ISS Releases GRId 2.0

ISS Releases GRId 2.0

February 21 2012

ISS recently released transition information and a technical document related to the launch of its newly revised governance product, Governance Risk Indicators 2.0 (“GRId 2.0”). The Compensation category has been significantly modified to incorporate ISS’ recently announced principles for evaluating the alignment of pay and performance for purposes of formulating Say on Pay vote recommendations.  The technical document on GRId 2.0 can be found here.  From now until February 23rd, companies have the opportunity to review their scores and correct any errors prior to the publication of the new GRId ratings.

For Immediate Action: GRId 2.0 Transition Information
ISS has posted a preview of updated GRId 2.0 data profiles for U.S. companies.  The data verification site also includes results for the new quantitative pay for performance tests. These results were calculated using the most recently available data for your company and ISS designated peers at the time of the GRId 2.0 launch.  While this analysis will be updated upon the publication of the ISS proxy analysis prior to your company’s next shareholder meeting, this assessment nevertheless provides an important preview of how your company may be evaluated under the new pay for performance methodology later this spring.

Company representatives can access their free GRId profile through ISS’ data verification site and can use this online tool to inform ISS of any data corrections. To obtain a data verification user name and password, contact ISS at support@isscorporateservices.com or by calling 301-556-0570.

ISS will research, verify and subsequently accept or reject any corrections submitted through the data verification tool until February 23rd. The entire GRId universe of U.S. companies, which consists of Russell 3000 Index members as of July 2011, will then be scored under GRId 2.0 and published on Monday, February 27th.

ISS’ standard data verification process will be closed starting February 24th and resume as normal on February 27th.  Once a company has filed their 2012 definitive proxy statement the data verification form will be closed until the ISS proxy research report has been published.

Summary of Updates to Compensation Category in GRId 2.0
GRId 2.0 now incorporates the measures utilized in the new ISS quantitative methodology for evaluating pay for performance alignment.  In addition, the subcategories in compensation have been realigned to better reflect the framework of principles used by ISS to make Say on Pay vote recommendations.  The six new subcategories are: pay for performance, non-performance based pay, the use of equity, equity risk mitigation, communication & disclosure, and termination/severance.  Data from ISS’ new Executive Compensation database will be employed to review the magnitude of severance pay and perquisites.

Summary of GRId 2.0 Scoring and Rating Approach:
The updated Compensation Category includes 42 questions.  Each answer is assigned a number of points, based on the relative importance of the question and the nature of market practice.  In general:

  • Negative scores represent practices that ISS deems fall short of market practice and therefore tend to raise ISS concerns
    • Score of -50 points represents high concern
    • Score of -25 points represents medium concern
  • Zero/neutral scores represent practices that ISS views as consistent with market practice, local governance codes, and/or ISS voting policy on the topic
  • Positive scores indicate an ISS belief of “best practices” that may mitigate concerns elsewhere

The number of points assigned to an answer is designed to communicate a level of concern.  If an answer by itself should drive a medium level of concern in its category, it will receive -25 points.  If it is significant enough to warrant high concern, then it will receive -50 points.

To calculate an overall category score, the subcategory scores are summed, subject to a category-level floor and ceiling of -75 and +25, respectively.  Finally, 75 points are added to normalize this score to a scale between 0 and 100.  The thresholds for Category concern levels are as follows:

  • 0 – 50 points indicates High concern
  • 51 – 75 points indicates Medium concern
  • > 75 points indicates Low concern

Our View:  The explicit incorporation of the new ISS pay for performance methodologies into GRId 2.0, particularly when coupled with their relative weight, further underscores ISS’ narrow focus on the alignment of CEO pay and TSR performance as the predominant arbiter of sound corporate governance.  We believe that this view is short-sighted and does not take into account the many complex and varied factors which contribute to a strong corporate pay program designed to attract, motivate and retain the executive talent needed to drive shareholder growth over the long-term.  Companies should continue to ensure that their CD&A defines corporate success and clearly demonstrates how the corporate pay program aligns the interests of executives with those of shareholders.

Next Steps: We urge companies to review the initial GRId 2.0 assessment during the preview period ending February 23rd.  In the past, we have found errors in ISS’ analyses and believe a careful review of their findings is warranted.  Additionally, we believe that an early preview of how the company might be treated under the pay for performance methodology used to determine this year’s Say on Pay vote recommendation may be of interest, although we note that this assessment will be updated again prior to the 2012 annual shareholder meeting.  As always, we stand ready to assist in any way; please don’t hesitate to call.

A complete list of the Compensation Category questions organized by subcategory follows:

Compensation Category Questions (Total of 42 Questions)

1. Pay for Performance subcategory (5 Questions)
The primary factors identified in this section are the quantitative measures incorporated in ISS’ evaluation of executive compensation for proxy analyses and are being incorporated into GRId as compensation-related risk indicators.  Factors in this section may raise a high level of concern for the Compensation category.  There are no mitigating questions in this subcategory.

  • What is the degree of alignment between the company’s cumulative 3-year pay percentile rank, relative to peers, and its 3-year cumulative TSR rank, relative to peers?
  • What is the degree of alignment between the company’s cumulative 1-year pay percentile rank, relative to peers, and its 1-year cumulative TSR rank, relative to peers?
  • What is the size of the CEO’s 1-year cumulative pay, as a multiple of the median pay for company peers?
  • What is the degree of alignment between the company’s TSR and change in CEO pay over the past five years?
  • What is the ratio of the CEO’s total compensation to the next highest paid executive?

2. Non-Performance Based Pay subcategory (7 Questions)
This subcategory focuses on elements of pay programs that ISS views as being disconnected from performance considerations, or tend to erode the relationship between pay and performance. Concerns identified in this section can raise a moderate level of concern for the Compensation category; there are no mitigating questions in this subcategory.

  • Did the company provide dividends on unvested performance shares in the last fiscal year?
  • Has the company reimbursed NEOs for losses on sale of a home?
  • Did the CEO receive tax gross-ups on perks other than relocation and other broad-based benefits?
  • Are any of the NEOs eligible for multi-year guaranteed bonuses?
  • Did the company pay tax gross-ups on a secular trust?
  • Are executives given credit toward pension for years not worked?
  • What is the ratio of the CEO’s non-performance-based compensation (All Other Compensation) to Base Salary?

3. Use of Equity subcategory (9 Questions)
This section addresses how the company uses equity as part of its long-term compensation program, focusing on the effect of equity grants on shareholders through dilution, and the shareholder-friendliness of provisions such as repricing, recycling, buyouts, etc.  The repricing question can raise a high level of concern; the other questions can raise a moderate level of concern.

  • Do the company’s active equity plans prohibit share recycling for options/SARS?
  • Do the company’s active equity plans prohibit option/ SAR repricing?
  • Does the company’s active equity plans prohibit option/ SAR cash buyouts?
  • Do the company’s active equity plans have an evergreen provision?
  • Do the company’s active equity plans have a liberal CIC definition?
  • Do the company’s active equity plans provide for automatic vesting of equity awards in the case of change-in-control?
  • Has the company repriced options or exchanged them for shares, options or cash without shareholder approval in the last three years?
  • Does the company grant equity awards at an excessive rate, according to ISS policy?
  • If a new or amended broad-based plan is proposed, then what is the expected duration of shares?

4. Equity Pay Risk Mitigation subcategory (10 Questions)
The questions in this subcategory address whether there the company’s pay programs contain provisions that tend to mitigate the risks and potential executive-shareholder misalignment that can be embedded within equity pay grants. The absence of effective equity pay mitigation may raise a moderate level of concern within the Compensation category, while the presence of equity pay mitigation can reduce levels of concern to a limited extent.

  • Did the company disclose a claw back or malus provision?
  • What are the minimum vesting periods mandated in the plan documents for executives’ stock options or SARS in the equity plans adopted/amended in the last 3 years?
  • What are the minimum vesting periods mandated in the plan documents, adopted/amended in the last three years, for executives’ restricted stock?
  • What is the holding period for stock options (for executives)?
  • What is the holding period for restricted shares (for executives)?
  • What proportion of the salary is subject to stock ownership requirements/guidelines for the CEO / Is the CEO subject to ownership guidelines?
  • Are directors subject to stock ownership guidelines?
  • Do all directors with more than one year of service own stock?
  • Did any executive or director pledge company shares?
  • Does the company have a policy prohibiting hedging of company shares by employees?

5. Communications and Disclosure subcategory (2 Questions)
This subcategory focuses on the quality of disclosure surrounding short- and long-term performance metrics. It does not focus on the quality or challenging nature of the metrics themselves.  The absence of disclosure may raise a low to moderate level of concern, while partial disclosure will contribute a lower level of concern.  Full disclosure will provide an undisclosed small degree of mitigation.

  • What is the level of disclosure on performance measures for the short term incentive plan?
  • What is the level of disclosure on performance measures for the latest active or proposed long term incentive plan

6. Termination subcategory (9 Questions)
This subcategory focuses on termination-related factors, including the vesting of equity, the size of cash severance payments, and the events that trigger change-in-control payments. Factors in this subcategory may raise moderate to high levels of concern, while “best practices” may slightly mitigate concerns found elsewhere in the Compensation category.

  • What’s the trigger under the change-in-control agreements?
  • Does the CEO’s outstanding equity awards vest upon a change in control?
  • What is the multiple of salary plus bonus in the severance agreements for the CEO (upon a change-in-control)?
  • What is the basis for the change-in-control or severance payment for the CEO?
  • What is the multiple of salary plus bonus in the severance agreements for executives excluding the CEO (upon a change-in-control)?
  • What is the basis for the change-in-control or severance payment for executives excluding the CEO
  • Does the company provide excise tax gross-ups for change-in-control payments?
  • What is the length of employment agreements with the CEO?
  • What is the amount of the CEO’s estimated non-Change-in-Control severance amount as of the end of the last fiscal year, as a multiple of the executives’ average salary + bonus over the past three years?

PDF: SH&P Client Alert: ISS Releases GRId 2.0