ISS and Glass Lewis 2013 Executive Compensation Policies

ISS and Glass Lewis 2013 Executive Compensation Policies

November 26 2012

Both ISS and Glass Lewis recently released final policy guidelines for the 2013 proxy season.  The primary executive compensation related changes have been highlighted below.  Complete details for the ISS policy guidelines can be found here and for Glass Lewis can be found here.  Some of the concepts included in the new ISS policy guidelines remain undefined; the FAQs, which provide additional information about how these policies will be applied in practice, are expected in December.

The ISS guidelines will be effective for all companies with annual meetings on or after February 1, 2013.  Glass Lewis did not provide an effective date for their policies, although the release makes it clear that the changes are applicable to the 2013 proxy season.

ISS Policy Changes for 2013
The policy changes largely mirror those proposed by ISS last month (and described more completely by SH&P here).

  • Peer Group Methodology Updated for Quantitative Pay-for-Performance Assessment. ISS has adopted the proposed modifications to the peer group used for the pay-for-performance evaluation, but a detailed description of the methodology and how it will be applied was not provided.  Generally, the new methodology will:
    • Incorporate company-selected peers as an input to the ISS peer group methodology, subject to size and market capitalization restraints,
    • Focus initially on 8-digit GICS codes in an effort to identify peers that are more closely related in terms of industry, and
    • Prioritize the selection of peers that maintain the company near the median of the ISS-selected peer group.
  • Realizable Pay Incorporated into Qualitative Pay-for-Performance Assessment. For large cap companies, ISS will incorporate an analysis of realizable pay compared to grant pay into the research report.  In cases where ISS identifies an unsatisfactory pay-for-performance alignment under the quantitative assessment, an analysis of realizable pay compared to grant pay will now be one of the qualitative factors analyzed prior to the finalization of the ISS vote recommendation.
    • Realizable pay will consist of the sum of relevant cash and equity-based grants and awards made during a specified performance period being measured.
      • Equity awards will be valued using actual values for awards already earned and target values for ongoing awards, calculated using the stock price at the end of the performance period.  Stock options and SARs will be re-valued under the Black-Scholes model using the remaining term and updated assumptions, as of the performance period.
    • The length of the performance period is not further defined in the ISS guidelines.
  • Pledging and Hedging: Governance Failure. ISS has clarified that the significant pledging and hedging of company stock by directors and/or executives are considered failures of risk oversight, and will trigger AGAINST or WITHOLD vote recommendations against directors individually, committee members or the entire board.  In determining vote recommendations, the following factors, among others will be considered:
    • Proxy disclosure of an antipledging policy prohibiting future pledging activity;
    • Magnitude of aggregate pledged shares in terms of total common shares outstanding, market value or trading volume,
      • Note that no bright-line test has been disclosed;
    • Disclosure of progress or lack thereof in reducing the magnitude of aggregate pledged shares over time; and
    • Proxy disclosure that shares subject to stock ownership and holding requirements do not include pledged company stock.

      In the proposed policy changes released last month, ISS had incorporated this concept into its list of problematic pay practices.  The final guidelines have shifted it into the assessment of board responsiveness based on feedback received during the comment period.

  • Scrutiny of Existing Change-in-Control Arrangements in Say on Golden Parachute Proposals. Consistent with the proposed policy modifications, ISS will now consider existing change-in-control arrangements with named executive officers rather than focusing only on new or extended arrangements.  Additionally, further scrutiny will be placed on the number of problematic legacy features in change-in-control agreements.  Votes will be made on a CASE-BY-CASE basis.  Features that may result in an AGAINST recommendation include one or more of the following, depending on the number, magnitude, and/or timing of issues:
    • Single-or modified-single-trigger cash severance;
    • Single-trigger acceleration of unvested equity awards;
    • Excessive cash severance (>3x base salary and bonus);
    • Excise tax gross-ups triggered and payable (as opposed to a provision to provide excise tax gross-ups);
    • Excessive golden parachute payments (on an absolute basis or as a percentage of transaction equity value);
    • Recent amendments that incorporate any problematic features or recent actions (such as extraordinary equity grants) that may make packages so attractive as to influence merger agreements that may not be in the best interests of shareholders; or
    • The company’s assertion that a proposed transaction is conditioned on shareholder approval of the golden parachute advisory vote. 

      Recent amendment(s) incorporating problematic features will tend to carry more weight in the analysis, but the existence of multiple legacy problematic features will also be closely scrutinized.

      ISS has provided limited guidance on how this approach will work in practice, and companies should review the upcoming FAQ release for additional details.

Glass Lewis Policy Changes for 2013

  • No Changes to Pay-for-Performance Assessment. The policy changes released earlier this month do not include any further modifications to the pay-for-performance model, which was significantly revamped in July 2012 and is described more completely by SH&P here.

The newly disclosed policy changes with executive compensation implications for 2013 include:

  • Board Responsiveness to Significant (25%) Shareholder Vote. Glass Lewis clarified its long-standing approach to this issue, noting that the board should demonstrate some level of engagement and responsiveness to address the shareholder concerns when 25% or more of shareholders (excluding abstentions and broker non-votes) vote WITHOLD or AGAINST a director nominee, AGAINST a management-sponsored proposal, or FOR a shareholder proposal.

     

    While a 25% threshold alone will not be sufficient to warrant a negative recommendation on a future proposal, it will bolster arguments to vote against management’s recommendation in the event Glass Lewis determines that the board did not respond appropriately.  During an evaluation of responsiveness, Glass Lewis will make a case-by-case assessment following consideration of publicly available disclosures regarding:

    • Changes in directorships, committee memberships, disclosure of related party transactions, meeting attendance or other responsibilities;
    • Any revisions made to the company’s articles of incorporation, bylaws or other governance documents;
    • Any press or news releases indicating changes in, or adoption of, new company policies, business practices or special reports; and
    • Any modifications made to the design and structure of the company’s compensation program.
  • Modification to Analysis of Equity Compensation Plan Proposals. Glass Lewis also made an addition to the overarching principles used to evaluate equity plans.  Specifically, plans should not count shares in ways that understate the potential dilution, or cost, to common shareholders (specifically “inverse” full-value award multipliers).

Action Items
In light of the new ISS and Glass Lewis guidelines, companies should consider implications for the upcoming proxy season, and take the following actions:

  • Review hedging and pledging policies, and the current pledging practices of named executive officers and directors
  • Assess current company-selected comparator group and consider how this may differ from the group selected by the new ISS methodology.  Although we believe committees should continue to use the group they believe to be most appropriate for purposes of determining and assessing pay levels and pay practices, an understanding of how outside observers may evaluate pay decisions is important.  In instances where groups are expected to differ, CD&A disclosure should be crafted to clearly describe how the company-selected group is derived and the rationale for using the group.
  • Although directly applicable only to large cap companies, all committees should also begin reviewing realizable pay calculations for named executive officers, and consider incorporating this information into their CD&As, particularly when this information enhances the company’s pay-for-performance story.
  • In instances where voting results for either directors or the say on pay vote fell below the required 75% threshold for Glass Lewis or the 70% threshold for ISS, committees should ensure that public disclosure documents all steps taken to address shareholder concerns following the vote.
  • Review change-in-control arrangements for named executive officers and evaluate whether or not such policies remain in the best interests of shareholders, particularly in instances where they may be reasonably likely to trigger a WITHHOLD vote from ISS on a future Say on Golden Parachute vote.  Although immediate changes may not be possible, this analysis may impact future modifications to these programs.

    Finally, look for the release of the ISS FAQs this December to provide additional detail about how these policies are likely to be implemented during the upcoming proxy season.

Contact
Joseph Sorrentino
212-488-5400
jsorrentino@shallpartners.com