SH&P Short Take on ISS Pay for Performance White Paper

ISS Publishes “Evaluating Pay for Performance Alignment” White Paper

December 28 2011

Last week, ISS published a white paper detailing its new pay-for-performance methodology.  As in the past, a “significant misalignment” between pay and company performance may cause ISS to vote against a company’s Say on Pay vote.  The new methodology is effective for Annual Meetings on or after February 1, 2012.  We have summarized the key components of the new methodology below and posted a detailed analysis in the Client Alert section of our website.  The white paper can be found here.

ISS will use three measures of alignment between executive pay and company performance for its quantitative analysis.  Two relative measures and one absolute measure.  The new approach remains focused exclusively on CEO pay, and continues to rely upon TSR as the predominant indicator of company performance.

All cases where the quantitative analysis indicates the company is a significant outlier (High concern on one relative measure or Medium concern on multiple relative measures) will receive an in-depth qualitative assessment to determine either the likely cause or mitigating factors.

Quantitative Analysis: Relative Alignment:

  • Relative Degree of Alignment (RDA)
    • Compares the percentile ranks of a company’s CEO pay and TSR performance, relative to an industry-and-size derived comparison group, over one- and three-year periods (weighted 40%/60% so as to put more emphasis on the longer term)
  • Multiple of Median (MOM)
    • The multiple of the CEO’s one-year total pay relative to median CEO pay at the ISS selected peer group

Quantitative Analysis: Absolute Alignment:

  • Pay-TSR Alignment (PTA)
    • Compares trend of the CEO’s annual pay and the value of an investment in the company over the prior five-year period
    • The measure is calculated as the difference between the slopes of weighted linear regressions for pay and for shareholder returns over a five-year period

Qualitative Assessment

This step in the analytic process may include consideration of some or all of the following:

  • Strength of performance based compensation
    • Review the ratio of performance- to time-based equity awards and of performance-based compensation to total compensation
      • Note that time-vested stock options with an exercise price of less than a 25% premium and restricted stock are not considered performance-based by
    • ISS will review both recent cash awards paid and the award opportunities (long-term incentive grants) intended to drive future performance, to evaluate their performance conditions
    • Use of a single metric, or similar metrics, in either or both of the short- and long-term incentive programs may suggest inappropriate focus on one aspect of business results at the expense of others
    • If a company uses non-GAAP metrics, adjustments should be clearly disclosed (along with compelling rationale if such adjustments are nonstandard)
  • Results of financial/operational metrics
    • If disconnect is driven by cash pay, ISS considers the rigor of performance goals (if any) that generated the payouts
    • Recent (GAAP) results on metrics such as return measures and growth in revenue, profit, cash flow, on both an absolute and relative basis may also be examined to assess the rigor of goals and whether the quantitative analysis may be anomalous (if other metrics suggest sustained superior performance)
  • The company’s peer group benchmarking practices
    • ISS will examine the disclosed benchmarking approach to determine whether that may be a contributing factor to a pay for performance disconnect
  • Special circumstances
    • Examples mentioned include a new CEO in the prior fiscal year and unusual equity grant practices (e.g. bi- or triennial awards), however these circumstances do not automatically exempt a company from receiving an against recommendation

Next Steps: While ISS has indicated that they do not expect the new methodology to have a significant impact on the percentage of against Say on Pay votes ISS recommends, we strongly urge companies to begin testing their pay-for-performance results based on this new methodology.  If you wish to discuss further, please don’t hesitate to contact us.

SH&P Client Alert
ISS White Paper