Integrating Stock Ownership Guidelines With Stock Retention Requirements

Summary: This article discusses the interplay between stock ownership guidelines and stock retention requirements and suggests ways that the two types of policies can be best integrated to create a corporate culture centered on equity ownership and long-term value creation for shareholders.

In recent years, U.S. public companies have increasingly implemented stock ownership guidelines and stock retention requirements. Stock ownership guidelines require executives or directors to attain minimum stock ownership levels within a specified period of time, while stock retention requirements require executives and directors to hold a specified percentage of “net shares” delivered pursuant to options, restricted stock, and other equity compensation awards. ¹“Net shares” are the shares remaining after payment of the exercise price (if applicable) and taxes upon exercise, vesting, or settlement of equity compensation awards.

According to the Shearman & Sterling 2011 Corporate Governance Survey of the Largest U.S. Public Companies: Director and Executive Compensation (our “Survey”), ²Shearman & Sterling LLP reviewed the corporate governance practices of 100 of the largest U.S. public, noncontrolled companies that have equity securities listed on the New York Stock Exchange or NASDAQ. The companies were selected based on a combination of their latest annual revenues and market capitalizations. Generally, annual proxy statements, compensation committee charters, and corporate governance guidelines on the companies’ websites as of June 1, 2011, were reviewed. The Survey and our companion survey regarding general governance practices are available on the Shearman & Sterling LLP website. We will be publishing the highlights of our surveys in digital, mobile, and tablet-friendly App versions. Details of the surveys can be found at http://www.shearman.com/corporate-governance/. 70 of the top 100 companies (the “Top 100 Companies”) maintain both executive and director stock ownership policies, 16 maintain only executive stock ownership policies and three maintain only director stock ownership policies. Stock retention requirements currently appear less common at the Top 100 Companies: our Survey finds that 31 of the Top 100 Companies maintain executive stock retention requirements, and 59 maintain director stock retention requirements. ³See also With Say on Pay Looming, Companies Move to Further Tighten the Link Between Executive Pay and Performance, Towers Watson (2010) (conducting a survey in 2010 wherein 7 percent of the 251 respondent companies stated that they increased the value of stock ownership guidelines or added additional stock retention requirements in 2010, and 14 percent expressed that they were likely to take such action). The vast majority of the companies that maintain executive stock retention requirements also maintain director stock retention requirements.

Ownership guidelines are helpful in providing a path to executive and director ownership; however, over time, with increases in compensation levels and stock price, they may lose their effectiveness in linking an executive’s or director’s net worth to the value of company stock. On the other hand, retention requirements provide companies with a straightforward way to promote stock ownership, particularly when used in tandem with ownership guidelines. Stock retention requirements assure that a portion of the net shares from every award will be retained for a specific period of time.

Companies reevaluating their policies or deciding whether to implement stock ownership guidelines and stock retention requirements for the first time should consider the benefits below. Integrated stock ownership guidelines and retention requirements accomplish the following:

•   are easier to communicate and enforce;

•   serve as a tool to align shareholder interests with those of executives and directors, thus emphasizing long-term value creation, minimizing short-term profit-taking and restoring shareholder confidence; ⁴See generally Bradley N. Benson et al., CEO Stock Ownership Guidelines, Louisiana Tech Univ. (Mar. 18, 2011) (noting the lack of empirical data supporting the effectiveness of CEO stock ownership guidelines on creating long-term value, analyzing 576 companies that adopted CEO stock ownership guidelines between 1993 and 2008 and concluding that companies have better financial performance in the years following adoption of CEO stock ownership guidelines).

•   have the potential to mitigate excessive risk-taking by discouraging executives and directors from engaging in activities that could inflate short-term stock price at the expense of long-term value creation;

•   help create a culture of share ownership among employees through a combination of share targets and automatic net share ownership; and

•   coincide with good corporate governance and are supported by proxy advisers, like Institutional Shareholder Services Inc. (“ISS”), and institutional shareholders.

Coverage

Successful implementation of stock ownership guidelines and retention requirements requires, first, a determination of who should be subject to such policies. The individuals subject to the policies must be individually selected to suit the needs of each company. Ownership guidelines and retention requirements typically should apply to the executives who have the greatest impact on decisionmaking and company performance. By definition, this often means the chief executive officer (“CEO”), named executive officers (“NEOs”) ⁵NEOs include a company’s CEO and the next four most highly compensated executive officers who were serving as executive officers at the end of the last completed fiscal year. If a company had more than one CEO during the last completed fiscal year, all individuals who served in that capacity during the last completed fiscal year are considered to be NEOs. NEOs can also include up to two additional executive officers who would have been among the most highly compensated executive officers at the end of the fiscal year if they still had been serving as executive officers at the end of the fiscal year. and other executive officers and senior employees such as executive vice presidents, senior vice presidents, vice presidents, and division or business heads. Directors are also typically included in the list of individuals who are subject to these policies, although the application of these policies to directors should be uniquely tailored to take into account the director’s oversight role and the company’s compensation structure for directors.

Stock ownership guidelines and retention requirements may only be appropriate for a broader group of employees if a company compensates large numbers of employees with equity grants and creates ownership targets and retention ratios that decrease by position. ⁶The Coca-Cola Co. is an example of a Top 100 Company that extends its ownership guidelines to the CEO, executive vice presidents, and group presidents, as well as other senior executives and business unit presidents, with ownership requirements ranging from eight to one times base salary. However, retention requirements may not be appropriate for employees who typically receive the bulk of their pay in cash and who may not have the financial wherewithal to invest a substantial portion of their net worth in a single, illiquid investment. Additionally, adopting policies that cover the CEO only or the CEO and NEOs could make a strong statement to shareholders and employees regarding accountability. On the other hand, adopting policies that extend deeper into the ranks may foster a broader ownership culture among employees.

Beyond the determination of who is covered, however, a company also must decide what form the stock ownership guidelines and retention requirements should take, what types of equity interests should count towards the ownership policies, how much time should be given to executives and directors to meet the guidelines, whether and how compliance should be enforced and what consequences might flow from noncompliance. This article discusses these issues and describes the terms and current trends of stock ownership guidelines and stock retention requirements.

Forms of Stock Ownership Guidelines

Calculating Ownership Targets.

Companies most commonly employ value-based ownership guidelines, under which executives and directors are required to own a multiple of their base salaries or annual retainer. Under these guidelines, the number of shares that must be owned may vary widely based on fluctuations in share prices, so this approach does not necessarily work well when the share price is volatile or if there is a significant drop in the share price. An alternative approach is to use guidelines based on a fixed number of shares or guidelines that allow some flexibility in determining whether to use a multiple of base salary/retainer or a fixed number of shares to achieve compliance. Using a fixed number of shares will mitigate the effect of lower stock prices on executives’ and directors’ ability to meet their ownership guidelines.

Of the 86 Top 100 Companies in our Survey that maintain executive stock ownership guidelines, ownership targets are calculated using the following methods: ⁷Our Survey reveals that three companies calculate ownership targets differently, depending upon individual position. Eli Lilly and Co., for example, requires its CEO to own five times base salary but requires its other executive officers to own a fixed number of shares—42,000 or 55,000, depending on position. AT&T Inc. requires its CEO to own six times base salary, requires executive officers to own the lesser of three times base salary or 50,000 shares and requires all other officers to own the lesser of one times base salary or 25,000 shares. Finally, Amgen Inc. requires the CEO/chairman to own five times base salary and the chief operating officer/president and executive vice presidents to own three times base salary, but it requires senior vice presidents (including one NEO) to own a fixed number of shares—4,500 or 13,500, depending on position.

•   72 use a multiple of base salary,

•   13 use a fixed number of shares, and

•   four use the lesser of a multiple of base salary or a fixed number of shares.

Of the 72 companies whose executives must hold shares with a value equal to a multiple of their base salaries, the multiples vary with position and job responsibility level. CEO multiples are the highest, ranging between five and 15 times base salary, ⁸Our Survey points out that one Top 100 Company—International Business Machines Corp.—requires shares with a value equal to three or one times salary plus bonus, depending upon position and achievement of targets. with 51 percent of the 72 companies employing a five times multiple. For example, General Dynamics Corp. requires its CEO to hold shares equal to 15 times his base salary, The Coca-Cola Co. requires its CEO to hold eight times base salary and eBay Inc. requires its CEO to hold five times base salary. On the other hand, Intel Corp., Oracle Corp., and Costco Wholesale Corp. are three of the 13 companies whose executives must hold a fixed number of shares.

Of the 73 Top 100 Companies that maintain director stock ownership guidelines, ownership targets are calculated using the following methods:

•   42 use a multiple of annual cash retainer,

•   17 use a fixed number of shares,

•   six use a specific dollar value other than a multiple of annual cash retainer,

•   four use the lesser of a multiple of annual cash retainer or a fixed number of shares, and

•   four use some other definition. ⁹For example, two companies—Johnson Controls Inc., and Colgate-Palmolive Co.—require directors to own shares with a value equal to five times their annual equity grant.

Of the 42 companies whose directors must hold shares with a value equal to a multiple of their annual cash retainer, the multiples range between two and seven times the annual cash retainer. Anadarko Petroleum Corp., for example, has a seven times annual cash retainer requirement.

Our Survey finds that a multiple of five times annual retainer applies at 43 percent of the 42 companies (18 companies), with Cisco Systems, Inc., and United Technologies Corp. among the Top 100 Companies implementing this multiple. A multiple of three times the annual retainer applies at another 33 percent of the 42 companies (14 companies), with Microsoft Corp. and Marathon Oil Corp. among the Top 100 Companies implementing this multiple. Abbott Laboratories and CVS Caremark Corp. are two companies that require directors to own a fixed number of shares—5,000 and 10,000 shares, respectively.

Of the six companies that require directors to hold shares based on a specific dollar value other than a multiple of annual cash retainer, our Survey indicates that three require a value of $300,000, and three require a value of $500,000, $400,000, and $270,000, respectively. General Electric Co. is the Top 100 Company that requires a value of $500,000.

Determining Which Equity Interests Count and Setting a Time Frame.

Regardless of whether a company defines required ownership levels using a multiple of base salary or annual retainer, a fixed number of shares or some other measure, a company must determine what types of equity interests will count towards meeting the guidelines and how long executives and directors have to meet the guidelines. Allowing covered executives and directors to count multiple types of equity interests toward the guideline levels can significantly aid executives and directors in meeting these guidelines. Equity interests that may count towards the guidelines include shares owned outright (including those acquired in the market or through grants/awards), restricted shares, and the shares underlying stock units, phantom shares, options, performance shares, and performance units. Equity interests can also include plan shares, such as those acquired in a Section 401(k) plan or credited under a deferred compensation plan. Ownership guidelines must also consider whether to distinguish vested and unvested awards and shares and whether to give executives and directors credit for shares held by immediate family members and estate-planning vehicles, such as family trusts.

Certain best practices have emerged with respect to counting equity interests. Unexercised stock options, whether or not vested, are commonly excluded from the count for both executives and directors. ¹⁰See Equilar 2011 Executive Stock Ownership Guidelines Report, p. 5 (finding that, of the Fortune 100 companies that disclosed a definition of shares in the 2011 proxy season, only 10.3 percent disclosed that options count toward the guidelines); Equilar 2011 Director Stock Ownership Guidelines Report, p. 16 (finding that, of Fortune 100 companies that disclosed a definition of shares, only 8.3 percent disclosed that options count toward the guidelines). Ownership guidelines more commonly allow executives to count restricted stock units, deferred shares and stock equivalents, plan shares and restricted stock. ¹¹See Equilar 2011 Executive Stock Ownership Guidelines Report, p. 17 (finding that, of the Fortune 100 companies that disclosed a definition of shares in the 2011 proxy season, 44.9 percent, 43.6 percent, 42.3 percent, and 37.2 percent permitted restricted stock units, deferred shares/stock equivalents, plan shares, and restricted stock, respectively, to count toward executives meeting their guidelines). For directors, deferred shares and stock equivalents are included in the definition of “shares” more commonly than any other type of equity interest, followed by restricted stock units. ¹²See Equilar 2011 Director Stock Ownership Guidelines Report, p. 16 (finding that, of the Fortune 100 companies that disclosed a definition of shares in the 2011 proxy season, 51.4 percent and 36.1 percent included deferred shares/stock equivalents and restricted stock units, respectively, in the count toward directors meeting their guidelines).

Of the Top 100 Companies that disclose a time frame within which executives and directors must meet the guidelines, our Survey results indicate that the vast majority require achievement within three to five years. Monitoring statements, annual progress requirements, or gradual application of guidelines are commonly used to help ensure compliance with stock ownership guidelines. Our Survey indicates that 85 percent of the Top 100 Companies that maintain executive stock ownership guidelines disclosed in their proxy statements the progress by each executive toward meeting the guidelines, and 59 percent of the Top 100 Companies that maintain director stock ownership guidelines disclosed the progress by each director. Costco Wholesale Corp., Honeywell International Inc., Visa Inc., and the Boeing Co. are among Top 100 Companies that disclosed the progress by both executives and directors.

Consequences for Noncompliance
With Stock Ownership Guidelines

Companies that are reevaluating their policies or creating new policies should consider the consequences of noncompliance. Currently, only a small number of companies disclose noncompliance penalties for executives and directors. ¹³See Equilar 2011 Executive Stock Ownership Guidelines Report, p. 31 (indicating that 7.7 percent of Fortune 100 companies with executive stock ownership guidelines disclosed noncompliance penalties); Equilar 2011 Director Stock Ownership Guidelines Report, p. 26 (indicating that 5.6 percent of Fortune 100 companies with director stock ownership guidelines disclosed noncompliance penalties). Noncompliance penalties specified by Top 100 Companies include:

• reduction or elimination of annual or future equity compensation;

• increased stock retention requirements, including retention of all or a specified portion of net shares following exercise or settlement;

• replacement of cash compensation with equity awards; or

• reduction of aggregate compensation.

For example, Target Corp. increases stock retention requirements in the event of noncompliance, stipulating that an executive or director who does not satisfy the compliance deadline must retain all shares acquired through the vesting of equity awards or the exercise of stock options until compliance is achieved. Caterpillar Inc., on the other hand, automatically reduces grants to executives and replaces half of directors’ cash compensation with restricted stock units until the required stock ownership level is achieved.

Forms of Stock Retention Requirements

Under stock retention requirements, executives and directors must retain all or a portion of the net shares acquired from awards of equity-based compensation for a specified time period. Retention requirements have several advantages:

• (1)  they eliminate the effects of share price fluctuations because they do not require achievement of a traditional stock ownership guideline but are instead automatically effected by stock accumulated by executives and directors over the course of their careers;
• (2)  because a portion of equity-based compensation must be retained and the number of shares held is thus directly related to the level of incentive compensation paid, they address shareholder concerns that stock ownership guidelines do not keep pace with the increase in equity awards given to executives and directors; and
• (3)  over time, they encourage share accumulation in excess of a potential guideline.

Most retention requirements do not stand alone but are instead used in tandem with ownership guidelines. ¹⁴See Equilar 2011 Executive Stock Ownership Report, p. 11 (providing that the prevalence of Fortune 100 companies with only holding requirements has remained at 6.3 percent over the last three years). Executives and directors subject to retention requirements are typically required both to meet ownership guidelines and satisfy retention requirements for all or a portion of equity until a specified period or until or “through retirement.” ¹⁵In this article, retention “through retirement” refers to retention beyond the time at which an executive or director terminates from his or her active service to a company. According to our Survey, stock retention requirements are not as prevalent as stock ownership guidelines and are less common for executives than for directors.

Selecting an appropriate stock retention period may depend upon the requirements of the policy, e.g., what percentage of equity must be retained and which executives are covered. Longer retention periods obviously encourage those subject to the retention requirements to retain a long-term focus on the company when making key decisions. If a retention period extends only until retirement, the potential for engaging in excessive short-term risk may arise just before retirement, as an executive or director close to retirement may be seeking to maximize short-term stock profit at the expense of long-term value creation. ¹⁶See generally Timely “Best Practice” Disclosures for Your Compensation Discussion and Analysis, The Corporate Executive, Vol. XXIII, No. 1 (Jan. – Feb. 2009) (weighing the benefits of implementing a retention period that extends through retirement and providing sample “best practice” disclosure of such a policy).

The forms of stock retention requirements among Top 100 Companies vary widely; however, the following represent the different forms of stock retention requirements currently in place among Top 100 Companies:

• Retention Periods

• until stock ownership guidelines are satisfied; ¹⁷When used in this manner, stock retention requirements are useful as a means for executives and directors to achieve their designated ownership levels, but this is as far as the benefit of having such a short retention period extends. According to our Survey, 27 of the Top 100 Companies require that executives hold all or a portion of their equity grants until the ownership guidelines are met, while four companies extend this requirement to directors. American International Group, Inc., and Cardinal Health, Inc., are two companies who have a retention period for executives that extends only until the stock ownership guidelines are satisfied.

• for a specified period following exercise or settlement, with a one-year period following exercise or settlement being the most prevalent but two- to five-year periods also being used;

• until retirement/termination;

• through retirement, with one year post-retirement being the most prevalent; or

• until the earlier of a fixed date, e.g., upon attaining a specific age, or retirement/termination.

• Shares Covered

• a percentage of net shares, with 50, 75, and 100 percent being common formulations;

• all equity awards and underlying shares; or

• rarely, all equity held at the time the individual becomes subject to the stock retention requirements.

The Proctor & Gamble Co., for example, requires its CEO to retain all net shares from option exercises for two years following exercise, but it requires its other executives to retain them for one year. ConocoPhillips, in another formulation, requires its executives to retain restricted stock units for five years following grant. With respect to director retention periods and shares covered, Prudential Financial, Inc., is among the few companies that require directors to hold all equity award shares until the earlier of retirement or attainment of age 701/2.

Requiring retention through retirement or termination may not be prevalent, ¹⁸According to our Survey, among the 59 companies with director stock retention requirements, 37 require directors to hold subject shares until retirement or termination, five require retention for one year following retirement or termination, five require retention for a specified period following vesting or exercise, and five require retention until the earlier of a fixed date or retirement or termination. Of the five companies that require retention for a specified period following vesting or exercise, one company fixes the date at one year, three companies fix the date at three years, and one company fixes the date at four years. Of the five companies that require retention until the earlier of a fixed date or retirement or termination, two companies fix the date at one year and three fix the date at five years. Among the 31 companies with executive stock retention requirements, 11 require retention for one year following exercise or settlement, nine require retention until retirement or termination, and seven require retention through retirement. Three of those companies, like the Proctor & Gamble Co. referenced above, maintain different requirements for the CEO than for other NEOs, and one company applies post-guideline achievement retention requirements to the CEO only. Additionally, one of 31 companies requires executives to retain 75 percent of their equity holdings calculated as of the beginning of the year, and two of them, including PepsiCo, Inc., require retention for six to 18 months following termination. but to some it is considered in line with good corporate governance. Several Top 100 Companies thus have adopted retention requirements that extend beyond retirement. Wells Fargo & Co. requires its executive officers to retain 50 percent of net shares from option exercises and restricted stock vesting for one year following retirement. Exxon Mobil Corp. requires its senior most executives to retain 50 percent of restricted stock awards for 10 years or until retirement, whichever is later, and the remaining 50 percent for five years. ¹⁹At the 2008 NASPP conference, Jim Parsons of Exxon Mobil Corp. identified the need to ensure that executives make decisions that lay a foundation that is going to continue to generate superior results year after year, rather than decisions that merely allow them to leave on a high note. See “Hold Through Retirement”: Maximizing the Benefits of Equity Awards While Minimizing Inappropriate Risk Taking, The Corporate Executive, Vol. XXII, No. 5 (Nov. – Dec. 2008) (discussing Exxon Mobil Corp.'s approach to retention requirements generally). PepsiCo, Inc., requires its executive officers to retain 100 percent of shares needed to meet the ownership guidelines for at least six months after termination or retirement and 50 percent of shares needed to meet the ownership guidelines until at least 18 months after termination or retirement. Requiring retention beyond retirement or termination, as these companies do, holds executives and directors accountable for the decisions made during their tenure with the company and prevents them from leaving service with the company through retirement or otherwise and immediately selling shares.

Features of Stock Ownership Guidelines
And Stock Retention Requirements

The following table sets out the key features of stock ownership guidelines and stock retention requirements:

Exceptions to Stock Ownership Guidelines
And Stock Retention Requirements

A number of the Top 100 Companies have included financial hardship features or other exceptions (including estate planning, charitable gift giving, divorce, tuition or other educational needs, specific age attainment, or minimum years of service) to their policies. ²⁰For example, Caterpillar Inc. provides an exception for “compelling personal circumstances.” Including these exceptions eases the guidelines in circumstances outside an executive’s or director’s control that cause an undue burden on their ability to maintain or achieve their ownership guidelines or satisfy their retention requirements.

If exceptions are permitted, the applicable policy should specify who will have the discretion to waive or modify the stock ownership guidelines and retention requirements. Sysco Corp. provides a good example: “There may be instances where abiding by these stock ownership guidelines may place an undue hardship on a director or executive officer … . The Chairman of the Corporate Governance and Nominating Committee will make the final decision as to developing an alternative … that reflects the intent of these stock ownership guidelines and the individual’s personal circumstances.” Policies often do not contain specific exceptions, but the board of directors or the relevant committee will address particular situations.

Hedging Restrictions

To ensure the effectiveness of stock ownership guidelines and stock retention requirements, companies should consider prohibiting executives and directors from hedging employer stock or pledging ownership interests in company stock to secure a loan. ²¹Permitting hedging can be difficult to explain to shareholders because requiring an executive or director to take a short position on company stock seems out of line with shareholder interests. Permitting pledging may be less difficult to explain, as assets will not be disposed of at depressed stock prices. See David F. Larcker and Brian Tayan, Pledge (and Hedge) Allegiance to the Company, Stanford Knowledgebase, Stanford Graduate School of Business, available at: http://www.stanford.edu/group/knowledgebase/cgi-bin/2010/10/21/pledge-and-hedge-allegiance-to-the-company (Oct. 21, 2010) (discussing executive pledging and hedging generally and finding that approximately 25 percent of companies allow either pledging or hedging; of those, only 29 percent allow hedging while 79 percent allow pledging). For example, Google Inc. has a policy that prohibits employees, officers, and directors from engaging in any speculative or hedging transactions such as puts, calls, collars, swaps, forward sale contracts, exchange funds, and similar arrangements or instruments designed to offset decreases in the market value of Google securities. Google’s policy also states that employees and directors may not engage in short sales of Google securities, hold Google securities in a margin account, or pledge Google securities as collateral for a loan.

According to our Survey, 63 of the Top 100 Companies disclosed that they maintain policies against hedging. ²²Note that these policies are not limited to stock ownership levels or shares required to be retained but apply to hedging of any employer stock. Such a high number may in part be due to the provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act that, upon effectiveness, ²³This provision is not yet effective, but the SEC is presently expected to issue proposed disclosure rules between August and December 2011. will require issuers to disclose whether directors and employees are allowed to hedge against decreases in the value of company stock. ²⁴See Amanda Gerut, Proxies Disclose More Details on Hedging, AgendaWeek (July 25, 2011) (“There is no doubt that anticipation of SEC action on this disclosure requirement is having an effect on behavior.” (quoting Shearman & Sterling LLP partner, Kenneth J. Laverriere)). Additionally, ISS considers permitting hedging activities a “problematic pay practice” that will be considered when it makes recommendations on proxy proposals, including say-on-pay votes.

Shareholder Activism and ISS

Over the last three years, a number of annual proxy statements have included shareholder proposals requesting that companies adopt stock ownership guidelines and stock retention requirements. ²⁵According to our Survey, six shareholder proposals on stock ownership guidelines and stock retention requirements were submitted in 2011, 14 were submitted in 2010 and six were submitted in 2009. The proposed resolutions requested the adoption of a policy requiring senior executives to retain a significant portion of net shares, generally 75 percent. Although none of the proposed resolutions received majority support from shareholders, with disclosure of stock ownership guidelines and stock retention requirements on the rise and greater incorporation of “retain until or through retirement” requirements among Top 100 Companies, there may be greater incentive to support and adopt such policies in the future. ²⁶ISS voting policies provide that it will review such proposals on a case-by-case basis, taking the following into account: (1) whether the company has any holding period, retention ratio or officer ownership requirements in place and the nature of the policies; (2) actual officer stock ownership and the degree to which it meets or exceeds the proposal proponent’s suggested holding period/retention ratio or the company’s own stock ownership guidelines or retention requirements; (3) post-termination holding requirements or any policies aimed at mitigating risk-taking by senior executives; and (4) problematic pay practices of the company, current and past, that may promote a short-term versus long-term focus. 2011 U.S. Proxy Voting Guidelines Summary, Institutional Shareholder Services, Inc., available at: http://www.issgovernance.com/files/ISS2011USPolicySummaryGuidelines20110127.pdf (Jan. 27, 2011).

In March 2010, ISS introduced its Governance Risk Indicators (“GRId”) to help institutional investors assess governance-related risk, and several of the scoring items pertain to stock ownership guidelines and stock retention requirements. ²⁷See Governance Risk Indicators: A New Measure of Governance-Related Risk, Institutional Shareholder Services, Inc., available at: http://www.issgovernance.com/files/GRId_Tech_Doc_Final_20100915.pdf (updated Sept. 15, 2010) (indicating that where details regarding stock ownership are vague or not definitive with respect to the mandatory nature of the ownership guideline, ISS will deem the information ‘not disclosed’ for the relevant question, resulting in negative points). For GRId scoring purposes, ISS awards the greatest number of points to companies that require CEOs to own stock with a value of at least six times their base salaries and companies that require directors to own stock with a value of at least five times their annual retainer. ²⁸See id. (clarifying that if a company does not use a multiple of salary or multiple of annual retainer approach, ISS will use the company’s stock price to convert the guideline that the company uses into a multiple of salary/annual retainer). The ISS guideline is higher than the most prevalent multiple reported in our Survey for CEOs (five times base salary) but is consistent with the multiple most prevalently in place for directors. ²⁹ISS also awards points for questions inquiring about (i) whether a company can affirmatively state that all directors with more than one year of service own stock and (ii) what proportion of salary is subject to CEO and executive stock ownership policies. See id. ISS’s scoring system could push more companies to opt for adoption of a higher CEO multiple in the future.

With respect to stock retention requirements, the GRId scoring items relate to executive retention periods for options and restricted shares. In order to receive points for these items, the executive retention period must apply to a “meaningful portion” of net shares, defined as 50 percent or more. ³⁰Id. In addition, the retention periods must continue to apply after stock ownership guidelines are satisfied, with the highest number of points awarded when retention periods extend until or through retirement. ³¹Id. Directors who own stock with a value of at least five times their annual retainer must also be required to retain their stock awards until retirement or termination of board service in order to receive the greatest number of points on the GRId question related to director stock ownership guidelines. ³²Id.

Documentation and Disclosure

Companies that implement stock ownership guidelines and stock retention requirements document those policies in varying ways. Stock ownership guidelines can be memorialized in a company’s Corporate Governance Guidelines, Compensation Committee Charter, or in another stand-alone document. Stock retention requirements are often set forth in Corporate Governance Guidelines or other stand-alone documents, but they may more appropriately be expressed in equity award or employment agreements where individuals are required to countersign the award or agreement or acknowledge acceptance of the award terms by retaining the award.

As the maintenance of stock ownership guidelines and stock retention requirements is generally viewed positively by shareholders, companies should consider publicly disclosing the adoption or modification of these policies. Although not required under the rules of the Securities and Exchange Commission (“SEC”), an announcement can be made in a Form 8-K, with the policies filed as an exhibit. ³³See “Hold ‘Til Retirement” Requirements for Equity Awards: How to Pick and Implement What’s Right for Your Company, The Corporate Executive, Vol. XXII, No. 4 (Sept. – Oct. 2008) (quoting former SEC Chief Counsel David Lynn, who indicated that he does not think that the SEC requires that the policies be filed as an exhibit to a periodic report, but filing a Form 8-K and exhibit 99.1 to the Form 8-K may be the best approach). Announcement can also be made through a press release and/or by posting the policies on company websites. In many cases, the existence of ownership guidelines and retention requirements is featured in the compensation discussion and analysis section of the company’s annual proxy statement.

Conclusion

Many leading companies already require executives and directors to meet stock ownership guidelines and adhere to stock retention requirements to align shareholder interests with those of executives and directors and foster a sense of ownership within the company. In our view, these policies work best when operated in tandem with each other as part of an overall program designed to foster equity ownership and the creation of long-term shareholder value. Companies should consider both types of policies as corporate governance best practices when reviewing their compensation programs, particularly given ISS’s new GRId scoring system and the general level of support such policies receive from shareholders.