ISS Releases 2012 Proxy Voting Guidelines

ISS Releases 2012 Proxy Voting Guidelines

November 22 2011

Last week, ISS released the 2012 U.S. corporate governance policy updates to its benchmark proxy voting guidelines.  These policy changes are effective for Annual Meetings on or after February 1, 2012.  While the conceptual framework has been provided, complete details will not be available until January.  We have summarized the key executive compensation policy changes below. The entire release can be found here.

Executive Pay Evaluation: Advisory Votes on Executive Compensation – Management Proposals  – In keeping with past practice, in instances where ISS determines there is a lack of alignment between pay and performance, they may recommend:

  • AGAINST a Say-on-Pay proposal
  • WITHHOLD against members of the Compensation Committee
    • Particularly relevant in instances where the company does not have an annual Say-on-Pay vote

In response to feedback that the pay-for-performance alignment should be viewed in the context of a period longer than just the most recent year, ISS is modifying its approach to the evaluation of executive compensation, and specifically the pay-for-performance alignment.  The new approach remains focused exclusively on CEO pay, and continues to rely upon TSR as the predominant indicator of company performance.

ISS will identify companies that have demonstrated strong, satisfactory, or weak alignment between TSR and CEO pay over an extended period utilizing an approach that includes a quantitative analysis followed by a qualitative analysis to determine causal or mitigating factors.  ISS has back-tested this new methodology and does not expect a significant change in the percentage of negative recommendations.

The approach first evaluates the pay for performance alignment on a quantitative basis:

  • Peer Group Alignment (weighted 50%)
    • The degree of alignment between the company’s TSR rank and the CEO’s total pay rank within a peer group over one– and three-year periods (weighted 40%/60% so as to put more emphasis on the longer term)
      • The peer group is generally comprised of 14-24 companies that are selected using market cap, revenue (or assets for financial firms), and GICS industry group, via a process designed to select peers that are closest to the subject company, and where the subject company is close to median in revenue/asset size
    • The multiple of the CEO’s total pay relative to the peer group median.  The final guidelines provide no additional guidance on how this will work in practice
  • Absolute Alignment (weighted 50%)
    • Alignment between the trend in CEO pay and company TSR over the prior five fiscal years – i.e., the difference between the trend in annual pay changes and the trend in annualized TSR during the period

Companies demonstrating strong or satisfactory performance will generally receive a positive recommendation.

Companies demonstrating weak alignment between pay and performance will be subject to a qualitative review which will consider the following:

  • The ratio of performance- to time-based awards
  • The ratio of performance-based compensation to overall compensation
    • Note that time-vested stock options and restricted stock are still not considered performance-based
  • The completeness of disclosure and rigor of performance goals
    • No guidance provided as to how the rigor of performance goals will be assessed
  • 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, a new CEO in the prior fiscal year or equity grant practices (e.g. biennial awards)
  • Any other factors deemed relevant

In another departure from prior policy, ISS notes that, “except in extenuating circumstances,” a new CEO will not exempt the company from consideration under the pay-for-performance analysis as the Compensation Committee is also accountable when a company is compelled to significantly “overpay” for new leadership due to prior poor performance.  Thus, ISS will begin to weigh in, albeit indirectly, on the succession planning practices of companies and boards.

Board Response to High Levels of Management Say-on-Pay Opposition – Vote CASE-BY-CASE on Compensation Committee members (or, in exceptional cases, the full Board) and the Management Say-on-Pay proposal if the company’s previous Say-on-Pay proposal received the support of less than 70 percent of votes cast, taking into account:

  • The company’s response, including:
    • Disclosure of engagement efforts with major institutional investors regarding the issues that contributed to the low level of support
    • Specific actions taken to address the issues that contributed to the low level of support
    • Other recent compensation actions taken by the company
  • Whether the issues raised are recurring or isolated
  • The company’s ownership structure
  • Whether the support level was less than 50 percent, which would warrant the highest degree of responsiveness

ISS believes an appropriate response from the company must include substantive and meaningful disclosure of its outreach efforts to major institutional investors as well as specific actions that it has taken or will take to address the compensation issue(s) that resulted in significant opposition votes.  ISS further specifies that these specific actions should ideally be new rather than a reiteration of existing practices, and cautions against providing boilerplate disclosure as this does not enable shareholders to gauge the level of effort taken by the company.

Board Response to Frequency of Advisory Vote on Pay Results – Vote AGAINST or WITHHOLD from the entire Board (except new nominees, who should be considered CASE-BY-CASE) if the Board implements an advisory vote on executive compensation on a less frequent basis than the frequency that received the majority of votes cast at the most recent shareholder meeting at which shareholders voted on the Say-on-Pay frequency.

In addition, ISS will vote CASE-BY-CASE if the board implements an advisory vote on executive compensation on a less frequent basis than the frequency that received a plurality, but not a majority, of the votes cast at the most recent shareholder meeting at which shareholders voted on the Say-on-Pay frequency, taking into account:

  • The board’s rationale for selecting a frequency that is different from the frequency that received a plurality
  • The company’s ownership structure and vote results
  • ISS’ analysis of whether there are compensation concerns or a history of problematic compensation practices
  • The previous year’s support level on the company’s Say-on-Pay proposal

Incentive Bonus Plans and Tax Deductibility Proposals – Previously, ISS generally recommended that investors support equity plan proposals that were up for vote solely to secure Section 162(m) approval, regardless of whether or not the plan included provisions viewed as not shareholder friendly (evergreen provisions, liberal change-in-control definitions, etc.).

Beginning in 2012, ISS will generally vote FOR proposals to approve or amend executive incentive bonus plans if the proposal:

  • Is only to include administrative features
  • Places a cap on the annual grants any one participant may receive to comply with the provisions of Section 162(m)
  • Adds performance goals to existing compensation plans to comply with the provisions of Section 162(m) unless they are clearly inappropriate
  • Covers cash or cash and stock bonus plans that are submitted to shareholders for the purpose of exempting compensation from taxes under the provisions of Section 162(m) if no increase in shares is requested

ISS will generally vote AGAINST proposals to approve or amend executive incentive bonus plans if:

  • The Compensation Committee does not fully consist of independent outsiders, per ISS’ director classification or
  • The plan contains excessive problematic provisions

ISS will vote on a CASE-BY-CASE basis if:

  • In addition to seeking 162(m) tax treatment, the amendment may cause the transfer of additional shareholder value to employees (e.g., by requesting additional shares, extending the option term, or expanding the pool of plan participants). In this case, ISS will evaluate the Shareholder Value Transfer in comparison with the company’s allowable cap
  • A company is presenting the plan to shareholders for Section 162(m) favorable tax treatment for the first time after the company’s initial public offering (IPO). ISS will perform a full equity plan analysis, including consideration of total shareholder value transfer, burn rate (if applicable), repricing, and liberal change in control. Other factors such as pay-for-performance or problematic pay practices as related to Management Say-on-Pay may be considered if appropriate

ISS notes that they anticipate continuing to support the vast majority of Section 162(m) proposals that do not seek additional shares.

Our View: The policy updates indicate that ISS is adopting an increasingly complex approach to evaluating compensation.  In drafting 2012 proxies, companies need to leverage the CD&A to persuasively tell their pay-for-performance story and back it up with clear and robust disclosure regarding the programs and policies in place.  Additionally, companies should plan to explicitly address in the CD&A the results of last year’s Say-on-Pay vote and describe actions taken following a review of the vote results.  While this is critical for companies that did not receive at least 70% approval on last year’s Say-on-Pay vote, we note that investors overwhelmingly favored an explicit response in the ISS 2011-2012 Policy Survey.

Further Information: ISS will conduct a webcast to discuss its U.S. policy updates on December 7 and is expected to provide additional guidance on the 2012 Pay-for-Performance methodology in a technical document that is scheduled for release in December.  ISS will disclose its peer group methodology and rationale in communications leading up to the 2012 proxy season.  In addition, FAQs on key policy issues will be published in January.  If you wish to discuss further, please don’t hesitate to contact us.

PDF: ISS Releases 2012 Proxy Voting Guidelines