Divergent Views on Executive Compensation: Results of ISS’ 2011-2012 Policy Survey
This week, ISS released the results of their annual survey of institutional investors and companies on emerging corporate governance issues. ISS considers the survey a critical component of its annual policy review and formulation process.
Not surprisingly, both investors and companies believe that executive compensation will be one of the top governance topics for the coming proxy season. However, despite greater dialogue between companies and shareholders than ever before, there remain several significant differences of opinion related to compensation and corporate governance practices.
Response to Say on Pay Votes: Investors and companies differ significantly regarding the level of opposition to a say-on-pay vote that should trigger a board response regarding improvements to pay practices. Perhaps not surprisingly, investors expect responses at much lower levels of opposition. Nearly half of all companies reported that an explicit response was not necessary unless opposition exceeded 50%, while an equal percentage of investors (48%) felt that such a response was necessary for levels of opposition above 20%.
Equity Vesting upon Change in Control: “Single-trigger” vesting of equity remains a polarized issue. An overwhelming number of investors do not consider accelerated vesting of outstanding grants upon a change in control (either automatically or at the board’s discretion) to be appropriate, but an almost equal percentage of companies disagree. Most investors and companies agree that accelerated vesting in certain circumstances after a change in control (e.g., if awards are not converted or replaced by a surviving entity) is appropriate.
Splitting CEO and Chairman Roles: Investors and companies also hold remarkably different views on leadership. While 70% of investors believe that companies should split the roles of CEO and Chairman after the current (combined) incumbent departs, 73% of companies disagreed.
Pay for Performance: When determining whether executive pay is aligned with company performance, investors and companies agree that relative pay levels and misalignment of pay and performance are relevant considerations. However, there was some disagreement regarding the magnitude of importance.
- 62% of investors believe pay that is significantly higher than peer pay levels is “very relevant”, while the majority of companies believe it to be “somewhat relevant.”
- 88% of investors report that whether pay levels have increased disproportionately to the company’s performance trend is a “very relevant” consideration. For companies, responses of “very relevant” and “somewhat relevant” were almost equal (47% and 48% respectively).
Interestingly, ISS did not define either “performance” or “performance trend.” Defining performance within the context of compensation continues to be a challenge and the debate over whether stock price or financial performance is the better indicator remains unresolved.
Discretionary Bonuses: Both investors and companies agree that discretionary awards can be problematic, particularly in instances where the awards are not aligned with performance. But a significant minority of investors (34%) believe that they are “always” problematic, while 22% of companies believe that they are “never” problematic.
Positive Factors Mitigating Equity Plan Cost: Investors and companies generally agree that in instances where the Shareholder Value Transfer (“SVT”) cost of the equity plan is deemed by ISS to be excessive relative to peers, positive factors such as above median long-term shareholder return, low average burn rate relative to peers, double-trigger CIC equity vesting, reasonable plan duration, and robust vesting requirements serve to mitigate the cost to shareholders. However, investors and companies disagreed on the relative importance of these factors.
- Investors were reluctant to indicate that any of these factors would “very much” mitigate the cost, with above median long-term shareholder return (47%) and robust vesting requirements (43%) receiving the most support.
- A majority of companies believe that the following factors should be considered mitigators: above median long-term shareholder return (72%), low average burn rate relative to peers (59%), and reasonable plan duration based on historical usage (53%)
Negative Factors Impacting Equity Plan Approval: In situations where SVT cost is not excessive, the bulk of investors agree that the following factors should “very much” weigh against the plan: prolonged poor financial performance (73%), prolonged poor shareholder returns (73%), excessive potential share dilution relative to peers (59%), automatic replenishment (57%), and liberal change in control definitions with automatic award vesting (55%).
Interestingly, companies responded that most of these factors should only matter “somewhat”, except in instances of prolonged poor financial performance.
The complete study can be found here.
Key Takeaways: As companies formulate their shareholder outreach programs to ensure a positive 2012 Say on Pay recommendation, it is important to recognize and understand the key issues from the investor’s perspective. Results from the ISS policy survey indicate that there are significant divergent views on critical compensation issues and that executive compensation will remain a hotly debated topic for the foreseeable future.
As the survey represents a significant part of ISS’ annual policy review, we may see some of these issue incorporated into the 2012 policy updates which will be released in November.