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On December 19, 2011, ISS posted the Technical Document, Evaluating Pay for Performance Alignment, ISS’ Quantitative and Qualitative Approach to its 2012 Policy page.  The complete document can be downloaded from:

http://www.issgovernance.com/sites/default/files/EvaluatingPayForPerformance_20111219.pdf

The Pay-for-Performance (P4P) methodology laid out differs in certain aspects from what ISS had previously communicated about its 2012 P4P Policy, e.g., peer group methodology. I’m in the process of reviewing and will post more details once I’m done with my analysis, but wanted folks to know that the document is available.

On November 17, 2011 (right on time), ISS issued its final policies for 2012. The policies will be effective for shareholder meetings occurring on or after February 1, 2012. Generally, the final policies kept to the draft policies issued a few weeks back and there were very few new surprises (a very welcome occurrence).  That said, there are a few interesting things to note about the final policies:

• Say on Pay Votes that receive less than 70% votes cast in favor will trigger additional scrutiny under the ISS Management Say on Pay (MSOP) Policy which can cause ISS to recommend against compensation committee members (or, in rare cases, the full board) and the next MSOP proposal. ISS has identified things it will take into account and has indicated that support levels of less than 50% will warrant the highest level of company responsiveness.
• Pay-For-Performance (P4P) Alignment – virtually identical to the draft policy put forward several weeks ago. ISS still offers scant details on how peer companies will be selected, although the final policy update includes a footnote identifying factors that ISS will consider (see Footnote 1, page 9).
• Say When on Pay / Say on Pay Frequency - ISS includes a new policy that indicates ISS might recommend against or withhold from the entire board (except new director nominees) if the Board implements a SOP frequency that is less frequent than the frequency that received a plurality, but not a majority, of the votes cast. In making its recommendation, ISS will consider the Board’s rationale for such action, the company’s ownership structure and vote results, its own analysis of whether there are compensation concerns or a history of problematic compensation practices, and the previous year’s support level on the company’s SOP proposal.

The ISS materials about the final 2012 Policies can be found by following these links:

• ISS Press Release announcing the final policies: http://www.issgovernance.com/press/2012PolicyUpdateRelease
• ISS’ U.S. Corporate Governance Policy, 2012 Updates (November 17, 2011): http://www.issgovernance.com/files/ISS_2012US_Updates20111117.pdf
• ISS’s U.S. Corporate Governance Policy Updates and Process, Executive Summary (November 17, 2011): http://www.issgovernance.com/files/ISS_2012ExecutiveSummary20111117.pdf
• ISS’s Policy Gateway with links to the final policies, press release, executive summary, etc.: http://www.issgovernance.com/policy

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:

http://blog.issgovernance.com/gov/2011/10/iss-policy-comment-period-extended-to-nov-7.html

On October 18, 2011, Institutional Shareholder Services (ISS) issued its draft 2012 Policies for comment.  These policies are available at:

http://www.issgovernance.com/policy/2012comment

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?