Conflicting Opinions: Views on Executive Compensation from Investors and Companies Results of ISS’ 2014-2015 Policy Survey
ISS recently released the results of their annual survey of institutional investors and corporate issuers on emerging corporate governance issues. ISS considers the survey a critical component of its annual policy review and formulation process.
The survey was structured around several high-level corporate governance themes. The primary compensation areas focused on CEO pay magnitude, goal setting, equity plan evaluation and the impact of forward-looking compensation disclosures on pay-for-performance reviews. A significant theme that continued from prior years’ survey results: the dramatic divergence in opinions held by those in the investment community versus companies.
A summary of the key results for the U.S. market is provided below.
When asked if there was a threshold at which the magnitude of a CEO’s compensation should warrant concern, one-quarter of investor respondents and one-half of company respondents indicated their organizations do not consider the magnitude of a CEO’s compensation when evaluating pay practices. Among the remaining three-quarters of investors, 27% indicated their organization would support relative “proportional limits” on CEO compensation, 19% favored absolute limits on CEO compensation regardless of performance, 14% supported absolute “proportional limits” and the remaining 17% supported some other type of threshold. Not surprisingly, company support was low for any limits on CEO compensation. Only 5% of company respondents supported absolute limits on CEO compensation regardless of performance.
ISS asked respondents who indicated support for a limit on CEO compensation which of the following three ratios would be appropriate to determine excessive pay:
- Comparison of CEO pay to median CEO pay at peer companies
- CEO compensation to pay of other proxy officers
- Excessive proportion of corporate earnings or revenue
Both investors and companies strongly agreed with these three alternatives for determining excessive pay magnitude. The comparison of CEO pay to median peer group pay received the most support (95% of investors and 90% of companies) among the three ratios. Of course, the ratio of CEO pay to median pay at peers is already a meaningful component of ISS’ pay for performance evaluation.
Investors and companies had differing views on the relationship between performance goal setting and target award values. A sizable minority of investors (43%) agreed that if performance goals are significantly reduced from one performance period to the next, target award levels should be commensurately modified to reflect the expected lower level of performance.
Only 3% of company respondents agreed with this notion. Instead, a majority of companies (67%) indicated that the compensation committee should have broad discretion to set both goals and target awards at levels deemed to be appropriate under the circumstances. Only 26% of investor respondents shared this view. A third option, setting performance goals independently of target awards, was supported by 19% of investors and 25% of company respondents.
Equity Plan Evaluations
As previously announced, ISS will take a more holistic approach to the evaluation of equity-based compensation plans. ISS plans to implement a “balanced scorecard” in evaluating plan proposals for U.S. companies that gives weight to various factors under three broad categories:
- Plan features
- Company grant practices
Both investors and companies signaled that plan cost should have the highest weighting among the three categories, followed by plan features and grant practices, respectively. A majority of investors (70%) indicated plan cost should be weighted between 30% and 50%, with 40% being cited most often. Regarding plan features and grant practices, most investors suggest weightings from 20% to 35% for both factors. Responses from company respondents were similar, although plan cost was weighted slightly higher while plan features and grant practices were weighted slightly lower when compared to investor responses.
Forward-looking Compensation Disclosures
When evaluating Say on Pay, a majority of investor respondents (63%) indicated positive changes that will be implemented to the compensation program in the succeeding year can “somewhat” mitigate pay-for-performance concerns for the year in review, a view held by 34% of company respondents.
Companies put even more weight into such prospective changes. The majority of company respondents (52%) indicated changes in the succeeding year can “substantially” mitigate pay-for-performance concerns for the year in review. Only 14% of investors agreed with this view.
Of those investor respondents who believed that positive changes to the company’s pay program in the succeeding year can “somewhat” or “substantially” mitigate pay-for-performance concerns, 90% expect disclosure of specific details of such positive changes (e.g., metrics, performance goals, award values, effective dates) in order for the changes to be considered.
The complete study can be found here.
While not an official statement of policy, this annual survey provides a foreshadowing of likely policy changes to apply for the upcoming 2015 proxy season. Based on the survey results, we expect ISS to increasingly focus on absolute magnitude of pay when evaluating executive compensation programs, not just the relative level of pay. We also expect the equity plan evaluations to be more complex, with equity usage/grant practices and plan features to play a more significant role in ISS’ vote recommendations going forward. We anticipate that ISS’s governance risk model (“QuickScore”) will also be impacted by these potential policy changes.
On a positive note, commitments to future pay reforms appear to be a useful mitigating factor for past pay for performance concerns. We continue to advise clients to tailor proxy disclosures to acknowledge investors’ views, and in cases where company policy differs from known or anticipated investor positions, we suggest providing a clear and convincing rationale for why the company’s position is in the best interests of shareholders.
We will likely see these themes reflected again in the draft 2015 policy update, which is expected to be released later this month. We will provide an update once the proposed policy changes are announced.
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