1. Stock Ownership Guidelines & Holding Requirements

Since the financial crisis of 2008, USU.S. public companies have made great efforts to improve corporate governance. The corporate governance reforms included in the Dodd-Frank Act of 2010 accelerated this movement by requiring shareholders to approve executive compensation on a non-binding advisory basis, beginning in 2011. Companies worked to strengthen their compensation policies as a way to increase shareholder support for Say on Pay proposals. Certain executive compensation program elements quickly evolved from “nice-to-have” status to “expected.” In this section, we summarize five common policies that enhance the alignment of executives with shareholder interest and support strong governance.

a. Stock Ownership Guidelines

CEOs and other senior executives receive the majority of their compensation in the form of company stock. Stock ownership guidelines have been established by 98% of companies in the CAP 120 to ensure that executives hold onto a pre-defined level of the company’s stock over the course of their tenure with the company. Shareholder advisory firms and institutional shareholders support ownership guidelines, viewing ownership of company stock as a way to align management with shareholders. Most compensation committee members also support the use of stock ownership guidelines but recognize that executives may have some desire to diversify their interests out of company stock over time.

Most stock ownership guidelines share certain characteristics, as summarized below:

Stock Ownership Guideline Feature	Market Approach
Basis for Requirement	A majority of companies (95% of CAP 120) define ownership as a multiple of base salary A minority of companies (5% of CAP 120) define ownership as a number of shares
Requirement	CEO: 5x-6x salary is most common (56% of CAP 120) Other NEOs: 3x-4x salary is most common
Time to Comply	Five years to comply is the most common (from date of hire or promotion to executive role or for any increase in guideline)
Shares Counted Toward Compliance	Shares owned outright Shares held in company benefit plans Unvested, time-vested restricted stock or restricted stock units (in some cases on a net of tax basis) Unvested performance shares and unexercised stock options typically do not count toward compliance
Assessment of Compliance	At least annual testing of compliance Many companies use an average stock price over a period of time (e.g., average for the year)
Consequence if not in Compliance	Most companies expect executives to comply, but do not have formal consequences for noncompliance Most common “penalty” is to require that all or a portion of shares (net of taxes) vesting be held until guideline is achieved

In practice, most executives are able to comply with ownership guidelines over a five-year period without making any purchases in the open market. This is particularly true for companies that deliver a substantial portion of their long-term incentives in restricted stock or performance shares. Companies that use stock options as the primary long-term incentive may inadvertently encourage early exercise of stock options if they require executives to comply within five years.

When a company experiences a severe decline in the stock price, executives may fall out of compliance with the ownership guidelines. Committees are often lenient in assessing compliance as long as executives do not fall out of compliance due to the sale of shares.

Key Questions for Committee Members to Ask:

• Are our stock ownership guidelines consistent with the levels of peers?
• Do our compensation programs deliver adequate shares so that executives will not need to purchase shares to achieve the guidelines?
• Are our executives all in compliance with the ownership guidelines? If not, do the noncompliant executives still have sufficient time to achieve compliance?
• What are the consequences of failing to achieve the ownership guidelines within the specified compliance period?

b. Stock Holding Requirements

Stock holding requirements are similar to stock ownership guidelines. They require an executive to hold all or a portion of the shares delivered at vesting of full-value shares or at exercise of stock options for a defined period of time. Stock holding requirements first arose out of concerns that executives may have incentives to “pump and dump” a company’s stock. That is, they may take actions that lead to a short-term increase in the company’s stock and immediately sell shares before the market recognizes that the shares are overvalued. In theory, this makes sense for stock options, since the executive could time the stock option exercise, but it is harder to make the case that stock holding requirements are necessary for full-value shares, where executives do not control the timing of vesting.

Key features of stock holding requirements include the following (based on the CAP 120):

Stock Holding Policy Feature	Market Practice
Shares to be Held	Typically applies only to net shares (i.e., net of any shares used to satisfy the option exercise price or taxes on the shares)
Application	Most include option exercises Some include vesting of restricted shares Some also apply to payouts of performance shares
Percentage of Shares Held	100% is the most common; 50% of net shares is also common
Period of Time	Most companies have a 1-year holding requirement 28% of companies require the shares to be held until retirement

Similar to their treatment of stock ownership guidelines, shareholder advisory firms view stock holding requirements as an effective shareholder alignment tool, preferring that companies adopt these policies, even if they already have stock ownership guidelines. However, many committee members and executives view stock holding requirements as redundant if ownership guidelines are already in place. Approximately 66% of CAP 120 companies disclose a holding requirement. Among the CAP 120, 28% of companies have a holding requirement that is separate from stock ownership guidelines or comes into effect after stock ownership guidelines are met. Some shareholders and advisory groups have promoted the concept of holding requirements until retirement. While this concept has not caught on to date, there is a minority of companies — particularly in the financial services industry — who have implemented this approach.

Key Questions for Committee Members to Ask:

• Will stock holding requirements encourage executives to retain company stock beyond current holding levels?
• Will stock holding requirements improve shareholder advisory views on our compensation program?
• How are our stock holding requirements viewed by executives? Would adopting guidelines meaningfully change executive behavior?
• How do our stock holding requirements align with our stock ownership guidelines?