On October 15, 2014, Institutional Shareholder Services Inc. (“ISS”) published for comment proposed changes in the way ISS evaluates equity-based compensation plan proposals and independent chair shareholder proposals. The proposed changes are likely to have a significant impact on US companies in the 2015 proxy season if adopted as currently proposed. Copies of the ISS proposals are available here.
New Approach to Equity Plan Proposals
Current Method of Evaluation: “Pass/Fail” Approach
ISS currently evaluates equity plan proposals based on the following pass/fail tests:
- the total cost of the company’s equity plans is unreasonable;
- the equity plan expressly permits repricing;
- a pay-for-performance misalignment exists;
- the company’s three-year burn rate exceeds the burn rate cap of its industry group;
- the plan has a liberal change-of-control definition; or
- the plan is a vehicle for problematic pay practices.
If a company seeking shareholder approval of a new equity plan fails to pass any of these factors, ISS would generally recommend a vote against the equity plan proposal.
Proposed Method of Evaluation: “Scorecard” Approach
ISS proposes to establish an Equity Plan Scorecard (“EPSC”) for evaluating equity plan proposals instead of the current pass/fail approach. Under this scorecard approach, ISS will recommend a “For” or “Against” vote depending on the company’s total EPSC score. Specifically, a company’s EPSC score will be based on the following three main factors: (1) plan costs; (2) plan features; and (3) grant practices. The details regarding what matters ISS takes into account for purposes of evaluating each factor are as follows:
- Plan Costs. ISS will measure the total potential cost of a company’s equity plans relative to industry/market cap peers using its shareholder value transfer (“SVT”) measure. Unlike the current practice, however, ISS will now calculate SVT for both (1) new shares requested, plus shares remaining for future grants, plus unvested/unexercised grants, and (2) new shares requested, plus shares remaining for future grants.
- Plan Features. ISS will take into account whether the proposed plan provides for: (1) automatic single-trigger award vesting upon a change-in-control; (2) discretionary vesting authority; (3) liberal share recycling; and (4) minimum vesting period for grants made under the plan (rather than merely under the award agreement).
- Grant Practices. ISS will consider: (1) the company’s three-year burn rate relative to its industry/market cap peers; (2) vesting requirements in its most recent CEO equity grants; (3) the estimated duration of the proposed plan based on the sum of shares remaining available and the new shares requested, divided by the average annual shares granted in the prior three years; (4) the proportion of the CEO’s most recent equity grants/awards subject to performance conditions; (5) whether the company maintains a claw-back policy; and (6) whether the company has established post exercise/vesting holding requirements.
ISS has also indicated that such scorecard factors will be keyed to company size and status, and that weightings will be differentiated depending on which of the following categories the company falls under: S&P 500, Russell 3000 (excluding S&P 500), Non-Russell 3000, recent IPOs, or bankruptcy emergent companies. This includes calibration of burn-rate benchmarks for respective index groups (based on the use of the relevant GICS industry classification within each index group).
Notwithstanding the proposed EPSC system, ISS has indicated that certain “highly egregious” features, such as authority to reprice options without seeking shareholder approval, will result in a recommendation to vote “Against” a proposed equity plan, regardless of other factors.
New Approach to Independent Chair Shareholder Proposals
Current Approach: “Generally For”
Currently, ISS generally recommends a “For” vote for shareholder proposals to have an independent chair unless the company satisfies all of the following criteria:
- The company has a lead director elected by and from the independent board members with clearly delineated and comprehensive duties stipulated by ISS;
- The board is at least two-thirds independent;
- Key committees of the board are fully independent;
- The company has disclosed governance guidelines;
- A company in the Russell 3000 index must not have exhibited sustained poor total shareholder return (“TSR”) performance (defined as one- and three-year TSR in the bottom half of the company’s four-digit industry group), unless there has been a change in the chairman/CEO position within that time; and
- The company does not have any problematic governance or management issues such as egregious compensation practices or excessive problematic corporate governance provisions.
Proposed Approach: “Holistic” Review
ISS is proposing to change its policy by (1) adding new criteria relating to governance, board leadership and performance that must be satisfied by the company and (2) evaluate the various factors in a holistic manner. Specifically, ISS has indicated that it will add the following factors:
- Absence or presence of an executive chair;
- Recent board and executive leadership transitions at the company;
- Tenure of directors and CEO; and
- A longer (five-year) performance period for evaluating TSR.
In proposing these changes, ISS noted that the “retention of a former CEO in the role of chair may prevent new CEOs from making performance gains by dampening their ability to make strategic changes at the company” and that the lead independent director may not be “an effective counterbalance to both a CEO and an executive chair.”
In addition, ISS proposes to implement a “holistic review” of a company’s practice (including board leadership structure, governance practices and financial performance) when making a vote recommendation for independent chair shareholder proposals. This is a departure from the current practice, where ISS would recommend “For” a shareholder proposal if the company failed to meet any one of the criteria set out by ISS. Instead, under the proposed approach, ISS may recommend a vote “Against” a shareholder proposal for an independent chair even if a company has failed to meet a particular criterion so long as there are other positive mitigating factors. However, ISS could also recommend a vote “For” notwithstanding the company’s compliance with all of the criteria under its current policy. In fact, ISS has indicated in its proposal release that the back-testing of the new approach for companies targeted in 2014 resulted in a higher level of support for independent chair shareholder proposals. As such, the adoption of the proposed “holistic review” approach will increase uncertainties for companies facing independent chair shareholder proposals.
Comments Sought by ISS
ISS has requested comments on both proposals, which can be submitted via email by October 29, 2014 to email@example.com.
With respect to the proposed changes to Equity Plan Proposals, ISS has specifically requested
comments on the following:
- Whether certain factors outlined in the scorecard approach should be more heavily weighted when evaluating equity plan proposals; and
- Whether there might be any unintended consequences from shifting to a scorecard approach.
With respect to the proposed changes to Independent Chair Shareholder Proposals, ISS has specifically requested feedback on the following:
- What factors are most important when determining whether an independent chair shareholder proposal warrants support;
- How much weight should be given to recent changes in board leadership structure (e.g., a switch from an independent chair to a non-independent chair; a recombination of the CEO/chair roles); and
- What timeframe should ISS use when assessing financial performance in evaluating independent chair proposals.
ISS is expected to release its final 2015 proxy voting policies on or around November 7, 2014. The final 2015 proxy voting policies will be applied for shareholder meetings taking place on or after February 1, 2015.