retain their employees for a given amount, most other companies in that industry should be able to compensate their employees within a similar budget.
ISS generally limits the percentage of companies receiving an against vote recommendation as a result of this quantitative analysis to not more than 30 percent of companies reviewed in each industry group. The actual percentage receiving against vote recommendations is determined by analyzing how requests for SVT are clustered in a given industry.
Plan features such as eligible participants, plan administration, award types, payment terms, award terms, vesting provisions, historic grant patterns, and the ability to reprice underwater stock options, are considered. ISS analyses describe how such features may increase or reduce the cost of a proposed plan. Such factors are highlighted so that shareholders can give consideration to these issues when reviewing the proposed cost of a plan relative to the allowable cap.
Determining the Vote Recommendation: Vote recommendations are primarily driven by the quantitative analysis outlined above. If the proposed cost is above the allowable cap, an AGAINST vote is recommended. If the proposed cost is below the allowable cap, a FOR vote is recommended unless the plan violates our repricing guidelines. If the company has a history of repricing options or has the express ability to reprice underwater stock options without first securing shareholder approval under the proposed plan, ISS recommends a vote against the plan even in cases where the plan is considered acceptable based on the quantitative analysis. These policies are summarized below.
SVT + VPD > Allowable Cap = AGAINST
SVT + VPD < Allowable Cap, and repricing guidelines met = FOR
SVT + VPD < Allowable Cap, but repricing guidelines violated = AGAINST
This section discusses various topics relating to executive and director compensation.
Executive Compensation
Votes on compensation plans for executives are determined on a CASE-BY-CASE basis, using a proprietary, quantitative model developed by ISS.
Costs Associated with Stock-Based Incentives
Assessing the cost of stock-based incentive plans raises difficulties not encountered with straight, cash-based compensation. When an executive is paid a cash salary of $400,000, the board knows its worth to the recipient and the total cost to the company. Stock-based plans ultimately have an absolute dollar cost as well, and this cost must be measured if it is to be managed. Two primary costs are incurred when stock-based incentives are utilized. The first cost, referred to as shareholder value transfer, is measured using an option pricing model. The second cost, referred to as voting power dilution, is measured using a simple division equation. ISS analyzes both costs to assess the impact of a proposed compensation plan on shareholders' wealth and voting power.
Shareholder Value Transfer
Shareholder value transfer is a dollar-based cost which measures the amount of shareholders' equity flowing out of the company to executives as options are issued and exercised. In the case of options, the exercise price, paid at the time of exercise, flows back to the company. The profit spread, or the difference between the exercise price and the market price, represents a transfer of shareholders' equity to the executive. In the case of performance shares, restricted stock, or stock grants, no money flows back to the company, since these awards do not typically carry any exercise price.
Additionally, prior to exercise, there is a cost associated with the time value of money which measures the potential future appreciation of the stock over the remaining term of the option and represents a potential future liability. To the extent that executive stock options represent substantial claims against a firm, they can have a significant impact on the market value of shareholders' equity. These costs, referred to as shareholder value transfer, are measured using a binomial model.
Voting Power Dilution
Voting Power Dilution cost measures the relative reduction in voting power as options are exercised and existing shareholders proportional ownership in the company is diluted. This cost is measured as follows:
(A + B + C) / (A + B + C + D), where:
A = shares reserved for new plan or amendment
B = shares available for grant under continuing plans
C = granted but unexercised shares under continuing plans
D = shares outstanding, plus convertible debt, convertible equity, and warrants
Voting power dilution is combined with shareholder value transfer to obtain the total cost to shareholders of a proposed new plan or amendment, in conjunction with shares available for issue and outstanding under all continuing executive and director compensation plans.
Table 8-1. An Introduction to the Binomial Model
Shareholder value transfer is measured using a Binomial Model, which is a variation of the widely known Black-Scholes mathematical option pricing formula and allows for the possibility of early option exercise and other characteristics unique to privately traded options. The binomial model, developed by John Cox, Stephen Ross, and Mark Rubenstein, takes into consideration the most significant differences between publicly-traded call options and employee stock options: longer maturity, delayed vesting, the possibility of early exercise, forfeiture, nontransferability, dilution, and taxes. The methodology is described briefly below.
The fair market value of an option (its premium) is the value at which the buyer and seller can break even over a large number of trials. To determine the probability of a gain or loss on an option, the expected pricing behavior of the underlying stock is determined. Assume you have a stock with a current value of $100 which has a 50:50 probability of moving up or down in price by $5 by the time the option expires. Thus, the expected price of the stock will be either $105 or $95.
105
100<
95
The assumption that prices will move up or down by a fixed amount in accordance with a known probability is referred to as a binomial price distribution, i.e., that the stock price may assume one of two values. Given that the stock assumes one of two values, the value of the option at each price level must be determined. The value of an option at expiration, or its terminal value, is simply a reflection of its in-the-money amount. If the option is out-of-the-money, it expires worthless. Thus, the terminal value of the option is the greater of (1) the stock price less the exercise price and (2) zero.
5
Option Value<
0
If the stock price rises to $105, the terminal value of an option with a strike price of $100 equals the maximum of ($105 - $100) and zero, or $5. If the stock price falls to $95, the terminal value equals zero because this out-of-the-money option would not be exercised. Given the 50:50 probability of either result, the value of the option equals $2.50.
(0.50 * $5) + (0.50 * $0) = $2.50
Over future time periods, the stock price may continue to move up or down $5 displaying the same dispersion:
115
110<
105< 105
100< 100<
95< 95
90<
85
The model requires one to work backwards to assess the value of the option at each branch of the tree. For example, when the stock price is at $110 one period prior to expiration, the option is worth $10 because you have a 50-percent probability that the price will rise to $115 where the option will be worth $15, and a 50-percent probability that the price will fall to $105 where the option will be worth $5.
(0.50 * $15) + (0.50 * $5) = $10.00
Thus, by working backwards, the value of the option (in parentheses) at any given branch of the probability tree may be identified:
115 ($15)
110 ($10) <
105 ($6.25) < 105 ($5)
100 ($3.75) < 100 ($2.50) <
95 ($1.25) < 95 ($0)
90 ($0) <
85 ($0)
The probability tree confirms many pricing characteristics associated with options. For example, it illustrates how the option value advances or declines as the underlying stock price fluctuates, driving the option into or out of the money. Time value decay is also shown. Holding the stock price constant at $100, the option value declines from $3.75 to $2.50 over two periods and to zero upon expiration. Accelerated time value decay is illustrated for at- or near-the-money options. Holding the stock price in the money at $105, the option value declines from $6.25 to $5.00 over two periods. Lastly, the greater the time period to expiration, the greater the value of the option.
Why Use a Binomial Model?
Developments to mathematical models for pricing options underwent revolutionary changes with the publication of the Black-Scholes model in 1973 by professors Fisher Black and Myron Scholes. Designed to value publicly traded options, the Black-Scholes model is relatively simple to use as it incorporates just five variables: the underlying stock price, the option strike price, interest rate, underlying asset volatility, and option life. The model is sometimes modified to incorporate dividends and is best applied to publicly traded European options (options that can only be exercised at expiration).
Interest in modeling techniques increased dramatically following the creation of the first registered securities exchange for the purpose of traded options: the Chicago Board Options Exchange in 1973. The Black-Scholes model became the basis of extensive empirical research that yielded alternative valuation techniques that are superior for handling the unique characteristics of nonpublicly traded options. The binomial valuation model takes into consideration the most significant differences between publicly traded call options and employee stock options: longer maturity, delayed vesting, the possibility of early exercise, forfeiture, nontransferability, dilution, and taxes. However, the Black-Scholes model, which does not accommodate these factors, is still widely used due to its simplicity.
Our research suggests that the binomial model is at the cutting edge of valuation techniques and that its credibility led the Financial Accounting Standards Board to propose its usage as a methodology for estimating the expense of employee stock options. Valuations using various forms of the binomial model are widely available by purchasing software packages that can be run on a PC from such firms as Pennsylvania-based Montgomery Investment Group or checking valuations using a quotron terminal. Bloomberg, for example, provides prices for publicly traded options and estimated values for executive stock options using a variety of option pricing models, including the binomial model.
Shareholder Value Transfer (SVT)
The binomial model utilized by ISS for measuring shareholder value transfer incorporates 14 inputs which are key determinants in estimating the dollar cost of stock-based incentives. The variables are divided into two groups: those accounting for the core model valuation (inputs one through eight), and those having a smaller impact, but serving to improve the accuracy of our estimates (inputs nine through 14). The variables are ranked by importance to the valuation, with the inputs having the greatest sensitivity on the estimated award value listed first.
MODEL INPUTS
The inputs are defined below. Following each definition is a brief summary of how each variable is handled within the model and how each variable impacts the estimated value of an option.
1) Dividend Yield
Higher Dividends = Lower Option Value
Executives holding options instead of common stock usually forego the dividend paid on the shares. Throughout the option term, a steady dividend stream with a constant dividend payout rate is assumed.
The higher the dividends paid, the lower the estimated value of the option. This is easily seen in the extreme where a firm sacrifices the necessary investments in future growth, research, and development to pay large dividends.
2) Stock Volatility
A Highly Volatile Stock = Higher Option Value
Volatility measures potential stock price dispersion over the life of an option and is calculated using historic daily price movements equivalent to the standard deviation of the stock price over a 200-day sampling period.
The greater the dispersion of the stock price, the higher the expected value of the options. This is because wide swings in share price increase the possibility that an option will become exercisable. Optionholders are not subject to downside risk from price swings since the optionholder has a right, but not an obligation to purchase the underlying shares at a fixed price.
3) Stock Price
Higher Initial Stock Price = Higher Option Value
Option grants to executives may be made at any time over the life of the plan. The initial stock price at grant date is represented by the company share price at the date of the model run.
A higher initial stock price at grant date yields a higher expected option value, while a lower initial stock price at grant date yields a lower expected option value.
4) Option Strike Price
Lower Strike Price = Higher Option Value
Also referred to as the exercise price, the strike price is the specified price at which the purchaser of an option may acquire the underlying shares. Using the plan document provided in the proxy statement, analysts apply the lowest strike price permitted under the plan's terms. If, for example, options may be granted at a price determined by the administering committee, a strike price set at par value is used to estimate the cost of all options reserved under the plan. If, on the other hand, a given percentage of the reserved shares may be granted at a price determined by the administering committee, while the balance must have a price equal to or greater than fair market value at grant date, then the portion of the options with an unspecified strike price are valued at par, while the remaining shares are valued using a strike price of 100 percent of fair market value at grant date. The latitude afforded by the language of the plan document takes precedence over a company's historic grant patterns.
The lower the strike price relative to current market price, the higher the expected option value since the price paid by the executive at the time of exercise is lower.
5) Risk-Free Interest Rate
Higher Interest Rate = Higher Option Value
A U.S. Treasury security is generally considered the safest investment available. A 30-day U.S. Treasury bill with a zero coupon rate is used to determine the risk-free interest rate. The 30-day bill is matched to the 30-day time interval used in each step of the binomial model.
The more costly funds become, the higher the expected return demanded by investors and optionholders, thus increasing the option's expected value.
6) Expected Forfeiture Rate
Higher Risk of Forfeiture = Lower Option Value
An executive who leaves voluntarily or is fired must typically exercise his options within 30 to 90 days. Forfeiture rates are estimated using the three-year average for awards terminated, cancelled, or forfeited as disclosed in the footnotes to the financial statements.
The risk of forfeiture potentially reduces the estimated value of an option to its immediate exercise value and removes the time value of the option.
7) Option Term
Longer Option Term = Higher Option Value
The period during which an option may be exercised is referred to as the term. Most options have a ten-year term. Using the plan document provided in the proxy statement, analysts apply the longest time to maturity permitted under the plan's terms.
A longer option term increases the expected value of the underlying option, since the longer holding period increases the possibility that the company's stock price will exceed the strike price.
8) Expected Stock Return
Higher Expected Return = Higher Option Value
Rates of return affect the likelihood that an executive will exercise his stock options. Expected stock returns are calculated by multiplying the risk premium by beta (a measure of the relationship between the movement of an individual stock relative to the overall market) and adding to the result the risk-free interest rate.
The higher the expected rate of return, the less likely an executive will exercise his options immediately. Options held longer have a greater expected value.
Variables one through eight represent the core parameters for establishing an estimated award value. The remaining six variables have a smaller impact on the valuation, but are necessary to improve the accuracy of our estimates. Variables ten through 12 are used to account for the possibility that an option will be exercised prior to term.
9) Vesting Provisions
Longer Vesting Provisions = Lower Option Value
Vesting provisions restrict an executive's ability to exercise his options for a specified period of time. Frequently, options vest incrementally over a three- or four-year period with a prorata portion of the shares becoming exercisable on an annual basis following grant date. Using the plan document provided in the proxy statement, analysts use the minimum vesting schedule that may be set by the plan administrators. If the vesting provisions are unspecified, or only typical vesting provisions are provided, an immediate vesting schedule will be used for valuation purposes.
During the vesting period, the portion of an option that has not vested is forfeited if the executive leaves, thereby reducing the expected value of the option.
10) Employee's Nonoption Wealth
Higher Nonoption Wealth = Higher Option Value
An executive is less sensitive to an option's risk when the potential option payout is a smaller portion of his total wealth. Sources for such data include statistics collected by the Federal Reserve, combined with salary and bonus data for top executives from the proxy statement.
As nonoption wealth increases, research indicates that the options tend to be worth more since they are typically held longer. The expected holding period approaches the term of the option as nonoption wealth becomes very large, because diversification-motivated potential for early exercise diminishes.
11) Employee's Risk Aversion
Higher Risk Aversion = Lower Option Value
An employee's willingness to bear risk impacts the expected time an option is held. Risk aversion is assumed to be a constant rather than increasing. The coefficient is set at 2.0 based on the research of various academic studies.
As risk aversion rises, the estimated value of the option falls rapidly because a more risk-averse employee will exercise his options sooner.
12) Employee's Tax Rate
Efforts to Defer Taxes = Higher Option Value
Taxes may have a variety of effects on the value of an option grant, but most importantly, taxation impacts the timing of an employee's decision to exercise his options. Nonqualified stock options priced at fair market value at grant date are taxed at the time of exercise at the employee's ordinary income tax rate based on the difference between the strike price and the market price. The highest marginal tax rate of 39.6 percent for taxable income of $263,750 and higher is applied.
Since the profit from such options is only taxed upon exercise, the executive will likely delay exercise in an attempt to postpone the tax. Delayed exercise increases the estimated value of the option.
13) Earnings Dilution Factor
Increased Dilution = Lower Option Value
This input accounts for the downward pressure on share value as common stock is issued to cover option exercises. Dilution is calculated by dividing shares reserved for the new plan or amendment by fully diluted shares outstanding, plus shares available for issue under continuing plans and granted but unexercised shares.
Option exercises drive down the stock price and reduce the estimated option value.
14) Number of Steps
The binomial tree model applied uses 120 steps. Each step represents a 30 day time interval so as to be matched with the 30-day Treasury bill used as the risk-free interest rate. One hundred twenty 30-day periods represents the typical term of an option, ten years.
Determining the Plan-Specific Model Inputs
Much of the financial, accounting, and market data used in the binomial valuation is downloaded directly from numbers compiled by Compustat. However, plan-specific data and information on executive cash compensation is taken from the proxy statement and footnotes to the financial statements. Correctly identifying the numbers that are used to determine the costs of a proposed compensation plan requires an understanding of compensation terminology, the flow of awards into and out of the compensation system, and familiarity with the disclosure documents.
Ideally, all numbers are pulled from the proxy statement because these numbers have often been updated with the printing of the proxy and are plan-specific. When the proxy provides some, but not all of the numbers needed, the footnotes to the financial statements are reviewed. The annual report, or 10K, often provides numbers in an aggregate form and sometimes the information needed is incomplete. In such cases, the company is contacted for additional information or reasonable estimates are made.
To calculate voting power dilution, the following must be determined:
Number of shares reserved under the new plan or amendment
Number of shares available for grant under each continuing plan
Number of shares granted but unexercised, and
Number of fully diluted shares outstanding
To estimate shareholder value transfer, the data points listed above along with the following must be determined:
The lowest allowable exercise price at grant date for each award type under the new plan and each continuing plan
The weighted average exercise price for granted but unexercised shares
The maximum term for each award type under the new plan and each continuing plan
The approximate term remaining for granted but unexercised shares
The minimum vesting requirements for grants under the new plan and each continuing plan, and
The performance criteria and hurdle rates associated with grants of performance shares
These core data points are supplemented with additional data as required for variations to the typical stock option plan (for example, evergreen plans), or for company-specific factors (for example, companies with multiple classes of common stock with unequal voting rights). The location and description of each data element is described more fully below.
Shares reserved: The number of shares reserved for a new plan or an amendment to an existing plan is found in the proxy statement under the description of the plan or amendment. An amendment may specify either an additional number of shares to be reserved or a new overall share ceiling.
Shares available for grant under each continuing plan: The number of shares available for grant under each continuing plan can sometimes be determined by adding up shares available for issue under each continuing plan as disclosed in the proxy statement. In other cases, the figure for shares available may be given or calculated using the footnotes to the financial statements. In many cases it must be calculated. Shares available for grant = Shares reserved - Shares granted + (Shares cancelled, terminated, or expired).
Shares granted but unexercised: The number of shares granted but unexercised under all plans is usually found in the footnotes to the financial statements. Sometimes this number, which includes both vested and unvested shares, can be reconstructed by using numbers in the proxy statement.
Fully diluted shares outstanding: Shares outstanding at record date is taken from the proxy statement and added to convertible debt, convertible equity, and warrants as disclosed in the footnotes to the financial statements.
Initially, shares are reserved for grant. Once granted, the shares exit the system upon exercise. Shares that are granted but unexercised may or may not have vested.
Once vested, these shares may be exercised at any time prior to the termination date of the contract (typically ten years). Some shares will leave the system when they expire unexercised, or the option contract is cancelled. Awards falling into the latter category typically flow back into the pool of shares available for grant.
The additional data points pulled for estimating shareholder value transfer come primarily from the proxy statement. The full plan document, usually placed in an appendix, is the best document to work from since information contained about the plan in other parts of the proxy statement simply summarizes the plan document. Exercise prices, vesting provisions, award terms, performance goals, and hurdle rates are all contained in the plan document. Details about granted but unexercised shares (average exercise price and average term remaining) are typically found in or estimated from data in the footnotes.
Award Types
Stock-based compensation can take many forms. The most commonly utilized award types, incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, performance shares, and performance units, are shown in the table below. A definition of each award type is accompanied by a brief discussion of tax treatment (for both the company and participant) and how such awards are treated in the model. A glossary of compensation terminology at the end of this chapter gives further definition about these and less commonly used award types.
Incentive Stock Options (ISOs)
ISOs are rights to purchase stock at a fixed price of not less than 100 percent of fair market value at grant date over a ten-year term. ISOs may only be granted to employees. Nonemployee directors, consultants, and independent advisors may not receive ISOs.
Table 8-2. Incentive Stock Options
Tax Treatment Treatment Under Valuation Model
Company: No tax deductions are allowed unless a disqualifying disposition takes place.
Participant: If shares are held for two years after grant date and one year after exercise, profits are taxed as capital gains.
Options are valued with an exercise price of 100 percent of fair market value at grant date and a ten-year term.
Nonqualified Stock Options (NSOs)
NSOs are rights to purchase stock at a fixed exercise price that may be set at, above, or below fair market value at grant date. The term of such awards is typically ten years, but may be unspecified.
Table 8-3. Nonqualified Stock Options (NSOs)
Tax Treatment Treatment Under Valuation Model
Company: A tax deduction is permitted for the amount of the participant's taxable income for SARs.
Participant: The value of the rights is taxed as ordinary income.
Options are valued at the lowest exercise price at which shares may be granted. If the exercise price is determined by the committee, but may be set as low as par value, the options are valued at par value. If the term is unspecified, a 20-year term is applied.
Stock Appreciation Rights (SARs)
SARs are rights to receive the dollar appreciation of the underlying shares of common stock without actually having to acquire the shares. The rights may be attached to an option, thereby providing a specific exercise price and term.
Table 8-4. Stock Appreciation Rights
Tax Treatment Treatment Under Valuation Model
Company: A tax deduction is allowed for the amount the participant recognizes as taxable income.
Participant: At exercise, the option spread is taxed as ordinary income.
From a valuation standpoint, SARs are equivalent to a stock option and are valued accordingly. If the recipient takes payment in the form of cash, there is no voting power dilution.
Restricted Stock
Restricted stock are grants of stock subject to a restriction period during which time the shares cannot be sold or exchanged. If employment is terminated prior to the lapse of restrictions, the restricted shares are subject to forfeiture. Typically, no payment is required and restrictions lapse after a three- to five-year period.
Table 8-5. Restricted Stock
Tax Treatment Treatment Under Valuation Model
Company: A tax deduction equivalent to the amount of the participant's taxable income from the award is permitted.
Participant: Typically, taxation occurs when the restrictions lapse. Awards are taxed as ordinary income.
Restricted stock is valued as an option with an exercise price of $0 after factoring in vesting restrictions.
Performance Shares/Units
Performance shares/units are contingent grants of shares or cash payable at the end of a performance cycle, depending on how well performance objectives are achieved. The performance cycle is typically three to five years.
Table 8-6. Performance Shares/Units
Tax Treatment Treatment Under Valuation Model
Company: A tax deduction equivalent to the amount of the participant's taxable income from the award is permitted.
Participant: Ordinary income tax must be paid on the value of the award.
An estimated payout scenario is developed based on the probability that the company will achieve the performance benchmarks and that the participants will be with the firm to receive the award. If performance criteria and hurdle rates are unspecified, the award could be paid out without being linked to ambitious performance goals. In such cases, the awards are treated in the same manner as restricted stock (options with an exercise price of $0.)
Reload Stock Options
Reload stock options allow an optionee who exercises a stock option with stock already owned to receive a new option for the number of shares delivered upon exercise. The exercise price of the new option is set at 100 percent of fair market value on the date of delivery, and the expiration date is equivalent to the term remaining on the original option. By reloading the option, the participant has continued upside potential through share price appreciation on the swapped shares. Reloads can increase actual share ownership as the mechanism encourages participants to exercise early and hold a portion of the grant outright. On the other hand, since the company grants additional shares each time options are exercised, the company depletes its pool of option shares faster. ISS believes that the reload option may promote greater long-term share ownership among employees.
Granted But Unexercised Shares
Granted but unexercised shares are valued as if the grants were newly issued shares with built-in value and shorter terms. For example, consider an option granted five years ago at 100 percent of fair market value and with a ten-year term. Assume further that the per-share stock price at this company was $30 five years ago and is now trading at $60. For valuation purposes, the present value of each option is recalculated as if it had been granted today with a five-year term (the number of years remaining under the original option contract) and at 50 percent of fair market value (the implicit discount given based on the stock price appreciation from $30 to $60 since grant date).
Combining the Costs: Shareholder Value Transfer and Voting Power Dilution
The dollar-based cost of each compensation plan, or shareholder value transfer (SVT) as valued by the binomial model, is expressed in dollar terms and as a percentage of market value (defined as the 200-day average share price times shares outstanding, including convertible debt, convertible equity and warrants). Voting power dilution (VPD) is expressed as a percentage of fully diluted shares outstanding. The costs are combined by assigning a 95-percent weight to SVT and a five-percent weight to VPD. Note that equity analysts typically value voting rights at five percent of the company's market value.[1] Using the example below, SVT and VPD are combined to determine the total cost of the company's plans as follows:
(8.81% * 95%) + (13.04% * 5%) = 9.02%
Table 8-7. Shareholder Value Transfer and Voting Power Dilution
Current stock price: $36 Shares outstanding on record date: 18,000,000
200-day average stock price: $33.00 Warrants, convertible debt, and equity: 0
Market value: $594,000,000 Total share allocation from plans: 2,700,000
Stock's first trade date: October 2, 1984 Fully diluted shares outstanding: 20,700,000
Share Allocation Average Award Value SVT SVT (% Market Value) VPD (Fully Diluted Basis)
Reserved For Plan 1,200,000 $23.00 $27,600,000 4.65% 5.80%
Available to Grant (under existing plans) 659,000 $18.00 $11,862,000 2.00% 3.18%
Granted, Unexercised (under existing plans) 841,000 $15.25 $12,825,250 2.16% 4.06%
Total 2,700,000 $52,287,250 8.81% 13.04%
Allowable Cap
Vote recommendations are determined by comparing the cost of the company's stock-based compensation programs (shares proposed under new plan, shares available for issue under all continuing plans, plus granted but unexercised shares) to an allowable cap.
The allowable caps are industry-specific, market cap-based, and pegged to the average amount paid by companies performing in the top quartile of their peer groupings. Such a benchmark suggests that if the top performing companies in a given industry are able to attract and retain their employees for a given amount, most other companies in that industry should be able to compensate their employees within the same budget.
Industry classifications are established using standard industry code (SIC) groups. SIC code groups are combined into the following 25 groups:
Table 8-8. Standard Industry Code Groups
Agricultural products, food, beverages, and tobacco Leisure services
Banking Manufacturing
Chemicals Materials and construction
Consumer goods, durable Pharmaceutical manufacturing
Consumer goods, nondurable Real estate management and investment trusts
Computer hardware Retail
Computer software services and internet Savings institutions and credit unions
Diversified business services Telecommunications
Energy, metal, and mining Transportation equipment
Electronics and semiconductors Transportation services
Financial services, excluding REITs Utilities
Healthcare services Wholesalers
IPOs
Companies are further segmented within industry subgroups according to market capitalization. Companies are segmented by market capitalization as follows: less than $100 million, small cap; $100 million to $850 million, mid cap; and greater than $850 million, large cap.
Companies performing in the top quartile of their respective peer groupings are identified using five-year total shareholder returns. A normative SVT level is established for each industry using ISS's historic data of the amount of SVT authorized for issue at each top quartile-ranked company.
After benchmarking average industry pay levels, an industry-specific cap equation is formulated by identifying those variables having the most significant impact on SVT. Regression analysis tests are run on the following variables: sales growth, earnings growth, return on equity, return on assets, debt-to-equity ratio, market capitalization, total shareholder returns relative to the market, and cash compensation. Regression analysis is useful in relating a number of independent variables (those listed above) to a dependent variable (SVT) and developing a prediction or correlation equation. Once the independent variables are identified, regression analysis measures the strength of the relationship between the independent variables and the dependent variable. These industry-specific equations are updated on a semiannual basis.
The benchmark SVT level for companies performing in the top quartile of each industry is then adjusted upward or downward by plugging company-specific performance, size, and cash compensation data into the industry-specific cap equation. As might be expected, the company's size, as measured by market capitalization, is a variable in each industry equation, as company size is strongly correlated to pay levels. The performance variable most frequently used in the industry- specific equations is total shareholder returns (stock price appreciation plus reinvested dividends), as it is also strongly correlated to pay levels.
The process for setting a company-specific cap eliminates the need for analysts to categorize companies into groupings of mature, growth, and emerging. It also eliminates the need to adjust a base cap for company-specific performance. This is because the information previously derived from company classifications and performance adjustments to a base industry cap is now inherent in the formula.
ISS limits the percentage of companies receiving an against vote recommendation as a result of this quantitative analysis to not more than 30 percent of companies reviewed in each industry. The actual percentage receiving against vote recommendations is determined by analyzing how requests for shareholder value transfer are clustered in a given industry. Only those companies at the tail of the curve, or the outliers, receive an against vote recommendation, up to a ceiling of 30 percent.
Determining the Vote Recommendation
To determine the vote recommendation, the plan cost, as measured by SVT and VPD, is compared to an allowable cap, as described above. If the proposed cost is above the allowable cap, an against vote is recommended. If the proposed cost is below the allowable cap, a for vote is recommended unless the plan violates our repricing guidelines. If the company has a history of repricing or has the express ability to reprice underwater stock options without shareholder approval under the proposed plan, ISS recommends a vote against the plan-even in cases where the plan is considered acceptable based on the quantitative analysis. These policies are summarized below.
Vote AGAINST if:
SVT + VPD > Allowable Cap
SVT + VPD < Allowable Cap, but repricing guidelines violated
Vote FOR if:
SVT + VPD < Allowable Cap, and repricing guidelines met
Repricing/Replacing Underwater Stock Options
Option repricing occurs when companies adjust outstanding stock options to lower the exercise price-a relatively uncommon practice. Option replacing occurs when the company reduces the terms of exercise through cancellation and regrant, a practice that is far more common. Option replacements may be accomplished through option swaps or option regrants, as described below.
Under a classic option swap, for example, an executive holding a ten-year option to purchase 1,000 shares at $10 finds that three years after receiving the award, his shares have finally vested but his company's stock has fallen to $6. While the executive still has the right to exercise this award any time over the next seven years, some argue that the award no longer provides the recipient with the intended incentive value. As a result, the company may cancel the old option and grant a new one with an exercise price of $6. The new "at-the-money" option may be fully vested and have a seven-year term remaining.
Other companies may use option regrants in such a situation whereby the original option is canceled and replaced with an entirely new grant. The typical new grant would have a ten-year term, new vesting restrictions, and today's lower exercise price. In the vast majority of cases, the number of shares canceled through option swap or regrant flow back into the pool of reserved shares that may be issued. Thus, the net reduction in shares avail-able for issue is not 2,000, but 1,000.
Companies have an enormous amount of latitude with respect to option repricing: plan terms are generally silent on this issue, shareholder approval is not required before repricing occurs, and disclosure is only provided after the fact, and only as it relates to the top executive officers and directors. While the SEC requires that all material terms of a compensation plan be disclosed when submitted to shareholders for approval, there is no specific requirement that a plan explain whether repricing is allowed without shareholder approval.
The SEC's compensation disclosure rules require companies that reprice stock options for the top five named executives to provide shareholders with a ten-year history detailing option repricing activity. The disclosure requirement extends to any replacement grant that is related to any prior or potential cancellation. Companies are also required to disclose the reason for repricing underwater stock options in the compensation committee report of the proxy statement.
Table 8-9. Sample Repricing Language
The Committee has the authority to reset the price of any stock option after the original grant and before exercise.
Subject to Applicable Laws and the provisions of the Plan (including any other powers given to the Administrator hereunder), and except as otherwise provided by the Board, the Administrator shall have the authority, in its discretion to amend the terms of any outstanding Award granted under the Plan, including a reduction in the exercise price (or base amount on which appreciation is measured) of any Award to reflect a reduction in the Fair Market Value of the Common Stock since the grant date of the Award, provided that any amendment that would adversely affect the Grantee's rights under an outstanding Award shall not be made without the Grantee's written consent.
Subject to the terms and conditions and within the limitations of the Plan, an option shall be evidenced by such form of agreement as is approved by the Committee, and the Committee may modify, extend or renew outstanding options (up to the extent not therefore exercised) and authorize the granting of new options in substitution therefore (to the extent not theretofore exercised).
The Committee also has the discretion to modify, extend or renew outstanding awards and to issue new awards in exchange for the surrender of outstanding awards.
Repricing is a key factor in ISS's vote recommendation. After completing the quantitative analysis described above, each company's policy with respect to repricing is reviewed. If the company has a history of repricing or has the express ability to reprice underwater stock options without shareholder approval under the proposed plan, ISS recommends a vote against the plan-even in cases where the plan is considered acceptable based on the quantitative analysis. Examples of plan language expressly permitting option repricing follow. Note that none of these examples include the term "repricing" in them.
Companies with a history of repricing underwater stock options can address ISS's concern by including language within the proxy statement that expressly prohibits repricing, unless shareholder approval is first received, when seeking to reserve additional shares.
Some companies put limits around repricing activity by prohibiting repricing for the top executives, restarting the vesting requirements, instituting an exchange program whereby two options must be given up for each new option granted, or restricting those shares that may be repriced to a certain percentage of reserved shares. Such factors are disclosed in the analysis. Other companies have begun seeking shareholder approval prior to repricing underwater stock options. These proposals are evaluated on a case-by-case basis, giving consideration to management's reason for seeking to reprice the options, the price history for the company's shares, and the number and terms for shares to be repriced.
FIN 44: Repricing Redefined
In December 1998, the Financial Accounting Standards Board (FASB) announced that under FASB Interpretation 44 (FIN 44), companies must account for repriced stock options using variable plan accounting. Under this methodology, the company must recognize compensation expense equal to the excess of the fair market value over the option price on the date the stock option is exercised, expires, or is cancelled. This expense must be estimated and recorded quarterly through the life of the option.
Pursuant to FIN 44, an award would be subject to variable plan accounting under the following conditions:
A stock option is amended to reduce the exercise price,
An existing stock option is cancelled and a new lower-priced option is granted within six months,
A stock option is granted and an old higher-priced option is cancelled within six months,
A stock option is amended to allow for the payment of a cash bonus upon option exercise, or
An option holder is permitted to exercise an option with a full-recourse note that does not bear a market rate of interest.
As a result of FIN 44, issuers devised alternative repricing mechanisms to avoid the expense associated with variable accounting treatment. The most popular methods are cancelling and regranting lower-priced options in six months and one day (6&1 repricing) and replacing underwater options with restricted stock.
Under ISS guidelines, all of the following constitute repricings:
Reduction in the exercise price of an outstanding option,
Cancellation and regrant of an option at a lower exercise price, including 6&1 repricings,
Grant of an option with an accelerated vesting schedule in exchange for the cancellation of an underwater option six months and one day later (bullet option),
Substitution of restricted stock for underwater options, and
Buyback of underwater options and issuance of new awards.
Payment Terms
Plan participants are frequently offered a variety of alternatives for payment of the exercise price, including cash, check, stock, broker exercise notice, promissory notes, a company loan, or various methods of cashless exercise. The latter two payment mechanisms may add to the costs associated with a plan. While company loans are legal in most states, there is an inherent conflict of interest in such actions and, if the loan is not repaid, the company assumes the obligation of trying to collect on the payment (if the loan has been collateralized) or forgiving the loan. An additional cost is incurred when loans are made on an interest-free basis.
Cashless exercise arrangements vary. A cashless exercise may be accomplished through an arrangement with a broker such that the participant exercises the number of options necessary to cover the exercise price. The company tenders the shares to the broker under the condition that the exercise price will be paid to the company prior to the remainder of the shares being released to the participant. Pyramiding, a cashless payment mechanism that must be disclosed in the proxy statement, involves a nearly simultaneous series of stock-for-stock exercises whereby the delivery of a few appreciated shares are used to acquire a larger number of shares under the plan, followed immediately by an exchange of the shares acquired for more shares. This type of exchange is repeated until all options have been exercised. With a cashless exercise, the participant does not have to own the stock (the share price appreciation from an option not yet exercised is utilized), and no cash is put up to take profits. ISS analyses include a list of payment alternatives provided under the plan.
Participation
Participants eligible to receive grants under a plan must be disclosed in the proxy. Eligible participants may include officers, key managers, nonemployee directors, all employees, independent contractors, and consultants. Many companies provide grants primarily to top management, but increasingly some companies are beginning to provide grants further down into the organization and are working to develop a corporate culture that encourages all employees to think like owners. While this concept has appeal, critics worry about demoralizing employees when salaries are reduced or frozen to provide a broad-based stock plan, or when expected payoffs evaporate in a sustained bear market or a prolonged corporate downturn. Others argue that stock-based awards should be provided to managers with overall responsibility and that employees with limited areas of responsibility should have incentives that pay off relative to the areas that are directly under their control.
Empirical evidence does not suggest higher returns from any particular grant strategy. ISS believes that plan administrators, typically the compensation committee of the board, are in the best position to determine how to maximize the value of such incentives by determining who receives the awards, when awards are granted, and the size of the awards. ISS analyses provide a list of eligible participants as disclosed in the proxy statement.
Plan Administration
Stock-based incentive plans are sometimes administered by the full board, but are more often administered by the compensation committee. The compensation committee sets the terms of awards granted, including the timing and size of grants, the exercise price, time to expiration, and vesting provisions. Questions of interpretation are determined by the committee, and its decisions are final and binding upon all participants. Obvious conflicts of interest suggest that the administering committee should be composed solely of independent outside directors. ISS analyses provide details about which directors administer the plan and their affiliations to the company.
Impact of Share Buybacks
Share buyback programs are sometimes established to run simultaneously with stock option plans. Company stocks typically react favorably to the announcement of a share buyback program, as share repurchases lower the supply of a company's stock and spread the company's earnings over a smaller number of shares. A buyback announcement may also serve as a signal to the market that management believes that its stock is undervalued. The impact on share price from an announced buyback program is captured in the model valuation. However, a share buyback does not offset SVT since shareholders' equity is used to repurchase the shares.
A share buyback does reduce voting power dilution and is subtracted out of the cost. For example, consider a plan with shareholder value transfer of 6.3 percent and voting power dilution of 7.1 percent. Assume further that a buyback program is instituted whereby the number of shares granted under the plan are bought back through open market purchases. The total cost of the plan is not (6.3% * 95%) + (7.1% * 5% ), or 6.4 percent. Rather, the total cost is only 6.0 percent since the impact of voting power dilution is entirely offset.
Some companies are seeking shareholder approval to reserve a fixed number of shares for issue under their incentive plans, plus to permit shares repurchased on the open market to be issued under the plan. If plan documents provide an estimate of the number of shares that may be bought back and the timing of such purchases, ISS analysts will incorporate these estimates into the analysis. In the absence of any information, ISS will recommend a vote against such plans since the buyback component represents an open-ended liability to shareholders that cannot be measured.
Impact of Dual Class Capital Structures
Companies with two or more classes of common stock require an adjustment to the voting power dilution calculation. This adjustment is easily made after running the model to determine shareholder value transfer from the plan. For example, consider a company with two classes of common stock: class A shares entitled to ten votes per share (20,000,000 shares outstanding) and class B shares entitled to one vote per share (50,000,000 shares outstanding). Assume further that the company seeks to authorize 3,000,000 class A shares for issue under a new plan and that there are no other existing plans. The numerator is (3,000,000 * 10). The denominator is (20,000,000 * 10) + (50,000,000) + (3,000,000 * 10), or 280,000,000. Voting power dilution is 10.71 percent. Ignoring the fact that shares reserved under this plan carry superior voting rights would significantly understate the cost, as measured by voting power dilution.
Multiple Compensation Plans
Some companies seek approval of multiple stock-based incentive plans at their shareholders' meetings. As shareholders are permitted to vote on each plan separately, ISS recommends voting for those individual plans that, when combined, allow the company the greatest value with which to motivate and retain plan participants without exceeding the allowable cap. Analysts assess the total cost of the first compensation proposal along with the incremental cost associated with each additional plan. Doing so ensures that the costs associated with shares available for issue and granted, but unexercised shares are not double counted.
For example, consider a company with three ballot items proposing to reserve shares for issue under separate stock incentive plans. Assume further that the allowable cap for the company is 5.2 percent. The terms of the plans are outlined below and show (1) the SVT for each proposal, and (2) the total cost (SVT and VPD) for the proposal, shares available for grant under continuing plans, and granted but unexercised shares.
Table 8-10. Multiple Compensation Plans Example
Plan 1 Plan 2 Plan 3
SVT = 0.37% SVT = 1.75% SVT = 0.50%
SVT + VPD = 3.77% SVT + VPD = 5.14% SVT + VPD = 3.92%
Analysts decide which plan or combination of plans is the closest to the allowable cap of 5.2 percent without exceeding it. Plan 2, with a combined cost of 5.14 percent, is just 0.06 percent below the allowable cap. While it may seem unlikely that a combination of the plans will come closer to the allowable cap without exceeding it, other combinations should still be examined. The total cost for Plan 1, SVT and VPD, is 3.77 percent. Adding the incremental shareholder value transfer from Plan 3 of 0.50 percent is 4.27 percent. This combination of plans is 0.93 percent below the allowable cap. Therefore, the best choice is to recommend a vote for Plan 2.
Evergreen Plans
Some stock-based incentive plans provide for an evergreen feature which automatically provides for an increase in the shares available for grant on an annual basis and operates in perpetuity. The most common configuration provides that the pool of shares available for issue under the plan is increased by a specified percentage of shares outstanding each fiscal year. Such plans pose difficulties from a valuation standpoint, as assumptions must be made about shares outstanding over an assumed term for the plan.
An estimate of the shares reserved for issue under an evergreen plan is made by assuming a plan term of ten years, in the absence of other information. The annual compound growth rate in shares outstanding over the past five years is assumed to be the growth rate for shares outstanding over the next ten years. It is further assumed that the entire percentage of shares available for issue each year will be granted. Consider a plan reserving 0.5 percent of shares outstanding at each fiscal year end. Five-year historic shares outstanding (adjusted for stock splits) are as follows:
Table 8-11. Shares Outstanding (in millions)
1990 1991 1992 1993 1994 1995
17.10 17.68 18.08 18.09 18.51 18.04
The annual compound growth rate of 1.08 percent is used to project shares outstanding over the plan term.
Table 8-12. Estimated Shares Outstanding (in millions)
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
18.24 18.43 18.63 18.83 19.04 19.24 19.45 19.66 19.87 20.09
The annual share reserve is 0.5 percent of estimated common shares outstanding, as shown below.
Table 8-13. Annual Share Reserve
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
91,200 92,150 93,150 94,150 95,200 96,200 97,250 98,300 99,350 100,450
By totaling the annual share reserve figures, it is estimated that 967,400 shares will be reserved for issue under the plan.
Another common version of the evergreen plan provides that the number of outstanding awards may not exceed a given percent of the company's common stock outstanding. Such plans require assumptions not only with respect to shares outstanding over an assumed plan term, but also require assumptions with respect to the number of options that will be exercised or canceled each year. Annual share exercises or cancellations over the remaining life of the plan are projected based average annual option exercises and cancellations over the past three years, as disclosed in the footnotes to the financial statements. The number of shares available for issue each year is determined through a two-step process. First, multiply projected shares outstanding times the percentage of awards that may be in the compensation system at any point in time (granted but unexercised shares) to get X. Second, subtract average annual option exercises and cancellations from granted but unexercised shares to get Y. Shares available for issue in year one is X - Y.
Shares available, Year 1 = X - Y, where:
X = shares outstanding * allowable %
Y = granted but unexercised shares - (average exercises + cancellations)
For example, assume that outstanding awards may not exceed five percent of outstanding common. Addition-ally, assume that the average number of shares exercised or canceled during the past three years is 50,000 and that granted but unexercised shares equals 565,000. Using projected shares outstanding from the example above, the calculation would be as follows:
Shares available, Year 1 = 912,000 - 515,000 = 397,000, where:
X = 18,240,000 * 5% = 912,000
Y = 565,000 - 50,000 = 515,000
Note that in year two, the estimated shares available in year one (397,000 shares) are assumed to have been issued and are added to granted but unexercised shares of 515,000. The total, 912,000 shares minus average shares exercised or canceled of 50,000 equals 862,000 shares. In year two, the calculation would be as follows:
Additional Shares Available, Year 2 = 921,500 - 862,000 = 59,500, where:
X = 18,430,000 * 5% = 921,500
Y = 912,000 - 50,000 = 862,000
Granted But Unexercised Shares (Overhang)
Some argue that by counting granted but unexercised shares, sometimes referred to as the "overhang," ISS unfairly penalizes companies whose employees hold their options and that ISS is encouraging optionholders to exercise early. Critics assert that the overhang should not be counted when reviewing a new plan, or an amendment to an existing plan because shareholders have already approved the issue of such shares.
That criticism is often intensified in cases where the company's stock has performed well and the options held by employees are deep in the money. (Counting such shares results in a higher cost since these options are more valuable). Critics argue that since the share price has appreciated, shareholders' have seen the value of their investments increase, so why should there be concern if employees also enjoy large payouts from their options?
ISS includes granted but unexercised shares in its valuation methodology for the following reasons.
Employees who exercise their awards early reduce the upside potential that could be realized by the optionholder who delays exercise. Absent insider information, profit maximization occurs when options are held close to term. If the employee elects to hold his option for a period after it has vested, the decision allows him to increase the probability of locking in a larger profit spread. That profit spread would be approximately the same whether the options were held to term or whether the options were exercised early (thereby locking in a smaller profit spread), and new options were regranted with a term equivalent to that specified in the original option contract. This is more easily seen at the extreme where options are canceled and regranted numerous times and the profit spread captured through each exercise is smaller, but over ten years the gain would approximate that achieved from holding the option to term.
ISS does not object to company employees holding their options to term. There are no instances where ISS has recommended that shareholders withhold votes from directors serving on the compensation committee because employees are holding their options for too many years and thereby locking in profits that are too large. The expected costs associated with the plan were assessed under the assumption that all reserved shares would be issued over the term of the plan, typically a ten-year time horizon. But, when companies seek to increase the reserve of shares available sooner than the original ten-year time horizon used to evaluate the initial proposal, the initial evaluation needs to be reassessed. A revised evaluation may show that it is no longer reasonable to keep adding new plans or increasing the reserve under an existing plan every couple of years, given that the original share authorization provided for grants that were expected to be spread out over the next ten years.
Granted but unexercised awards may again become available for future issue if the shares are terminated or forfeited. Therefore, granted but unexercised shares are quasi-available until they are exercised.
A significant number of grants may have been made outside of a shareholder-approved plan. By including granted but unexercised shares, all such costs are measured along with the new request.
Companies That Do Not Pay Dividends
Estimated option values are quite sensitive to assumptions regarding dividend payouts. For companies that have a history of paying dividends, the historical payout rates are used to project the future dividend yield. Throughout the option term, a steady dividend stream with a constant dividend payout rate is assumed.
Difficulties arise for companies that are growing rapidly, but currently pay no dividends. Companies can make a persuasive case that dividends could be instituted and increase markedly in future years. Assuming for valuation purposes that this company's dividend yield was in line with industry averages, it would result in a lower estimated option value. This is easily seen in the extreme, where a firm sacrifices the necessary investments in future growth, research, and development to pay large dividends. Such forecasts, while possibly accurate, are subject to considerable uncertainty and manipulation. For companies that have not paid dividends in the past, ISS assumes that no dividends will be paid in the future.
Notes
[1] Robert F. Brumer, "The Value of the Shareholder Voting Right." Paper presented before the Association for Investment Management and Research, Oct. 30, 1990. According to Brumer, the vote will carry a higher premium at companies with a high beta, if the company is in play, or if management owns a substantial position but less than a majority. The value of the vote is worth substantially less if the company has limited growth prospects or if management owns a majority position."
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