On Nov. 8, 2016, Institutional Shareholder Services (ISS) announced changes to its pay-for-performance methodology for U.S., Canadian and European companies broadening the financial measures that it will consider in its pay-for-performance analysis of U.S. companies. This is a significant departure from ISS’s sole reliance on Total Shareholder Return (TSR) as a metric. This change will be effective for proxies covering shareholder meetings on or after Feb. 1, 2017.
According to the announcement, after the effective date, ISS will begin evaluating a company’s corporate performance against compensation levels based on a weighted average of the following six financial metrics:
- Return on equity
- Return on assets
- Return on invested capital
- Revenue growth
- Growth in EBITDA (earnings before interest, taxes, depreciation and amortization) growth
- Cash flow
The inclusion of these metrics will likely provide companies with a more robust analysis when gauging executive compensation relative to company performance. The metrics and weightings will be based on the company’s four-digit Global Industry Classification Standard industry group, and based on extensive back-testing over multiple years. A company’s ISS proxy research report will now include the company’s three-year performance on both TSR and each of the six financial metrics relative to its ISS peer group.
This is a significant and important change from ISS’s current analysis, which is based primarily on relative TSR. However, the new metric will not impact the quantitative screening results for the 2017 proxy season, but may be considered in the qualitative review that impacts any pay-for-performance concerns. So, for example, if a company’s financial metrics are not aligned with its stock performance, it could impact significantly on whether the company receives a “for” or “against” recommendation on its say-on-pay vote.
While companies will need to wait for details on how each of the metrics is defined and how the weightings will be calculated, this change is a welcome development. By taking a broader view of a company’s financial and stock performance, ISS is now more likely to capture more accurately the linkage between actual compensation earned and underlying financial performance.