Yesterday, ISS announced some important updates relating to its 2017 pay-for-performance evaluation. Generally the changes apply to proxy advisory reports for annual meetings on or after February 1, 2017. However, I did not rush this out yesterday because the potentially most significant change will not fully apply in 2017.

For companies subject to ISS’s quantitative pay-for-performance screens, ISS will display a company’s three-year performance not only on TSR but also on six financial metrics relative to its ISS peer group (using data from S&P Compustat):

  • return on equity;
  • return on assets;
  • return on invested capital;
  • revenue growth;
  • growth in earnings before interest, taxes, depreciation, and amortization; and
  • growth in cash flow from operations.

ISS will compute relative three-year measures for each of the metrics, compared to the ISS selected peer group, compare performance on these metrics with relative compensation levels, and present the results, including an overall weighted financial performance metric, in a new standardized table.

This new assessment will not be a component of ISS’ quantitative pay-for-performance screening for 2017. The calculation and scoring of the three existing tests in the quantitative screening—Relative Degree of Alignment, Multiple of Median, and Pay-TSR Alignment—are not impacted by this change. ISS states that it “may” use the new relative financial performance information in its qualitative assessment of a company’s pay-for-performance alignment in 2017, and its consideration may mitigate or heighten identified pay-for-performance concerns.

As readers know, ISS’ pay-for-performance evaluation is a two-step process. ISS’ quantitative test of pay-for-performance is the initial screen for its voting recommendation (with the most important test comparing CEO pay and TSR performance relative to peer companies selected by ISS). Once the quantitative test is complete, ISS then conducts a “qualitative” assessment to determine a final vote recommendation. Approximately one-half of the companies that fail the quantitative test ultimately receive an ISS “FOR” SOP vote recommendation.

Other changes/announcements made by ISS were:

  • ISS will only consider the Relative Degree of Alignment (RDA) assessment in the overall quantitative concern level when the subject company has a minimum of two years of pay and TSR data. Companies that only have one year of data will receive an N/A (not applicable) concern for their RDA test.
  • The window for submitting peer groups to ISS is November 28 through December 9. Because ISS must construct its peer groups before most companies’ 2017 proxy filings are available, ISS welcomes companies to submit the peer groups they used in setting compensation for the most recently completed fiscal year (this means the 2016 peer group, not the 2017 peer group.) Peer submissions must be made through ICS’ Governance Analytics platform. Only representatives of the company may log into the Governance Analytics platform and complete the peer submission process.

Finally, the ISS announcement includes the following advice to advisers:

If your clients’ CD&As have not traditionally emphasized the company’s financial performance, now may be the time to suggest considering it—not merely because of today’s announcement from ISS, but because shareholders increasingly seek to understand at a high level how a company’s compensation decisions relate to the company’s recent financial and market performance, even before they dive into details of the company’s incentive program design.