Burn rate, overhang, dilution and shareholder value transfer — what each measure hides, and how to model a share reserve request that carries.
A share reserve request is one of the few compensation items shareholders vote on with real consequences. It succeeds or fails on numbers — how many shares, for how long, at what cost, against what the company has done historically.
Our team has reduced equity share usage and dilution by around 40 percent in an in-house capacity while increasing delivered employee value, and has modelled three-year LTIP savings in the region of $15 million. Those outcomes came from the modelling discipline described below, not from cutting grants.
Shares granted in a year as a percentage of shares outstanding. The headline measure, and the one most often computed inconsistently — whether full-value awards are weighted, whether forfeitures are netted, whether performance awards are counted at grant or at vesting. Compute it the way proxy advisers do and the way that reflects economic reality, and understand the difference between the two.
Outstanding awards plus shares available for grant, as a percentage of shares outstanding. It answers a different question: not what you used this year, but how much future dilution is already committed. A low burn rate with high overhang is a company that has already promised the shares.
The economic effect on existing holders. Distinguish basic from fully diluted, and be explicit about which awards are assumed to vest. Modelling that assumes full vesting of performance awards at maximum overstates dilution; assuming target understates it under strong performance. Model the range.
The aggregate value transferred from shareholders to employees through the plan, usually expressed against market capitalisation and benchmarked to a peer group. It is the measure that most directly determines whether a share request is supported, and the one most companies model last.
Related: peer group construction determines the benchmark these measures are assessed against, and a poorly received share request frequently accompanies a weak say-on-pay result.
Burn rate measures shares granted in a year as a percentage of shares outstanding — what the plan consumed. Overhang measures outstanding awards plus shares available for grant against shares outstanding — how much future dilution is already committed. A company can have a modest burn rate and still carry high overhang, which means it has already promised the shares it is not currently granting.
Inconsistently, which is the problem. Practice varies on whether performance awards are counted at grant or at vesting, whether full-value awards are weighted relative to options, and whether forfeitures are netted. Proxy advisers apply their own convention. Model it both their way and the way that reflects economic reality, and understand why the two differ before anyone asks.
Large enough to be credible for a defined period and no larger. Shareholders and advisers increasingly assess expected duration, and a smaller request made more frequently is often better received than one intended to last a decade — it also keeps the committee accountable for its grant practices in the interim.
Because burn rate is denominated in shares while grant targets are usually set in dollars. A lower share price means more shares are required to deliver the same value, so share usage rises mechanically without any change in compensation philosophy. It tends to bite in precisely the years a company can least afford the scrutiny, which is why the share price should be stressed in the model rather than held flat.
Share reserve modelling, plan design, and shareholder value transfer analysis ahead of the proposal.
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