A Harbinger of Things to Come? ISS Implements New Compensation and Governance Factors in QuickScore 2.0

A Harbinger of Things to Come? ISS Implements New Compensation and Governance Factors in QuickScore 2.0

February 6 2014

Cover2ISS recently released a Technical Document that outlined key changes to the methodology and new governance factors to its governance risk scoring system, ISS Governance QuickScore.  While we have previously circulated an Alert on this topic, the Technical Document includes a number of new and noteworthy items which we believe suggest a troubling expansion of the topics over which ISS has appointed itself arbiter.  While details regarding the relative weightings of these items remain undisclosed, we believe Directors and companies should be aware of these policy shifts and be mindful of the potential ramifications these policies may have on current and future governance practices.

In our view, these questions reflect a disturbing “mission creep” which may end with the incorporation of these factors into the ISS proxy voting guidelines.  We note that ISS is already soliciting comments on whether it should alter its Director election policy guidelines to account for director tenure.  We remain concerned about the potential utilization of a fixed, narrowly-defined methodology to determine voting recommendations for Say-on-Pay and Director elections.  It is our belief that these decisions should be made only upon a nuanced and holistic review of the specific facts and circumstances germane to each vote.

Additionally, a number of these concepts appear to have been borrowed from governance trends already manifested abroad.  We urge clients to continue to be mindful of international governance trends as a way to stay one step ahead of further US developments in the field.

Finally, as always, we remind clients that ISS policy should not be determinative.  We believe companies are better served by making thoughtful decisions in the best interests of their long-term shareholders rather than by blindly chasing the latest “best practices”.

Key Factors Added to QuickScore 2.0

  • Relative Director Compensation:  ISS will now assess director compensation levels on a relative basis.  ISS will measure the average director pay (based on the director compensation table as disclosed in the proxy) as a multiple of the median pay of the ISS-selected peers.  ISS did not disclose the level of multiple that will be considered harmful to QuickScore 2.0 ratings.
    • Our take: We have been advising clients for several years now of a troubling trend towards increased, and increasingly negative, public scrutiny of director pay levels.  In light of this, we recommend companies review director compensation on an annual basis and to make adjustments as needed to remain competitive.
  • Director Election Voting Results:  ISS will now consider the percentage of directors who received “less than average levels” of approval upon election, defined as Directors who receive less than 95% shareholder approval (on a votes cast basis).
    • Our take: Director election results are often more influenced by the Director’s role on the board (e.g. Chair of the Compensation Committee) than his/her qualifications.  We believe companies derive tremendous value from the expertise of their Directors, but it is critical that these individuals to do what is right for the company, even when it might not follow a narrowly-defined voting methodology.  Sound decisions made at-odds with the rigid methodologies of advisory firms do not, in our view, reflect poor governance.
  • Director Tenure: ISS will now consider the proportion of non-executive Directors on the board who have Board tenure greater than nine years.  ISS argues that tenure of greater than nine years potentially compromises a Director’s independence.
    • Our take: ISS itself notes that views on director tenure are divergent.  We believe that Directors are better able to evaluate the totality of the issue, weighing tenure against experience, institutional knowledge and perspective, and in our experience, Directors take these responsibilities very seriously.  We urge clients to enhance disclosure of these conversations to inoculate against potential criticisms of long-tenured directors.
  • Relative Say-on-Pay Voting Results:  ISS will now consider whether the company’s most recent Say-on-Pay received shareholder support below the index industry level, compared to results of 4-digit GICS groups, and the S&P 500, S&P 400, S&P 600, Russell 3000 – excluding S&P 1500 indices.
    • Our take: Say on Pay vote results, particularly negative ones, are often reflective of dissatisfaction with more than the pay program.  Indeed, 20% of companies failing Say on Pay votes in recent years have had approval levels in excess of 90% in the prior year, often for the exact same pay program.  Given these swings, we question the meaningfulness of a relative assessment of Say on Pay vote results.

We also note the inclusion of “zero-weight impact” factors measuring how many directors serve on the board and the proportion of women on the Board. While these items do not currently affect ISS results, we believe their inclusion in the analysis may be indicative of a future policy shift.  For reference, clients should be aware that ISS believes that Boards should have no fewer than six and no more than 15 members, and considers a Board comprised of nine to 12 members to be ideal.  Although ISS does not have a similar guideline for the proportion of women Directors, they do state that increasing the number of women on boards has been found to correlate with better financial performance.

ISS QuickScore
ISS Governance QuickScore Data Verification
ISS QuickScore 2.0 Technical Document

About Steven Hall & Partners
Steven Hall & Partners is an independent compensation consulting firm, specializing exclusively in the areas of executive compensation, board remuneration, non-profit compensation and related governance issues.  By focusing solely on this critical and complex segment of the human resources arena, we are able to provide our clients with the highest quality expertise and best counsel available on a practical basis.  For more information, please visit www.shallpartners.com and follow us on Twitter @SHallPartners.

Contacting Steven Hall & Partners
This publication is provided by SH&P as a service to clients and colleagues.  The information contained in this publication should not be construed as legal, tax or accounting advice.  We can assist with ISS modeling and engagement.  Please call Joseph Sorrentino, or any member of our staff with whom you have consulted in the past.  If you have not received this publication directly from us, you may obtain a copy of any past or future related publications from Kathie Mulroe (212-488-5400; kmulroe@shallpartners.com).

Joseph Sorrentino