Category Pay for Performance

This morning, ISS posted its draft voting policies on its website (https://www.issgovernance.com/policy-gateway/2019-benchmark-policy-consultation/). Anyone interested in providing comments on these draft voting policies may do so before 5:00 p.m. Eastern on November 1, 2018 by emailing his/her comments to ISS at  policy@issgovernance.com. Comments will be made public by ISS when the final voting policies are released–expected the middle of November 2018.

For the US market, ISS issued two draft voting policies:

• Board Gender Diversity, and
• Financial Performance Assessment Methodology

Board Gender Diversity

ISS is proposing to  generally vote against or withhold from the chair of the nominating committee (or other directors who are responsible for the board nomination process on a case-by-case basis) at companies when there are no female directors on the board. Mitigating factors that may be considered include:

• a firm commitment, as stated in the proxy statement and/or other SEC filings to appoint at least one female director to the board in the near term (before the next annual general meeting);
• the presence of at least one female director on the board at the immediately preceding annual meeting; and/or
• any other compelling factors considered relevant on a case-by-case basis.

ISS is proposing to apply the policy for meetings on or after February 1, 2020 , which gives a 1-year phase-in period (roughly 2019).

ISS is interested in comments concerning: when it should recommend against directors other than chair of the nominating committee, whether there are any mitigating factors that should be considered, and, if so, what weight should be given to such factors, the appropriate time period for a commitment to appoint a female director to an all male board, and whether commenters agree with the one year transition period for this policy to take effect.

Financial Performance Assessment Methodology

ISS is proposing shifting away from using GAAP financial measures to Economic Value Added (EVA)-related metrics, such as EVA Spread, EVA Margin, and EVA Momentum. ISS indicates that companies would be provided these EVA metric data points free of charge prior to their annual meeting and ISS analysis.

ISS is not clear on when this proposed policy change would take effect.  So it might be for 2019 or 2020.

ISS is asking whether commenters believe the quantitative P4P tests should continue to emphasize TSR. ISS is also interested in finding out if the decision is made to implement the EVA measures whether people would still like the GAAP measures to be reported on an informational basis.

On September 20, 2018, ISS issued a series of FAQs concerning Global Industry Classification Standard (GICS) Code 5020 Implementation (available at: https://www.issgovernance.com/file/policy/active/americas/GICS-5020-FAQ.pdf). This change caused a number of companies to be moved from the GICS 2540, Media, group to the new GICS 5020, Media & Entertainment, group.

The key points from these FAQs are:

• Companies in the new GICS 5020 group should see higher Burn Rate Thresholds than in the old GICS 2540 group.
• ISS peer groups being constructed for shareholder meetings starting September 15, 2018 have been updated to reflect the new GICS group.
• ISS will continue to use a company’s legacy GICS group to assess non-employee director pay (under ISS’ excessive NED pay policy) until February 1, 2019. At that date, ISS will switch over to utilizing the new GICS group in assessing NED pay.
• ISS will update the GICS groupings used to determine median 1-, 3- and 5-year TSR starting September 30, 2018.
• ISS will evaluate equity plan proposals using the updated GICS group for burn rate information starting with meetings on February 1, 2019.

Early this week ISS opened up its annual policy survey, the results of which will influence the new ISS policies and changes to existing policies for the 2019 proxy season (i.e., impacting shareholder meetings on or after February 1, 2019). Today, we will look a bit closer at the two surveys that ISS launched: the 2019 Governance Principles Survey, and the 2019 Policy Application Survey.

2019 Governance Principles Survey

There are five issues ISS is seeking input in on this survey:

• Auditor Independence: What factors should be considered in addition to non-audit services and fees as a percentage of total fees when evaluating independence of auditors?
• Audit Committee: What factors are important in evaluating the effectiveness of the Audit Committee?
• Director Accountability: Is it relevant for ISS to examine directors’ controversies on other boards when evaluating directors? If so, what would be relevant and what length of look-back period should be used?
• Board Gender Diversity: ISS here is repeating questions it asked last year on gender diversity to gauge whether it is concerning if there are no female directors on a board?
• One-Share, One-Vote Principle: Should ISS adjust vote results to show the results if all shares had equal voting rights? If so, should these adjusted results inform ISS’s board responsiveness review? What is the appropriate time period for a sunset provision on unequal voting rights?

2019 Policy Application Survey

The questions in this survey applicable to the U.S. are:

• Independent Chair: What factors are important when ISS determines its vote recommendation with respect to a shareholder proposal for an independent chair?
• Minimum Stock Ownership Requirements for Bylaw Amendments: Asks what the minimum ownership thresholds above the required SEC Rule 14a-8’s $2,000 stock holding requirement should be, and should multiple shareholder be able to aggregate holding to meet such threshold?
• Quantitative Pay-for-Performance Screens: ISS is considering supplementing or replacing the four (4) GAAP financial metrics used in its P4P analysis with Economic Value Added (EVA) for purposes of the Financial Performance Assessment. ISS is asking if the survey participant supports the use of EVA in the P4P analysis, and, if so, how it should be incorporated.
• Non-employee Director Pay: In 2018 ISS identified non-employee director (NED) pay outliers and will begin to recommend against compensation committees where elevated NED pay persists over multiple years without compelling justification. ISS is asking survey participants what should constitute a compelling justification.
• Board Qualifications Matrix: The New York City Pension Funds has advocated for the disclosure of a director matrix to help shareholders assess director fit and the mix of skills among all directors. ISS is asking survey participants what level of disclosure on directors skills they find most useful.

For links to these ISS surveys, please see my prior post:

ISS Releases Global Policy Survey

Survey Closing Times

• 2019 ISS Governance Principles Survey closes on August 24, 2018 at 5 pm Eastern, and the
• 2019 ISS Policy Application Survey closes on September 21, 2018 at 5 pm Eastern.

On December 14, 2017, ISS issued several important updated documents concerning its policies and methodologies for the upcoming 2018 proxy season:

• U.S. Compensation Policies, Frequently Asked Questions, Updated December 14, 2017
• U.S. Equity Compensation Plans, Frequently Asked Questions, Updated December 14, 2017
• Pay-for-Performance Mechanics, ISS’ Quantitative and Qualitative Approach (U.S.) (updated with regard to shareholder meetings held on or after February 1, 2018)

These are all available on ISS’s Latest Voting Policies: 2018 webpage on its website: https://www.issgovernance.com/policy-gateway/latest-policies/

This page also includes information ISS released on its European Pay-for-Performance Alignment and Methodology.

U.S. Compensation Policies: FAQs

This supersedes the preliminary FAQs on this topic issued in November 2017.  These FAQs make changes to or introduce ISS policies:

• How ISS Assesses Board’s Actions Taken in Response to Low Support (<70%) on a Say-on-Pay (SOP) Vote
  • Same as last year’s policy except now ISS will expect companies to address in their proxy statements: (1) the breadth of the engagement with shareholders, including the frequency and timing of engagements, number of institutional investors and the company participants including whether independent directors participated as well; (2) disclosure of specific feedback received from investors; and, (3) specific and meaningful actions taken to address shareholder concerns.
• Lay out the four measures now used in ISS’ quantitative Pay-for-Performance (P4P) screen
  • Relative Degree of Alignment (RDA) – relative measure
  • Multiple of Median (MOM) – relative measure
  • Pay-TSR Alignment (PTA) – absolute measure
  • Financial Performance Assessment (FPA) – relative measure – assesses CEO pay rank and financial performance rank over a two- or three-year period using up to four financial metrics which vary by industry
• Explain how the new Financial Performance Assessment (FPA) measure operates
  • Compares a company’s financial and operational performance over the long-term versus ISS peer group. Note: ISS has historical taken the position that you need a performance period of at least 3 years for it to consider the program long-term performance and yet, somehow it characterizes a two-year period of financial performance as long-term. FPA uses three or four financial metrics that are selected and weighted based on industry. The financial metrics that could be used include: return on invested capital (ROIC); return on assets (ROA); return on equity (ROE); EBITDA growth; and, cash flow (from operations) growth.
• Explain how the FPA result will impact the final quantitative P4P concern level
  • FPA may affect the overall quantitative P4P concern level only if:
    • a Medium concern under any of the three initial tests (RDA, MOM, PTA), or
    • a Low concern but bordering the Medium concern threshold under any of the three initial tests
  • FPA can modify the overall concern up to Medium or down to low in the above cases. If the concern level under any of three initial tests is a High concern or the three initial tests result in a Low concern not bordering on Medium concern, then FPA modification is not be available.
• Explain the time period used for TSR calculations for RDA
  • ISS uses a three-year period for measuring TSR ending closest to the fiscal year-end of the subject company. The TSR of the ISS peers will be measured over that same period. However, ISS will begin to average the closing prices across all trading days contained in the beginning and months of the TSR measurement period.
• Explain which problematic practices are most likely to result in an adverse ISS vote recommendation
  • Repricing or replacing underwater stock options/SARs without prior shareholder approval (including cash outs)
  • Extraordinary perquisites or tax gross-ups
  • New or extended executive agreements that provide for:
    • Excessive CIC payments (exceeding 3 times base salary and average/target/most recent bonus)
    • CIC severance payments without involuntary job loss or substantial diminution of duties
    • CIC payments with excise tax gross-ups
    • Multi-year guaranteed awards that are no at-risk due to rigorous performance conditions, or
    • Liberal CIC definition combined with any single-trigger CIC benefits
  • Any other provision or practice deemed to be egregious and present a significant risk to investors
• Explain how ISS will identify “excessive” levels of non-employee director pay and the impact it will have on its analysis
  • ISS is looking for extreme “outliers” in NED pay, which historically has represented pay figures above the top 5% of all comparable directors
  • If ISS finds excessive NED pay levels to exist, it may issue adverse vote recommendation for those board members responsible for approving/setting NED pay if no compelling rationale is provided
• Explain how ISS will consider the new CEO Pay Ratio disclosure
  • ISS will display in its research reports: (1) the median employee pay figure; and, (2) the CEO pay ratio.
  • ISS will continue to assess the CEO pay ratio data as it becomes available and seek feedback from investors on the usefulness of this information and what should be done with it

U.S. Equity Compensation Plans: FAQs

This supersedes the preliminary FAQs issued in November 2017 about ISS’ Equity Plan Scorecard (EPSC) policy. These updated FAQs

• Explain how ISS will treat the grant of time-vested restricted shares as consideration for an acquisition for purposes of its burn rate calculation
  • Generally, ISS factors all equity grants into its burn rate calculation. However, if companies grant time-vested restricted shares as part of an acquisition, they may request that such shares be excluded from the ISS burn rate calculation, but must provide tabular disclosure to enable ISS to determine the shares used in each of the three most recent years. Only time-vested restricted stock can be excluded under this policy; performance-based awards issued in an acquisition context will continue to be included. See the FAQs for a sample of the table that must be provided. Once companies make this initial disclosure, they should continue to provide it, even if they did not issue any time-vested restricted shares for acquisitions during the most recent year covered.
• Clarified that all previous ISS burn rate commitments are now dead and of no force and that ISS no longer gives any special treatment to such commitments
• Lay out the definition of “liberal change in control” and its impact on a plan with contains such a term
  • Means vesting triggers linked to: shareholder approval of the transaction, rather than its consummation; and/or an unapproved change in less than a majority of the board; and/or acquisition of a low percentage of outstanding common stock (15% or less); and/or announcement or commencement of a tender or exchange offer; or any other trigger that could result in windfall compensation without the occurrence of an actual change in control of the company.
• Explain how ISS evaluates an equity plan proposal seeking approval of one or more amendments
  • Evaluated on a case-by-case basis
  • ISS will generally base its vote recommendation on the EPSC evaluation/score if any of the following apply:
    • the proposal includes a material request for additional shares;
    • the proposal represents the first time shareholders have had an opportunity to vote on the plan;
    • the amendments include an extension of the plan’s term; or
    • the amendments include the addition of full value awards as an award type when the current plan authorizes only stock option/SAR grants
  • If none of the four scenarios above apply, then ISS’ vote recommendation will depend on the overall impact of the proposed amendments, i.e. whether deemed beneficial or contrary to shareholders’ interests
• Explain the factors ISS considers in its qualitative review of director pay for the purpose of a proposal seeking approval of a director equity plan
  • The relative magnitude of director compensation compared to companies of a similar profile
  • The presence of problematic pay practices relating to director compensation
  • Director stock ownership guidelines and holding requirements
  • Equity award vesting schedules
  • The mix of cash and equity-based compensation
  • Meaningful limits on director compensation
  • The availability of retirement benefits or perquisites
  • The quality of disclosure surrounding director compensation
• Lay out the changes to the EPSC policy for 2018
  • Passing score for S&P 500 companies was raised from 53 to 55 points
  • The CIC vesting factor was made binary – either full or no points are no earned depending on whether plan complies with the ISS CIC vesting requirements:
    • For performance-based awards: acceleration is limited to actual performance achieved, pro-rata of target based on the elapsed portion of the performance period, a combination of both actual & pro-rata, or the performance awards are forfeited or terminated upon a CIC, and
    • For time-based awards: acceleration cannot be automatic single-trigger or discretionary
  • The holding requirement factor was made binary – either full or no points are earned depending on whether all awards require a holding period of at least 12-months. No points are given if the holding period is less or the holding requirement applies until stock ownership guidelines are met.
  • The CEO vesting requirement factors were made binary – either full points or no points depending on whether the vesting period is at least 3 years from the date of grant
  • The broad discretion to accelerate vesting factor was updated so that full points are earned only if discretion is limited to cases of death and disability. Discretion to accelerate vesting upon a CIC will cause no points to be awarded under this factor unlike current policy which would give full  points. The ability to use discretion to accelerate vesting in any other situation would cause the plan to lose all points under this factor.
  • ISS adjusted certain factor scores, per ISS’ proprietary scoring model.
• Explain how the EPSC models differ now
  • Generally the same as current policy, except that the maximum points for S&P 500 and Russell 3000 companies under the Plan Features and Grant Practices pillars have been revised to be: 19 and 36 points, respectively.
• Explain the EPSC points required to receive a positive ISS vote recommendation
  • S&P 500 companies now must score 55 or more points under the EPSC model to receive a positive ISS vote recommendation for their equity plan proposals
  • All other companies must still score 53 or more points under the EPSC model to receive a positive ISS vote recommendation for their equity plan proposals
• Explain the ESPC factors, whether they are binary and if weighted equally
  • See chart in the FAQs on this. But note that ISS does not give out the actual points attributed to each factor
• Lay out when repricing provisions will constitute and overriding factor that would cause ISS to recommend against a plan proposal regardless of EPSC model score and other analysis
  • If the plan would permit repricing of stock options/SARs without shareholder approval it would constitute an overriding factor.
• Explain how ISS evaluates whether a plan meets the minimum vesting requirement
  • The plan must mandate a vesting period of at least one year for all equity award types grantable under the plan, which applies to no less than 95% of the shares authorized for grant. Exceptions to the minimum vesting beyond 5% will prevent a company from getting points under this factor. Also if the plan permits individual award agreements or other mechanisms to reduce or eliminate the minimum vesting requirement, the plan receives no points under this factor.
• Explain how ISS determines the treatment of performance-based awards that may vest upon a change in control
  • ISS will consider whether the amount of the performance award that would be payable/vested upon a CIC is (a) at target level, (b) above target level, (c) prorated based on actual performance as of the CIC date and/or the time elapsed in the performance period as of the CIC date, or (d) based on board discretion. Of the plan is silent, it will be treated as discretionary.
• Explain how ISS determines the vesting period for a CEO’s most recent equity grants
  • For time-vested awards, full vesting should not occur until three years from the date of grant
  • For performance-based awards, ISS will give credit for a vesting period of slightly less than three years from the grant date so long as the performance measurement period is three years, if the reason is due to the grant date being within the performance measurement period. For performance-based awards that are subject to subsequent time-based vesting, only the performance-contingent portion of the vesting period is counted.
• Explain how ISS will evaluate an equity plan amendment proposal when the company does not disclose the updated plan document
  • ISS may recommend against the plan amendment proposal because the company has not provided sufficient information to enable shareholders to fully evaluate the revised plan
• Lay out the new 2018 Burn Rate Benchmarks
  • See the Appendix to this FAQ

Pay-for-Performance Mechanics (U.S.)

Those that were hoping that ISS would go into more sufficient detail so that they might be able to determine how they will fare under ISS’ quantitative P4P assessment are likely to be a bit disappointed.  While ISS does give some direction on how it will the P4P quantitative test will work, it stops short of giving sufficient details for a company to calculate these on its own. So much for transparency. But, I guess too much transparency is bad for the bottom line and if companies could calculate how they would fare under the ISS quantitative P4P tests they might need to purchase P4P simulation modeling from ISS Corporate Solutions (ISS corporate services arm).

However, this document does lay out a change in the concern thresholds under the Multiple of Median (MOM) test for S&P 500 companies. For S&P companies, the level that triggers a medium concern level has decreased from 2.33x to 2.00x. For non-S&P 500 companies, the medium concern threshold under the MOM test remain at 2.33x.

While this document does lay out the metrics that will be used for FPA for each GICS group, it does not specify the weighting of those metrics.