ISS has posted its draft 2012 policies for comments. The policies indicate a departure from prior ISS positions in evaluating executive compensation. Perhaps more significantly, if a prior say-on-pay vote indicated significant opposition to pay practices, ISS may recommend withholding votes from compensation committee members, and a “no” vote on any current say-on-pay-proposal, depending on a number of circumstances.
Evaluation of Executive Pay
According to ISS, the advent of near universal say on pay has underscored the importance of a balanced evaluation of executive pay practices. ISS believes both investors and issuers have indicated in roundtables and other feedback that pay-performance alignment should be viewed in a long-term context rather than the most recent year. In light of this guidance, ISS is proposing to revise its approach to identifying pay-for-performance alignment in order to better address market needs. ISS intends that the new approach will identify strong as well as weak pay-for-performance alignment over a sustained period, thus giving clients a more robust view of the relationship between executive pay and performance at portfolio companies.
ISS claims backtesting of the new methodology indicates strong correlation between the results and shareholder say-on-pay votes in 2011. ISS does not anticipate a significant change in the number or percentage of negative recommendations issued due to a change to the proposed methodology. However, the set of companies that are identified as having long-term pay-for-performance misalignment may differ somewhat from those that would be identified under the current methodology (which focuses primarily on companies that have underperformed a broad industry group and where a veteran CEO’s pay increased in the most recent year).
The new methodology incorporates a quantitative analysis, followed as applicable by further qualitative analysis.
The quantitative pay-for-performance analysis utilizes three factors; together they provide a useful signal to pay-for-performance alignment over sustained periods (one, three, and five years), including both high and low performing companies that provide proportionate (or disproportionate) pay and pay opportunities to the CEO. The analysis measures three factors in two categories:
- Relative Alignment– Two factors are analyzed to determine the pay-performance alignment within a group of companies similar to the company in market cap, revenue (or assets), and industry.
- The degree of alignment between the company’s TSR rank and the CEO’s total pay rank within the peer group, as measured over one-year and three-year periods (weighted 40/60, to put more emphasis on the longer term);
- The multiple of the CEO’s total pay relative to the peer group median, which may identify cases where a high performing company may nevertheless be overpaying.
- Absolute Alignment– this factor measures long-term alignment between pay and company performance.
- Alignment between the trend in the CEO’s pay and the company’s TSRs over the prior five fiscal years – i.e., the difference between the slope of annual pay changes and the slope of annualized TSR changes during the prior 5-year period.
Peer Alignment and Absolute Alignment may be weighted 50/50 in this portion of the analysis. Companies that demonstrate strong or satisfactory alignment will generally receive a positive recommendation (in the absence of other pay-related issues), while companies demonstrating weak alignment will receive further qualitative review to determine a final vote recommendation.
The qualitative review considers the following:
- The ratio of performance- to time-based equity awards;
- The overall ratio of performance-based compensation;
- The robustness of disclosure and rigor of performance goals;
- The company’s peer group benchmarking practices;
- Actual results of financial/operational metrics, such as growth in revenue, profit, cash flow, etc., both absolute and relative to peers;
- Special circumstances related to, for example, a new CEO in the prior FY or equity grant practices (e.g., biannual awards); and
- Any other factors deemed relevant.
Board Response to Management Say-on-Pay Vote
This policy update clarifies that ISS will recommend case-by-case on compensation committee members and the current say-on-pay proposal if the company’s prior say-on-pay proposal received significant opposition from votes cast, taking into account:
- The level of opposition;
- The company’s ownership structure;
- Disclosure of engagement efforts with major institutional investors regarding the compensation issue(s);
- The company’s response;
- Specific actions taken to address the issue(s) that appear to have caused the significant level of against votes;
- Other recent compensation actions taken by the company; and
- ISS’ current analysis of the company’s executive compensation and whether any prior issues of concern are recurring or one-time.
A higher level of scrutiny will be placed on companies where the say-on-pay proposal received less than 50 percent support from all votes cast. Further, the recurrence of previously identified compensation issues or newly identified compensation concerns, depending on the severity, may result in an against vote on Management Say on Pay and the Compensation Committee members.
Board Response to Management Say-on-Pay Frequency Vote
ISS is proposing the following new policy/vote recommendation with respect to say-on-pay frequency:
- Vote withhold/against on all incumbent director nominees if the board implements an advisory vote on executive compensation on a less frequent basis than the frequency which received the majority of votes cast at the most recent shareholder meeting at which shareholders voted on the say-on-pay frequency.
- Vote case-by-case if the board implements an advisory vote on executive compensation on a less frequent basis than the frequency which received a plurality, but not majority, of votes cast at the most recent shareholder meeting at which shareholders voted on the say-on-pay frequency.
Proxy Access Proposals
ISS’ current policy on shareholder proposals asking for open or proxy access is to recommend on a case-by-case basis taking into account the ownership threshold proposed in the resolution and the proponent’s rationale for the proposal at the targeted company in terms of board and director conduct.
Under the proposed policy for 2012, ISS would continue to evaluate these proposals on a case-by-case basis in determining a vote recommendation taking into account additional factors. The proposed policy update is as follows:
Vote case-by-case on shareholder proposals seeking proxy access, taking into account, among other factors:
- The proponent’s rationale for the proposal at the targeted company;
- The ownership thresholds proposed in the resolution (e.g., percentage and duration);
- The maximum number of directors that shareholders may nominate each year; and
- The method of determining which nominations should appear on the ballot if multiple shareholders submit nominations.
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