stock compensation trends and best practices for 2018 · 2. assess major trends in executive...

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March 13, 2018

Stock Compensation Trends and Best Practices for 2018

22 © 2018 Equity Methods - Proprietary & Confidential

Agenda and Learning Objectives

Agenda

1. Regulatory and other updates affecting stock compensation

2. Long-term incentive award design trends

3. Survey background and introduction

4. Team staffing, role allocations, and system utilization

5. Forecasting and budgeting

6. Granting insights and technical methodologies

Stock Compensation Accounting Best Practices SurveyReserve your copy here

Learning Objectives

1. Understand how recent standard-setting and other regulation will impact stock compensation

2. Assess major trends in executive compensation and their expected impact on corporate accounting

3. Evaluate how different organizations staff stock compensation and divide roles and responsibilities

4. Consider the prevalence of manual processes and how to prioritize automation and other initiatives

5. Review how different companies approach their forecasting and budgeting for stock compensation

6. Briefly preview other areas in Equity Methods’ Stock Compensation Accounting Best Practices Survey

7. Wrap-up and parting thoughts

https://www.equitymethods.com/white-papers/2017-stock-based-compensation-accounting-best-practices-survey/



Regulatory and Other Updates Affecting Stock Compensation


Tax Cuts and Jobs Act

Obviously a big topic—we’ll focus on the executive compensation pieces

# Tax Revision Expected Result

1 Corporate tax rate lowered from 35% to 21% è Earnings volatility and need for performance adjustments

2 Section 162(m) tax deductibility for executive awards worsened è Maybe some design changes toward subjective goals or more cash

3 Private company “qualified equity grant” design introduced è Some use in order to avoid “dry income” situations

4 Excise taxes on highly compensated individuals at tax-exempt firms è Further scrutiny and compensation pressure

The Latest on Tax Reform and Equity Compensation

Content on tax reform:

Executive Compensation Performance Metrics Will Change Under Tax Reform


Aftermath of ASU 2016-09 ASU 2017-09§ Updated ASC 718 and became

effective for all companies in 2017

§ Most impactful changes:

Ø Excess tax benefits and deficiencies flow through P&L

Ø Forfeiture rate optionality

Ø Liability trigger relaxed for tax withholding

Non-Employee Accounting Changes

§ Accounting for nonemployees will be governed by ASC 718, rather than ASC 505-50

§ Measurement date will be grant date instead of vesting date (no mark-to-market)

§ Presumption toward using contractual term vs. expected term

Regulatory Updates

Two emerging best practices:1. Integrate tax and overall

expense reporting processes2. Use tax settlement forecasting

to forecast P&L impacts of future settlements


Where Executive Compensation May Need Help in 2018

1. Use of Non-GAAP Performance Metrics 2. Goal-Setting

3. Pro Forma Cost Analysis for TSR Awards 4. CEO Pay Ratio

More quantitativeMore qualitative

Guess-timating

FP&A Modeling

HistoricalData

Analyst Estimates

Simulation Modeling

Trend toward using multiple, corroborating approachesComp committees want to understand how and why

Measuring twice and cutting once can get you bang for your $ You might be called upon to provide data or do the calculation itself

§ SEC released C&DIs on non-GAAP measures in October 2017§ If non-GAAP results are better than GAAP results, shareholders or

shareholder advisors may have concerns§ Important to understand when adjustments to non-GAAP metrics

will be acceptable vs. controversial

§ TSR awards can be designed with many different features, such as value caps, different peer groups, and various payoff schedule slopes

§ Pro forma cost analysis provides a precise and reliable way of comparing costs of multiple different award designs

Identify the median

employee

1Calculate the ratio

2Communicate

3CEO Pay

Median Employee Pay

ü Proxy disclosureü Internal

employee communications


Polling Question #1

Where does your company currently stand in its CEO pay ratio preparations?

A. Not applicable§ Ex: vendor, private, or otherwise exempt

B. Fully ready§ Ex: preliminary calculations complete, disclosure drafted, and median selected

C. At least one dry run§ Ex: disclosure and other loose ends not tied down, but have a good estimate of ratio

D. Started, but nothing firm yet§ Ex: initial steps have been taken, but there are not yet any results to use in planning

E. Have not yet started§ Ex: we’re waiting to see if it was repealed, or have a later fiscal year

F. I don’t know§ Ex: not personally involved or responsible


Performance Awards: Increasing Usage and Complexity

Source: Compensation Advisory Partners CAP 100 database. Used with permission.

43%40%

17%20%

42%38%

0%

10%

20%

30%

40%

50%

1 2 3+

Number of LTIP Metrics Used

2010 2016

38% 35% 35%

22%

56%

47%

29% 24%

0%

10%

20%

30%

40%

50%

60%

TSR Return Measures EPS Revenue

LTIP Metrics

2010 2016

Key Takeaway #1: Use of Total Shareholder Return and other

returns-based metrics like ROE, ROIC, and ROA has increased in

recent years

Key Takeaway #2: The number of metrics seen in LTIP awards is

increasing. “Hybrid” awards that combine TSR and operational

metrics are on the rise



Introduction to EM Stock Compensation Accounting Best Practices Survey


Stock Compensation Accounting Best Practices Survey Introduction

In Q3 of 2017, we administered our biennial “Stock Compensation Accounting Best Practices Survey”– Separately, we ran our “Executive Compensation Decision Support Survey” devoted to the compensation function

Problem: companies adopt very different approaches toward stock compensation accounting—what are “best practices?”

Solution: link specific practices back to other areas of organizational strength (e.g., how do excellent forecasters approach SBC)

Goals of the Survey

1Understand common practices and how different companies approach staffing and technical decision points

2 Glean some insight into what best-in-class looks like—what separates the best from the rest?

3Set continuous improvement priorities and build a business case for driving change in a particular area

https://www.equitymethods.com/white-papers/2017-stock-based-compensation-accounting-best-practices-survey/

https://www.equitymethods.com/white-papers/2017-executive-compensation-decision-support-survey/


How Do You Identify and Isolate Best-in-Class?

Pool of respondents

Organizations with large plans (> 1,500 participants)

Organizations with relative outperformance in the market

Organizations with strong equity compensation reporting to senior management and the BOD

Organizations with a strength in analytics and predictive modeling

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Who Took the Survey?

230 respondents

In 2015: 245

Accounting/Finance 80%

HR/Compensation 8%

Stock Services 5%

Tax 6%

Legal 2%

Level 2017 2015Staff Accountant/Accounting Analyst 7% 10% Þ

Accounting Manager/Senior Accountant 32% 34% Þ

Manager of SEC/External Reporting 22% 24% Þ

Director of SEC/External Reporting 19% 14% Ý

CAO/CFO/Controller 20% 17% Ý

Broad coverage across accounting/finance roles

Good variation in scope of involvement

Level 2017 2015Prepare expense, tax, or related reports 43% 43%

Review final entries and work product 41% 42% Þ

General oversight responsibility (no direct involvement) 16% 15% Ý


Healthy Representation Across Size Levels and Sectors

Information Technology 18%

Financials 15%

Healthcare 15%

Consumer Discretionary 14%

Industrials 13%

Energy 11%

Consumer Staples 5%

Materials 4%

Real Estate 3%

Utilities 2%

Telecommunication Services 1%

Note: numbers in tables throughout the slides that follow may not add to 100%; this is due to rounding where our preference is to not show decimal points in order to keep slides clean and in a larger font.


The Punchline

Automate manual processes Prioritize analytics and predictive modeling

Develop broader impact through decision support

è HR (pre-grant modeling)

è Tax (forecasting)

è Tax (recharge optimization)

è International (IFRS reporting)

è Treasury (dilution modeling)

è M&A (acquisition modeling)

è Forecasting and budgeting

è Pre-grant forecasting

è Fluxes

è Variance analytics

è Spreadsheets

è Department handoffs

è Reduced key person risk

As impact grows, a positive cycle forms where more information is requested. That creates manual processes, which then require automation.



Team Staffing, Role Allocations, and System Utilization


Finance Leaders Remain Concerned with Stock Compensation Reporting

Describe your level of concern with each area of stock compensation:

33% when focused on assistant controller and up

EM Takeaways

1. Concern levels vary by role/level, suggesting different perceptions of risk

2. Manual processes and the associated risk of a process breakdown in the event of turnover dominate concerns


Polling Question #2

Which segment of your SBC reporting process creates the most headaches?

A. Data accuracy and controls

B. Valuation

C. Manual processes and workarounds

D. Analytics (forecasting, variance analysis)

E. Key person risk/dependence

F. Handoffs with tax or other departments


Team Structures and Division of Labor Vary Greatly

How many people are involved in the financial reporting (including tax accounting, FP&A, and review) for share-based compensation?

Counts number of FTEs (e.g., 0.25 FTE + .075 FTE = 1)

Counts total number of people involved (even partially) in a process step

EM Takeaways

1. Time demands are up slightly from the 2015 survey, suggesting levels of effort are flat or slightly increasing

2. Anecdotally, the skills required remain high (technical accounting, knowledge of equity) and yet turnover imposes high pressure


Roles and Responsibilities Are Often Shared with Other Departments

Please describe corporate accounting’s role in each of the following

areas:

EM Takeaways

1. Insignificant changes from 2015 survey,

suggesting general stability in how roles

are sliced by department

2. Risk is highest where there are handoffs

between departments and where no

single individual has deep insight into the

entire process

3. Watch out for international: ownership

levels vary greatly, creating major risk of

disconnects


Automation, Systems, and “Getting It Done”

What resources or tools do you use in performing your ASC 718 financial reporting?

Scope of Involvement

Stock Plan Administration Product Only

Manual Spreadsheets Only

Combination of Stock Admin Tool and Spreadsheets

ALL Firms 24% 24% 53%

Large Plans (> 1,500 participants) 9% 27% 64%

Medium Plans (250 – 1,500 participants) 13% 13% 74%

Small Plans (< 250 participants) 35% 30% 35%

EM Takeaways

1. It’s rare to be 100% automated, even when filtering for small plans

2. Spreadsheet-only processes are highest with small plans (30%) and large plans (27%) given limited choice and/or high complexity

For this question, we excluded clients for

whom we do financial reporting to

gain a pure market perspective



Forecasting and Budgeting Practices


Where Is Forecasting Used?

How do you use stock compensation budgets and forecasts?

EM Takeaways

1. Firms with robust upward reporting structures devote more energy to “advanced” forecasting areas

2. High levels of senior management engagement naturally segue into more cross-functional forecasting with HR, Tax, and Treasury


Forecasting Mechanics and Areas for Improvement

How do you set up hypothetical awards in your future

period expense forecasting process?

What is the longest horizon of your forecasting/budgeting

process?

To what extent is it important to analyze the drivers behind

budget-to-actual variances?EM Takeaways

1. Trend is toward forecasts needing to be more precise,

which is driving more scrutiny around the assumptions

2. Given the multiple moving parts (such as higher

forfeitures and more granting than planned), explaining

variances is not straight-forward—analytical framework

is needed

Technique All Upward Reporting

Using aggregated assumptions 33% 32%

Using granular assumptions 43% 48%

Hypothetical grants are not used 24% 20%


Current year or current + next year 46% 40%

3 years ahead 39% 47%

5 years or longer 15% 15%


Important all the time 31% 43%

Important only when variances exceed

a certain level62% 54%

Not important 6% 2%


Tax Settlement Forecasting

In light of the removal of the APIC pool via ASU 2016-09, do you forecast future award settlements for purposes of modeling expected tax windfalls or shortfalls?

How do you generate forecasts of future tax settlement events?

EM Takeaways1. Expect a greater push toward tax settlement forecasting, especially in response to market volatility

2. TSF is becoming much more scenario-based


Polling Question #3

Which of the following describes the biggest change your company has encountered as a result of the APIC pool removal of ASU 2016-09?

A. We now use tax settlement forecasting to produce estimates of expected future benefits/deficiencies

B. We are identifying and automating manual components of tax reporting now that this process will directly impact the P&L

C. We are implementing a push-down process to book tax expenses at the business unit level

D. Another big change not listed here

E. Our process has not changed at all

F. I don’t know



Granting Insights and Technical Methodologies


Total Shareholder Return (TSR) Considerations

Using the stock face value to set grant quantities = Proxy risk

§ Suppose the BOD decides to grant $6m in TSR awards, and this reflects an effort to pay at the 65th percentile

§ Stock is trading at $75, which would lead to an award of 80,000 units§ Accounting [fair] value of one unit is $96 (128% premium over face value)§ The disclosed proxy value of the grant is $7,680,000, which corresponds to

paying in the 90th percentile

Using the accounting value to set grant quantities = Participant risk

§ Suppose the BOD decides to grant $6m in TSR awards, and this reflects an effort to pay at the 65th percentile

§ Stock trading at $75; accounting value is $96 (128% premium over face)§ 62,500 awards are granted ($6m / $96) based on accounting value§ Many participants anchor their expectations against the face value; this

could pose quite a disconnect

How do you set grant quantities with regard to your TSR awards, i.e., what do you base the number of units granted on?

Method 2015 Survey

2017 Survey

Accounting Value 65% 60%Face Value of Stock 35% 40%

EM Takeaway

1. Not a clear best practice—the best practice is modeling to set expectations with all interested stakeholders (board, CHRO, other executives)


Employee Stock Purchase Plans (ESPPs) Are on the Rise

Please check which ESPP plan type you maintain:

Type A - Maximum number of shares 14%

Type B - Variable number of shares 14%

Type C - Multiple purchase periods 28%

Type D - Multiple purchase periods with a reset mechanism

5%

Type E - Multiple purchase periods with a rollover mechanism

14%

Type F - Multiple purchase periods with semi-fixed withholdings

9%

Type G - Single purchase period with variable withholdings

12%

Type H - Multiple purchase periods with variable withholdings

2%

Type I - Single purchase period with variable withholdings and cash infusions

2%

Do you perform financial reporting for your ESPP within your regular process for stock compensation accounting, or is the ESPP handled via a different process, spreadsheet, or tool?

Separate Process 58%

Same Process 42%

Do you calculate ESPP expense at the person level using estimated contributions from payroll, or adopt a pooled approach in which estimations are made regarding average contributions?

Pooled Approach 27%

Person-Level with Payroll Data 73%

Do you consider your ESPP reporting process to be more or less manual than the process used for other awards?

More Manual 65%

Less Manual 35%

EM Takeaways

1. Keep an eye on your ESPP reporting since it’s subject to high measurement error but is often overlooked in reviews

For this question, we excluded clients for whom we do financial reporting to

gain a pure market perspective


Forfeiture Rates: Mostly Still in Use Post ASU 2016-09

Do you apply a forfeiture rate now that, following ASU

2016-09, use of a forfeiture rate is optional?

We continue to apply a forfeiture rate 66%

We have stopped using a forfeiture rate 34%

Do you use a "dynamic" or "static" expense attribution

model?

‒ Static model applies a fixed forfeiture rate discount and then performs a true-up for actual forfeitures at vest

‒ Dynamic model involves expense true-ups during the vesting period based on actual forfeiture behavior§ “Manual dynamic" approach will involve true-ups at discrete

intervals, such as annually§ “Automated dynamic model" involves real-time true-ups

alongside a continuous reduction of the forfeiture rate haircut, and is performed by a system

Forfeiture Rate Method 2015 Survey

2017 Survey

Static 34% 17%

Manual Dynamic 15% 20%

Automated Dynamic 51% 63%

EM Takeaways

1. Most companies continue using a forfeiture rate to

reduce budget-to-actual variances, maintain consistency

with IFRS reporting, and because it’s easy

2. Shift toward a “dynamic” methodology continues


Polling Question #4

When it comes to describing your company’s stock based compensation reporting processes, which of the following risk categories would you say is most salient?

A. Expertise/bandwidth of staff allocated to ASC 718

B. Scope of spreadsheet reliance

C. Frequency of changing data

D. Disjointedness between expense and tax reporting

E. Presence of exotic plan provisions



Wrap-Up and Parting Thoughts


What We Covered

Regulatory/Other Updates Affecting

Stock Compensation

Long-Term Incentive Award Design

Trends

Team Staffing, Role Allocations, and

System Utilization

Forecasting and Budgeting Best

Practices

Granting Insights and Technical

Methodologies

The full survey report covers these areas in greater depth, as well as other sections:

§ Push-down (direct tracing) of expense within the corporate hierarchy§ Recharging stock compensation globally and transfer pricing§ International considerations, including IFRS and employee mobility§ Tax accounting (ASC 740) considerations and best practices


Key Takeaways

The executive compensation landscape is rapidly changing.And this creates pressure for flexible and adaptable reporting processes.1

Automation of stock compensation is a prerequisite to broader impact.Manually intensive processes are all about “getting it done” versus answering strategic business questions.2

Cross-functional collaboration with Compensation and Tax are becoming the norm.In order to get out in front of emerging issues and avoid problematic process handoffs.3

Forecasts are expected to be more granular and deliver lower future variances.Similarly, be prepared to explain variances quickly and clearly.4

Data and analytics are only going to increase in importance.With more availability and better tools, analytics are crucial both to make and to communicate big decisions.5


Speaker Information

Takis Makridis, CEPEquity [email protected]

As President and CEO, Takis is responsible for the strategy, service delivery, and thought leadership efforts at Equity Methods.Leveraging extensive consulting experience, Takis is relentlessly committed to delivering practical, plain-English, high-impact solutions to clients while remaining active in the firm’s research efforts.

Throughout his career, Takis has worked closely with finance and HR executives to address their equity compensation design, valuation, and financial reporting needs, and is critically engaged with thought leaders across the industry in addressing new and emerging issues. The 60-plus professionals at Equity Methods assist clients in the valuation, design, and financial reporting of equity compensation awards, as well as the valuation of other complex securities. Equity Methods has served over 500 companies, with a particular focus on large organizations with complex equity compensation programs (having served 30 Fortune 100 companies).

A nationally recognized speaker, Takis frequently leads conference presentations, executive briefing sessions, and firm webinars. Takis is the author of Advanced Topics in Equity Compensation Accounting and Accounting for Equity Compensation (third – fifth editions), published by the National Center for Employee Ownership. The two have been required texts for the Certified Equity Professional (CEP) designation. Takis also is a contributor to various technical publications and is cited in media such as the New York Times, Corporate Board, Thomson Reuters, Bloomberg BNA, CFO.com, FEI Daily, Compliance Week, and Treasury and Risk.

Takis is a member of the CEP Advisory Board and the WP Carey School of Business Dean’s Council. He holds a BS in economics and finance from Arizona State University, an MBA from Oxford University, and is a Certified Equity Professional (CEP).

mailto:[email protected]

http://www.nceo.org/Advanced-Topics-Equity-Compensation-Accounting/pub.php/id/39/

http://www.nceo.org/pages/nceo.php


Speaker Information

Nathan O’ConnorEquity [email protected]

Nathan O’Connor is a Managing Director at Equity Methods, a consultancy that helps hundreds of public and private companies

model, value and account for equity compensation and other complex securities. As the first point of contact for prospective

clients, Nathan brings over a decade of quantitative consulting experience to bear in collaborating with the Valuation, Reporting,

and HR Advisory practices within Equity Methods to ensure that prospective clients’ needs are met. As a liaison between the

company and the broader compensation community, he shares best practices at industry events throughout the country and

through publishing technical articles.

Prior to his current role, Nathan served as the national valuation practice leader at Equity Methods, where he oversaw all client

delivery, operations, and R&D in support of more than 400 public and private clients, in addition to directly serving the

compensation consultants and senior executives of several Fortune 50 companies.

A technician at heart, Nathan is a Certified SAS Base Programmer who has taught core finance topics in the University of

Arizona’s MBA program and internal derivatives workshops at Equity Methods. He holds a B.A. in International Relations

from Purdue University, an M.B.A. in Derivative Securities from the Quinlan School of Business at Loyola University Chicago, and

an M.S. in Finance (ABD) from the Eller College of Management at the University of Arizona. He previously served on the Board

of the Las Vegas NASPP as Program Chair and the Phoenix Chapter of the NASPP as Secretary.

Currently, Nathan serves as a Chapter Leader of the Arizona Chapter of Financial Executives International and an Advisory Board

Member of the Certified Equity Professional Institute.

mailto:[email protected]

http://www.naspp.com/chapters/main.aspx?ChapterId=68

http://www.naspp.com/chapters/main.aspx?ChapterId=59

https://www.financialexecutives.org/Network/Chapters/Arizona/Home.aspx

https://www.scu.edu/business/cepi/about/

stock compensation trends and best practices for 2018 · 2. assess major trends in executive...

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