On October 18, 2011, in anticipation of the 2012 proxy season, Institutional Shareholder Services Inc. ("ISS") issued draft policy changes for public comment. The proposed policy changes may affect ISS's recommendations with respect to say-on-pay votes on executive compensation and the election of directors of public companies. While ISS was accepting comments through October 31, 2011, given the relatively short comment period, it is unlikely that final policy changes will be substantially different from the proposed version. The following analysis summarizes the draft policy changes being considered by ISS for the upcoming 2012 proxy season.

Evaluation of Executive Pay (Say-on-Pay)

Previously, ISS assessed pay-for-performance alignment by examining a company's one-year and three-year total shareholder return ("TSR") relative to all other companies in the same 4-digit Global Industry Classification Standard ("GICS") industry group, and by considering other factors such as the year-over-year change in the CEO's total pay and five-year trends in company TSR and CEO pay. The ISS proposal includes changes to the peer group used by ISS to analyze pay for performance, quantitative evaluation of pay-performance alignment on a relative and absolute basis, and qualitative review of other factors for companies that demonstrate a weak pay-for-performance alignment.

  • Peer Group. Companies will no longer be evaluated against all companies in the 4-digit GICS industry group, but will instead be evaluated against a smaller peer group that is similar in market cap, revenue (or assets) and industry.
  • Relative Alignment. The degree of alignment between the company's TSR rank and the CEO's total pay rank within the peer group will be evaluated on a relative basis over one and three years (weighted 40/60, to put more emphasis on the longer term). The multiple of the CEO's total pay relative to the peer group median will be quantified, to identify cases where a high-performing company may be "overpaying."
  • Absolute Alignment. CEO pay alignment will be evaluated on an absolute basis against the company's TSR over each of the prior five fiscal years. This will be assessed as the difference between the slope of annual CEO pay changes and the slope of annualized TSR changes during the prior five-year period.
  • Qualitative Review. Companies that demonstrate strong or satisfactory quantitative alignments will generally receive a positive recommendation (in the absence of other pay-related issues), while companies demonstrating weak alignment will receive further qualitative review to determine a final vote recommendation. Factors considered may include:
  • the ratio of performance-based to time-based equity awards;
  • the overall ratio of performance-based compensation to total compensation;
  • the robustness of disclosure and rigor of performance goals;
  • the company's peer group benchmarking practices;
  • actual results of financial/operational metrics, such as growth in revenue, profit, and cash flow, both absolute and relative to peers;
  • special circumstances, such as a new CEO in the prior fiscal year or equity grant practices; and
  • any other factors deemed relevant.

Equity Plans Related to Section 162(m)

Under new proposed regulations related to Section 162(m) of the Internal Revenue Code, a company that has recently undergone an initial public offering will need to obtain shareholder approval before awarding certain performance-based RSUs to covered executives in order to qualify the RSUs as "performance-based compensation" under Section 162(m). ISS will make its recommendation with respect to a shareholder vote on the equity plans of a newly public company on a case-by-case basis after conducting a full equity plan analysis, including consideration of total shareholder value transfer, repricing, burn rate analysis (if applicable), and any liberal change in control definition. Other factors, such as pay-for-performance or problematic pay practices as related to say-on-pay, may be considered if deemed appropriate.

Board Response to Say-on-Pay Vote (U.S.)

For any company that received "significant opposition" in its prior say-on-pay vote, ISS will make its recommendation on a case-by-case basis with respect to the election of compensation committee members (or, in rare cases where the full board is deemed to be responsible, the full board) and the current say-on-pay proposal. ISS will take into account:

  • the level of opposition; 
  • the company's ownership structure;
  • disclosure of engagement efforts with major institutional investors regarding the compensation issue(s);
  • the company's response;
  • specific actions taken to address the issue(s) that appear to have caused the significant level of against votes;
  • other recent compensation actions taken by the company; and
  • ISS's current analysis of the company's executive compensation and whether any prior issues of concern are recurring or one-time.

Board Response to Say-on-Pay Frequency Vote

ISS is proposing the following new policy and vote recommendation with respect to the frequency of the say-on-pay vote implemented by the board:

  • ISS will recommend a "withhold/against" vote on all incumbent director nominees if the board implements the advisory say-on-pay vote on a less frequent basis than the frequency that received the majority of votes cast by shareholders.
  • ISS will make its recommendation on a case-by-case basis if the board implements the advisory say-on-pay vote on a less frequent basis than the frequency that received a plurality, but not majority, of votes cast by shareholders. ISS will take into account:
  • the board's rationale for choosing a frequency that is different from the frequency that received a plurality; 
  • the company's ownership structure;
  • ISS's analysis of the company's executive compensation and whether there are compensation concerns or a history of problematic pay practices;
  • the previous year's support level on the company's say-on-pay proposal; and
  • the difference between the frequency adopted and the frequency supported by shareholders.