On November 16, 2012, ISS released its final 2013 Updates to its U.S. Corporate Governance Policy. ISS also will release FAQ document in December 2012 for further guidance. The Updates will be effective for meetings on or after February 1, 2013.
Highlights of the 2013 Updates include:
Stock Pledges/Hedges: In response to comments, ISS will be taking a case-by-case approach in determining whether pledging of company shares rises to a level of serious concern for shareholders. Also in response to comments, ISS is including significant pledging of company stock as a failure of risk oversight and thus considered a governance failure for which directors should be held accountable (rather than communicating concern through a say-on-pay recommendation as originally proposed). However, hedging of company stock through covered call, collar or other derivative transactions, will be considered a problematic practice warranting a negative voting recommendation on the election of directors.
In determining vote recommendations for election of directors of companies who currently have executives or directors with pledged company stock, the following factors will be considered:
- presence in the company’s proxy statement of an antipledging policy that prohibits future pledging activity;
- magnitude of aggregate pledged shares in terms of total common shares outstanding or market value or trading volume;
- disclosure of progress or lack thereof in reducing the magnitude of aggregate pledged shares over time;
- disclosure in the proxy statement that shares subject to stock ownership and holding requirements do not include pledged company stock; and
- any other relevant factors.
Failure to Act on Shareholder Proposals: ISS will keep its current policy in effect for 2013, with some modifications: ISS will recommend a negative vote for individual directors, committee members or the entire board, if the board fails to act on a shareholder proposal that received the support of either (i) a majority of the outstanding shares, or (ii) a majority of the votes cast in the last year and one of the two previous years. Beginning in 2014, ISS will recommend a negative vote if the board fails to act on a shareholder proposal that received the support of a majority of shares cast in the previous year. Under the Update, ISS now has the flexibility to recommend a negative vote on members of the board as deemed appropriate, not necessarily the full board.
ISS also has included more guidance on the case-by-case examination of the sufficiency of a company’s action in response to a majority-supported shareholder proposal. Responding to the shareholder proposal will generally mean either full implementation of the proposal or, if the matter requires a vote by shareholders, a management proposal on the next annual ballot to implement the proposal. Responses that involve less than full implementation will be considered on a case-by-case basis, taking into account:
- the subject matter of the proposal;
- the level of support and opposition provided to the resolution in past meetings;
- disclosed outreach efforts by the board to shareholders in the wake of the vote;
- actions taken by the board in response to its engagement with shareholders;
- the continuation of the underlying issue as a voting item on the ballot (as either shareholder or management proposals); and• other factors as appropriate.
Peer Groups: ISS’ pay for performance evaluation begins with a preliminary quantitative screen of company pay and performance relative to an ISS-selected peer group. For ISS’ purposes, these peer groups are designed not for pay benchmarking or stock-picking, but rather to compare pay and company performance within a group of companies that are reasonably similar in terms of industry profile, size, and market capitalization. ISS’ current peer group methodology focuses on the subject company’s Global Industry Classification Standard (GICS) industry classification, which may not reflect multiple business lines in which many companies operate. As a result, some ISS peer groups omitted competitors of the target company and/or included firms that did not reflect a connection to the target considered appropriate for performance and pay comparisons.
The new methodology incorporates information from companies’ self-selected pay benchmarking peer groups in order to identify and prioritize GICS industry groups beyond the subject company’s own GICS classification. The methodology draws peers from the subject company’s GICS group as well as from GICS groups represented in the company’s peer group, while maintaining the approximate proportions of these industries in the final peer group where possible. The methodology additionally focuses initially at an 8-digit GICS resolution to identify peers that are more closely related in terms of industry. Finally, when selecting peers, the methodology prioritizes peers that maintain the company near the median of the peer group, are in the subject company’s peer group, and that have chosen the subject company as a peer. The peer group methodology maintains its focus on identifying companies that are reasonably similar to the subject company in terms of industry profile, size, and market capitalization. Other changes to the peer group methodology include using slightly relaxed size requirements, especially at very small and very large companies, and using revenue instead of assets for certain financial companies.
Realizable Pay: The ISS observed that during 2012 proxy season, more companies disclosed alternative measures of pay beyond the granted pay disclosed in the summary compensation table. Companies are providing a diverse set of “realizable” total compensation, which endeavors to show how executive pay has been affected by performance. While grant date pay in the Summary Compensation Table shows the intent of the pay decisions of the Compensation Committee, it does not necessarily reflect the final payouts of performance-based awards or changes in value due to gains or losses in the company’s stock price.
The ISS concluded, based on its 2012-2013 Policy Survey, that measures of pay that reflect the company’s performance—both standardized calculations and measures of such pay provided by the company—are favored by both issuers and investors as potentially appropriate for consideration in a pay-for-performance evaluation. As a result, realizable pay is being added to the research report for large capitalization companies. Realizable pay will consist of the sum of relevant cash and equity-based grants and awards made during a specified performance period being measured, based on equity award values for actual earned awards, or target values for ongoing awards, calculated using the stock price at the end of the performance measurement period. Stock options or stock appreciation rights will be revalued using the remaining term and updated assumptions, as of the performance period, using the Black-Scholes Option Pricing model. The realizable pay consideration may mitigate or exacerbate the CEO’s pay for performance concerns.
Voting on “Say on Golden Parachute” Proposals: The Updates (i) include existing change-in-control arrangements maintained with named executive officers rather than focusing only on new or extended arrangements and (ii) place further scrutiny on multiple legacy problematic features (e.g. single trigger equity, tax gross -ups, etc.) in change in control agreements.