On October 28, 2011, Institutional Shareholder Services Inc. (ISS) announced that it was extending the comment period on its Draft 2012 Policies until Monday, November 7, 2011. Furthermore, ISS announced that the final 2012 Policies are expected to be issued the week of November 14, 2011.
For more details, see this entry on the ISS Governance Blog by Ted Allen:
Ed will co-present with Fred Whittlesey at the NASPP’s Practical Guide to Performance-Based Awards conference on Plan Design and Implementation next Tuesday, November 1, 2011 at the Hilton San Francisco. For more details, see this page on the NASPP website:
On October 18, 2011, Institutional Shareholder Services (ISS) issued its draft 2012 Policies for comment. These policies are available at:
Comments will be accepted through October 31, 2011.
Here’s a quick summary of the draft compensation-related policy changes for 2012:
- Board: Board Response to Management Say-on-Pay Votes (US)—ISS will consider prior SOP proposals that received significant opposition (note: no bright line set) from votes cast when recommending on Compensation Committee Members, taking into account:
- The level of opposition
- The company’s ownership structure
- Disclosure of engagement efforts with major institutional investors regarding 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’s current analysis of the company’s executive compensation and whether any prior issues of concern are recurring or one-time
- Additional notes:
- Higher level of scrutiny for companies where MSOP received less than 50% support
- Recurrence of previously identified compensation issues or newly identified compensation concerns, depending on the severity, may result in an AGAINST vote on MSOP and the Compensation Committee members
- Request for comment:
- Does a support level of less than 70 percent warrant an explicit response from a company to address concerns – i.e., including actions or an action plan? If not, what opposition level warrants an explicit response?
- Should boards be expected to provide an explicit response to a low supported MSOP proposal by the year following that vote; or should accountability be based on the results of more than one low MSOP vote?
- Board: Board Response to Management Say-on-Pay Frequency Vote—ISS is proposing a new vote recommendation policy for MSOP:
- Vote WITHHOLD/AGAINST on all incumbent director nominees if board implements an advisory vote on a less frequent basis than the frequency which received a majority of the votes cast at most recent meeting.
- Vote CASE-BY-CASE if board implements a frequency that is different than the frequency that received a plurality, but not majority, of votes cast at most recent meeting, taking into account:
- The board’s rationale for doing so,
- The company’s ownership structure,
- ISS’s analysis of the company’s executive compensation and whether there are compensation concerns or a history of problematic pay practices,
- The previous year’s support level on the company’s SOP proposal
- The difference between the frequency adopted and the frequency supported by shareholders
- Request for comment:
- In cases where a company fails to adopt an MSOP frequency that received majority support by shareholders, should there be additional considerations given to these companies?
- In cases where a company implements an option that is less frequent than that which received a plurality, but not a majority, of votes cast (e.g., one year received 43 percent of votes cast, two year received 1 percent, and three year received 39 percent, excluding abstentions), would the proposed factors help your organization analyze such situations? Are there other factors that your organization would recommend?
- Compensation: Evaluation of Executive Pay (Management Say-on-Pay)—ISS is proposing a new methodology for evaluating pay-for-performance alignment – strong, satisfactory or weak alignment. Methodology would combine a quantitative analysis followed by a qualitative analysis:
- Quantitative Analysis – 3 factors in 2 categories:
- Relative Alignment—2 factors are analyzed to determine the PFP 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 1- and 3-year periods (weighted 40/60), to put more emphasis on 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 as:
- Alignment between the trend in the CEO’s pay and the company’s TSR over the prior 5 fiscal years – difference between the slope of annual pay changes and the slope of annualized TSR changes during the 5-year period
- Peer Alignment and Absolute Alignment may be weighted 50/50 in this portion of the analysis. Companies demonstrating a weak alignment will receive further qualitative review to determine a final vote recommendation.
- Qualitative review will consider:
- The ratio of performance- to time-based equity awards
- The overall ratio of performance-based compensation
- The robustness of disclosure an 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, new CEO in prior FY or equity grant practices (e.g., biannual awards)
- Any other factors deemed relevant
- Request for comment:
- Do the factors utilized in ISS’ proposed pay-for-performance evaluation approach align with those that your organization believes should be considered?
- Does the proposed new approach give adequate consideration to long-term alignment?
- Will the proposed new approach be beneficial to your organization in identifying companies with strong pay-for-performance alignment?
- What additional factors, if any, should ISS consider and display to improve investors’ ability to evaluate companies’ long-term pay-performance alignment?
- Compensation: Equity Plans Related to Section 162(m)—Looks like ISS would conduct a full analysis of an IPO equity plan put to shareholders for 162(m) purposes, regardless of whether the plan was approved prior to the company going public.
- Request for comment:
- Should the potential tax deduction on performance-based compensation for named executive officers outweigh the adverse impact of problematic features in equity plans for 162(m) proposals from new IPO companies?
- If shareholders do not support the 162(m) proposal at the newly public company, the company would not be able to obtain tax deduction for performance-based compensation. Should the Compensation Committee be held accountable for the problematic design in the equity plan instead?
- Are there additional factors that investors should consider for the case-by-case analysis, besides those mentioned above?
After having had some time to review and reflect on the 2011-2012 Policy Survey Summary of Results (see prior blog entry, ISS Releases 2011-2012 Policy Survey Summary Results), I wanted to share where these survey results might lead ISS for its 2012 Policy Updates with regards to its compensation policies:
- Make companies that don’t respond and explain what they have done to address compensation concerns when there is a SOP vote that gets less than 80% support (some chance could be set at 70% or 75%) subject to some heightened review, probably factored into ISS’s vote recommendations on directors under the (poor) communications practices analysis piece.
- Introduce a new policy with respect to discretionary annual bonuses – perhaps ISS will just weigh it as a factor as part of its subjective pay-for-performance analysis.
- Equity compensation plan proposal policy could get additional factors that ISS will weigh FOR/AGAINST such proposals. This could make the evaluation of equity plan proposals a bit more subjective, but perhaps these factors would only come into play when a bright line test is failed, i.e., SVT cost exceeds a company’s allowable cap. However, some factors may get weighed even when the allowable cap isn’t exceeded, somewhat like problematic pay practices, i.e., factors like Liberal CIC definition, excessive potential voting power dilution relative to peers, High CEO/NEO concentration ratio, evergreen features, prolonged poor financial performance, and prolonged poor shareholder returns.
- Make single-trigger CIC equity vesting in the following cases enough to recommend AGAINST an equity plan proposal:
- Automatic accelerated vesting upon a CIC
- Accelerate vesting at the board’s discretion after a CIC
- ISS could decide to evaluate all equity compensation plan proposals under its equity compensation plan policies (including the SVT model) even if the proposal is made just after an IPO to gain 162(m) qualification. Possibly could be expanded to cause ISS to analyze any equity compensation plan proposal under its equity compensation plan policy regardless of whether any new shares are being requested.
- ISS might expand the problematic pay practices policy further to not only apply to new and materially amended agreements but also to existing/formerly grandfathered agreements that include problematic pay practices such as excise tax gross-ups. That might be a stretch, but this past year (for the 2011 Policy Updates issued in late 2010) ISS effectively applied its policy change retroactively at least to company actions since the prior proxy (1/1/2010 for calendar-year companies), and ISS has been focused on getting rid of excise tax gross-ups. This might not happen for 2012, could be in 2 years (i.e., for 2014) since that would then put them out 3 years from the introduction of the semi-retroactive problematic pay practices policy with respect to agreements and the term of most employment agreements is 3 years.
All of the above are just my own speculations. I have heard nothing about any of these these things actually being introduced as policy changes for 2012. But, they do represent my best guess as to what ISS might change for 2012 based on the recently released policy survey results. We’ll just have to wait to see what changes ISS has in store for proposals in 2012.