Archive January 2017

That’s a FAQ, Jack! – New Interpretations from ISS

On December 19, 2016, ISS issued updates to several of its key FAQs, including those on Equity Compensation Plans, Executive Compensation Policies, and also the explanation of ISS’ Pay-for-Performance Mechanics. Below I look at the specific updates under each FAQ and the P4P Mechanics.

U.S. Equity Compensation Plans

FAQ #19 If a company grants performance-based awards, how will the shares be counted for the purposes of calculating burn rate?

ISS makes clear that unless a company provides disclosure of the performance-based awards that vest and are earned in each year during the past three years, ISS will use the number of performance-based awards that are granted in each year when calculating its burn rate for a company.

FAQ #28 How does ISS evaluate an equity plan proposal seeking approval of one or more plan amendments?

If there is not a request for additional shares (or other modification that is deemed to potentially increase the plan’s cost), ISS will review the overall impact of the amendments to shareholders. If beneficial, ISS will support the proposal; if detrimental, then ISS will oppose the proposal.

If there is a request for additional shares (or other modification that is deemed to potentially increase the plan’s cost) or this is the first time public shareholders will have an opportunity to opine on the plan, then ISS will consider both the Equity Plan Scorecard (EPSC) score as well as an analysis of the overall impact of the amendments to shareholders (as above). But the EPSC score is more heavily weighted. If the EPSC score is such to warrant a positive vote recommendation, ISS will only recommend against the proposal if the amendments represent a substantial diminishment to shareholders’ interests.

See FAQs #29 and 30 for proposals seeking approval only for Section 162(m) purposes.

FAQ #30 How are proposals that include 162(m) reapproval along with plan amendments evaluated?

The general ISS positive override for Section 162(m) proposals does not apply to bundled amendments. For bundled amendments, even those that include Section 162(m) reapprovals, ISS will evaluate the plan proposal in terms of the impact to shareholders and/or the EPSC score as detailed above under FAQ #28.

FAQ #32 How does ISS view a plan amendment to increase the tax withholding rate applicable upon an award settlement?

Generally, ISS views such a change as neutral to shareholders’ interests. However, if the plan also has a liberal share recycling feature, ISS will view the amendment negatively. But, if this is the only amendment being made to the plan, by itself it would not be sufficient for ISS to recommend against the plan (see my blog post on this). If this is bundled with other amendments, then ISS will review it using its EPSC policy framework discussed in FAQ #28.

FAQ #36 What changes were made to the EPSC policy for 2017?

Effective for shareholder meetings on or after February 1, 2017, the EPSC policy generally remains the same, though ISS did make the following adjustments:

  • A new factor was added to the Plan Features pillar that looks at whether the plan permits the payment of dividends or dividend equivalents on unvested awards. Full points are awarded if the plan expressly prohibits, for all awards, the payment of dividends and dividend equivalents before the vesting of the underlying awards; however, accrual of dividends and dividend equivalents payable upon vesting is acceptable. No points will be awarded if the plan does not include an express prohibition on the current payment of dividends and dividend equivalents.
  • The minimum vesting factor is updated so that full points are only awarded if the plan specifies a minimum vesting period of one year for all equity awards. Further, no points will be awarded if the plan permits the administrator, through individual award agreements or other mechanisms, to reduce or eliminate the one-year vesting requirement beyond the allowable 5% carve-out.
  • Companies that have 33 or more months of trading history as of the applicable lock-in date (QDD or quarterly data download date per ISS) will have burn rate incorporated into their EPSC evaluation if they disclose three years of burn rate data. For companies with 32 or fewer months of trading history, ISS will continue to evaluate them under its Special Cases models, see FAQs #37, 38 and 41.
  • Finally, ISS adjusted certain factor scores under its proprietary EPSC score model.
  • The EPSC threshold number of points remains at 53.

FAQ #41 How will equity plan proposals at newly public companies be evaluated?

Companies that are newly public will continue to be evaluated under an EPSC model that includes fewer factors. As previously was the case, the burn rate and plan duration factors will not apply if the company has less than 3 years of disclosed grant data. ISS will use its Special Cases models in two cases: (1) company has less than or equal to 32 months of trading history as of the QDD date, or (2) company has between 33 and 36 months of trading history and there is less than 3 years of burn rate data.

FAQ #42 What factors are considered in the EPSC, and why?

The EPSC has three categories/pillars under which ISS conducts its analysis: Plan Cost, Plan Features, and Grant Practices. This FAQ has been updated to reflect the updates to the EPSC model mentioned in FAQ #36.

FAQ #43 Are the factors binary? Are they weighted equally?

The EPSC factors are not weighted equally. Each factor is assigned a maximum number of points and the total maximum number of points is 100. A passing score remains at 53 points. This FAQ then includes a table with the factors, a definition of the factor, and information on how it is scored for purposes of the EPSC model (but not the actual maximum number of points for the factors).

FAQ #47 How does ISS assess a plan’s minimum vesting requirements for EPSC purposes?

In order for a plan to receive full points for the minimum vesting factor, it must require a vesting of at least 1 year for all equity award types and cannot permit individual award agreements to reduce or eliminate this minimum vesting requirement. This minimum vesting requirement must apply to at least 95% of the shares authorized for grant under the plan, i.e., the plan can permit up to 5% of the authorized shares to be granted without complying with the minimum vesting requirement.


U.S. Executive Compensation Policies

FAQ #3 How is Total Compensation calculated?

Total Compensation = Base Salary + Bonus + Non-equity Incentive Plan Compensation + Stock Awards* + Option Awards** + Change in Pension Value and Nonqualified Deferred Compensation Earnings + All Other Compensation.

  • * The value of all stock-based awards – both time- and performance-vesting) are calculated by multiplying the number of underlying shares (target number for performance awards) by the closing stock price on the date of grant.
  • ** The value of option and SAR awards is calculated using ISS’ Black-Scholes option pricing model.

FAQ #20 What are the factors that ISS considers in conducting the qualitative review of the pay for performance analysis?

Some of the key factors ISS considers in conducting its qualitative review of the P4P analysis include:

  • Ratio of performance- to time-based equity awards
  • Overall ratio of performance-based compensation
  • Completeness of disclosure
  • Rigor of performance goals
  • Application of compensation committee discretion
  • Magnitude of pay opportunities
  • Company’s peer group benchmarking practices
  • Results of financial/operational metrics both absolute and relative to peers
  • Special circumstances related to CEO and executive turnovers or anomalous equity grant practices
  • Realizable and realized pay compared to granted pay
  • Any other factors deemed relevant

FAQ #22 What is the Relative Pay and Financial Performance Assessment included in research reports?

ISS introduced a Relative Pay and Financial Performance Assessment for Russell 3000 companies for meetings on or after February 1, 2017. ISS will compare the long-term CEO pay and financial/operational performance rankings relative to a company’s ISS peer group. Financial/operational performance will be assessed across up to 6 financial metrics and TSR, depending on the company’s GICS industry group. The potential metrics include:

  • Cash flow (from operations) growth
  • EBITDA growth
  • Return on assets
  • Return on equity
  • Return on invested capital
  • Revenue growth
  • Total shareholder return

FAQ #23 How will ISS use the Relative Pay & Financial Performance Assessment (RPFPA) in its analysis?

For 2017, the RPFPA is part of the qualitative P4P assessment and not included in the quantitative P4P assessment.

Note: ISS seems to be using 2017 as an information-gathering year and will be evaluating the RPFPA information collected. I expect after this analysis, ISS may move the RPFPA into the quantitative P4P assessment in a subsequent year.

FAQ #34 If a company has not been publicly traded for at least three or five years, does the relevant quantitative pay for performance evaluation still apply? Does this affect whether a company would be used as a peer?

If a company has not been publicly traded for 5 fiscal years, the relative measures, specifically the 3-year Relative Degree of Alignment (RDA) and the multiple of pay against the ISS peer median will still apply. But if the company has been publicly traded for less than 3 years, the RDA measure will be based on 2 years of data. If less than 2 years of data is available, RDA will not be run.

ISS will generally only include a company as a peer company if it has 3 full years worth of data.

FAQ #48 What is ISS’ Problematic Pay Practices evaluation?

ISS has identified certain practices that are contrary to a performance-based pay philosophy, and evaluates these practices on a case-by-case basis:

  • Egregious employment contracts
  • New CEO with overly generous new-hire package
  • Abnormally large bonus payouts without justifiable performance linkage or proper disclosure
  • Egregious pension/SERP payouts
  • Excessive perquisites
  • Excessive severance and/or change in control (CIC) provisions:
    • CIC cash payments exceeding 3x base salary + target/average/most recent bonus
    • New or materially amended arrangements that provide for CIC payments without job loss or substantial diminution of job duties
    • New or materially amended arrangements that provide for an excise tax gross-up (regardless of whether full or modified)
    • Excessive payments upon an executive’s termination in connection with performance failure
    • Liberal CIC definition in individual contracts or equity plan which could result in payments to executives without an actual CIC occurring
  • Tax reimbursements: excessive reimbursement of income taxes on executive perquisites or other payments
  • Dividends or dividend equivalents paid on unvested performance shares or units
  • Repricing or replacing of underwater stock options/stock appreciation rights without prior shareholder approval
  • Other pay practices that may be deemed problematic in a given circumstance but are not covered in the above categories

FAQ #61 What is ISS’ policy on say-on-pay frequency?

ISS will generally recommend in favor of annual say-on-pay votes.

FAQ #63 In the event that a company does not present shareholders with a say-on-pay (SOP) vote where one would otherwise be expected, what are the vote recommendation implications?

If there is no SOP or SOP frequency vote on the ballot where one otherwise would be expected, and the company does not provide an explanation for the omission, ISS will generally recommend against the compensation committee chair (or full committee, as appropriate) until the company presents shareholders with an advisory vote on executive compensation.

FAQ #64 How does ISS evaluate the treatment of equity awards upon a change-in-control (CIC)?

Single trigger vesting of equity awards upon a CIC is viewed as a poor practice. ISS believes vesting acceleration should require both a CIC and a qualifying involuntary termination event (double trigger CIC vesting). ISS considers the potential windfall payments when evaluating equity award treatment upon a CIC. The factors ISS considers include:

  • Maintaining of vesting criteria
  • Pro rata vesting
  • The elapsed vesting period
  • Magnitude of accelerated awards

FAQ #67 How does ISS evaluate management advisory proposals seeking shareholder approval of non-employee director pay?

ISS looks for reasonable practices that adequately align the interests of directors with those of shareholders. ISS considers director pay composition, magnitude, and other qualitative features. ISS believes a director pay program should incorporate meaningful director stock ownership and/or holding requirements (i.e., at least 4x the annual cash retainer). When equity is a much larger component of director pay, the ownership and holding requirements should be more robust. ISS consider directors receiving performance-vesting equity awards, retirement benefits, or other perquisites to be a problematic practice. ISS also considers the magnitude of director pay, and the presence of a meaningful limit on annual director pay is a positive.

FAQ #68 How does ISS approach U.S.-listed companies with multiple executive compensation proposals on the ballot as a result of the company’s incorporation in a foreign country?

For U.S.-listed proxy (DEF 14A) filers that have multiple executive pay proposals on the ballot as a result of the company’s foreign incorporation, ISS will generally align the vote recommendation of the foreign compensation proposal to the U.S. management say-on-pay (SOP) recommendation so long as the foreign proposal is reasonably analogous to the SOP. Foreign Private Issuers are exempt from the U.S. SOP requirements.


Pay-for-Performance Mechanics

This document reviews ISS’s quantitative and qualitative approach to pay-for-performance (P4P) assessments.

On the quantitative P4P assessments, ISS has left the current concern thresholds that became effective February 1, 2015 unchanged:

  • Relative Degree of Alignment:
    • Medium Concern Threshold: -40
    • High Concern Threshold: -50
  • Multiple of Median:
    • Medium Concern Threshold: 2.33x
    • High Concern Threshold: 3.33x
  • Pay-TSR Alignment:
    • Medium Concern Threshold: -20%
    • High Concern Threshold: -35%

The major update for shareholders meetings on and after February 1, 2017 involves the addition of the relative pay and financial performance assessment (RPFPA). The document gives a sample of what the RPFPA disclosure will look like in the ISS proxy report.  Additionally, the Appendix gives the weightings of the various financial/operational metrics and TSR for each GICS industry group based on rank of the metric, not its exact weight.

The Appendix also details the Data Download Date for the TSR and financial/operational metrics used when ISS will conduct this analysis.

  • Shareholder Meeting Date Range -> Data Download Date
    • March 1 through May 31 -> December 1
    • June 1 through August 31 -> March 1
    • September 1 through November 30 -> June 1
    • December 1 through February 29 -> September 1

Note: Given the timing of things, ISS will use a common date for the subject company and the ISS peers, but it is unlikely to track to the company’s fiscal year end in most cases. Additionally, ISS will pull the information from the Compustat database and may not track to what a company used, especially if a company uses adjusted figures.

Maximum Tax Withholding and Liberal Share Counting – NOT So Deadly A Combination – UPDATE

Note: This is an update to my post of December 19, 2106  (available here) to reflect information I learned from a discussion with ISS Research personnel on January 4, 2017. Changes have been highlighted using italics.

This past week I learned that ISS will be issuing a set of equity compensation plan FAQs that will address a new combination of share provisions in equity plans: a plan having both liberal share counting (including the adding back of shares withheld to satisfy taxes) and permitting the withholding of shares at the maximum tax rate (as the change in accounting rules now permits).

As ISS stated in its proxy report for Coach, Inc., “Moving to a maximum withholding rate would be problematic for a plan with liberal share recycling, as this would exacerbate concerns regarding diminished transparency of share usage.” [emphasis added]

So what is the consequence of this being classified as a problematic?  Well, under ISS’s Equity Plan Scorecard policy, there are certain overriding features that would cause ISS to recommend against a plan proposal.  These overriding features include:

  • Ability to reprice underwater equity awards without shareholder approval
  • Ability to conduct a cash buyout of underwater equity awards without shareholder approval
  • Liberal Change-In-Control Vesting Risk (e.g., a CIC definition that could be triggered short of consummation of the deal)
  • Equity-related pay-for-performance (P4P) disconnect, i.e., ISS finds a P4P disconnect to exist and it is mainly attributed to equity awards to the CEO and the proposed plan permits the CEO to participate
  • Equity-related problematic pay practices, which include:

The above issues act as complete overrides.  If the plan has one of these issues/features then regardless of whether the plan scores above the ISS threshold (currently 53 points), ISS will recommend against the plan.

ISS issued new FAQs regarding equity compensation plans on December 19, 2016.  FAQ #32 deals with the issue of withholding at the maximum tax rate coupled with liberal share counting which permits shares withheld to be added back to the plan’s share authorization. The FAQ does not flat out state that such a combination of provisions would be viewed as a problematic pay practice that would cause ISS to recommend against a plan proposal. The full set of the Equity Compensation Plan FAQs can be found at: that time, after discussions with ISS Corporate Solutions, I believed that ISS Research would view such a combination of features as warranting an override and causing ISS Research to recommend against a proposed plan with both such features.

Since my initial blog post, ISS Research clarified that “amending a plan to provide for withholding above the minimum tax rate will not be considered an “equity-related problematic pay practice” egregious factor that would trigger the overriding factors policy — even if the plan in question has a liberal share recycling (LSR) feature.” The language from the Coach ISS Report was intended to convey that ISS would view amending a plan to the maximum withholding rate as a negative amendment if that plan had a LSR (if the plan did not have a LSR, then such an amendment would be viewed as administrative in nature and neutral for shareholders). While such an amendment would not be an overriding factor, it would be a factor considered under the policy framework applicable to equity plan amendments proposals (see FAQ #28 for a description of that policy framework:

This is good news for companies putting equity plans to shareholders that have a LSR and want to increase the withholding rate to the maximum statutory rate, as it means that this combination of features alone will not cause ISS to recommend against the proposed plan.  Rather, the proposed plan will be evaluated using the Equity Plan Scorecard policy, with significant weight placed on whether the proposed plan scores above the threshold level of points. If a plan does, and the other plan amendments are not viewed negatively and no other ISS policy is implicated (such as the pay for performance evaluation), a company should then expect ISS Research to issue a favorable vote recommendation.