On at least an annual basis, those who make executive compensation decisions at publicly traded companies should “score” their practices against ISS and other policy guidelines. The table below reformats, but generally tracks, the U.S. Compensation Policy FAQs that ISS most recently updated March 16, 2016. All references are to FAQ #57 unless another is noted.

When reviewing the table below, directors should aim to identify whether any of their company’s executive compensation structures involve problematic practices. The best companies avoid or eliminate such irritants to shareholders, unless there are solid business justifications for them. For instance, the payment of tax gross-ups for golden parachute taxes is generally verboten. Nevertheless, tax gross-ups may be justifiable under some circumstances, such as when executive compensation is being restructured, to be more performance-based, in anticipation of a corporate sale. Overall, boards should be scrutinizing pay practices, because ISS and others will.

Item to Consider

Problematic Practice

RED FONT HIGHLIGHTS PRACTICES THAT ISS IDENTIFIES AS HAVING "SIGNIFICANT WEIGHT" THAT "WILL LIKELY RESULT IN ADVERSE VOTE RECOMMENDATIONS."

Employment Contracts

Egregious contracts containing multi-year guarantees for –

  • salary increases,
  • non-performance based bonuses, or
  • equity compensation.

New CEO's Pay

Overly generous new-hire package [evidenced by] --

  • excessive “make whole” provisions without sufficient rationale, or
  • any of the problematic pay practices listed in this policy.

Bonus Payments

  • Abnormally large payouts without justifiable performance linkage or proper disclosure.
    • Includes performance metrics that are changed, canceled, or replaced during the performance period without adequate explanation of the action and the link to performance.
  • Guaranteed multi-year awards.
  • Guaranteed multi-year guaranteed target pay amounts, unless dependent on the attainment of rigorous performance goals (i.e., no payout would occur if performance is below a specified standard). [FAQ #64]

Retention Awards

Companies that grant special retention awards of cash or equity to executives when regular incentive plan goals are not met should provide clear and compelling rationale in their proxy disclosure. Such awards should be conservative and reflect the fact that performance is lagging (i.e., should generally be significantly less than unearned target award levels). Optimally, "extra" awards designed to encourage retention should also include performance conditions that will ensure strong alignment of pay and performance going forward and avoid "pay for failure" scenarios if the executive is not retained. [FAQ #61]

Pension/SERP

Egregious payout [potential from]:

  • Inclusion of additional years of service not worked that result in significant benefits provided in new arrangements.
  • Inclusion of performance-based equity or other long-term awards in the pension calculation.

Perquisites

  • Perquisites for former and/or retired executives, such as lifetime benefits, car allowances, personal use of corporate aircraft, or other inappropriate arrangements.
  • Extraordinary relocation benefits (including home buyouts).
  • Excessive amounts of perquisites compensation.

Severance and Other Change in Control (CIC) Benefits

Excessive due to –

  • CIC cash payments exceeding 3 times base salary plus target/average/most recent bonus.
  • New or materially amended arrangements that provide for CIC payments without loss of job or substantial diminution of job duties (single-triggered or modified single-triggered, where an executive may voluntarily leave for any reason and still receive the change-in-control severance package).
  • New or materially amended employment or severance agreements that provide for an excise tax gross-up.
    • Modified gross-ups would be treated in the same manner as full gross-ups.
  • Excessive payments upon an executive's termination in connection with performance failure.
  • Liberal CIC definition in individual contracts or equity plans which could result in payments to executives without an actual CIC occurring. [FAQ #59]

Tax Reimbursements

Excessive reimbursement of income taxes on executive perquisites or other payments (e.g., related to personal use of corporate aircraft, executive life insurance, bonus, restricted stock vesting, secular trusts, etc; see also excise tax gross-ups above).

Stock Awards

Dividends or dividend equivalents paid on unvested performance shares or units.

Repricing or replacing of underwater stock options/stock appreciation rights without prior shareholder approval (including cash buyouts, option exchanges, and certain voluntary surrender of underwater options where shares surrendered may subsequently be re-granted).

Stock plans with a liberal CIC definition (e.g. low % or occurrence before CIC closing) coupled with single trigger vesting upon the CIC "are likely to receive a negative recommendation" (FAQ #63).

Internal Pay Disparity

Excessive differential between CEO total pay and that of next highest-paid named executive officer (NEO).

Hedging and Pledging

Whether through covered call, collar or other derivative transactions, any amount of hedging will be considered a problematic practice warranting a negative vote recommendation against appropriate board members. [FAQ #58]

CIC Vesting for Awards

Equity plans or arrangements that include a liberal CIC definition (such as a very low buyout threshold or a CIC occurring upon shareholder approval of a transaction, rather than its consummation), coupled with a provision for automatic full vesting upon a CIC, are likely to receive a negative recommendation. [FAQ 59]

Amendments [FAQs 64-67]

  • Agreements that are extended or new will face the highest scrutiny and weight in ISS' analysis.
  • Material amendments will be considered an opportunity for the board to fix problematic issues, but as part of the holistic analysis.
  • If a problematic pay practice is present in a separate plan or agreement, ISS may view the modification of an employment agreement as involving the opportunity to remove that problematic practice.

Other Practices

_________

Any that may be deemed problematic in a given circumstance but are not covered in the above categories.

See generally: annual proxy statement planning for a comprehensive discussion of issues to address when preparing executive compensation disclosures.