Last week, ISS released the 2017 updates to its benchmark proxy voting policies. The updated policies will generally be applied for shareholder meetings on or after February 1, 2017. Not much new this year. However, ISS made significant changes to its voting guidelines on director compensation, reflecting the growing focus of shareholders, executive compensation professionals, and the public on this matter.
Equity-Based and Other Incentive Plans
Currently, ISS makes voting recommendations on equity-based compensation plans on a case-by-case basis, depending on a combination of certain plan features and equity grant practices, where positive factors may counterbalance negative factors, and vice versa, as evaluated using its “equity plan scorecard” (EPSC) approach with three pillars. ISS generally recommends a vote against the plan proposal if the combination of the EPSC factors indicates that the plan is not, overall, in shareholders' interests, or if certain egregious factors apply.
For 2017, ISS made minor changes to various factor weightings, but only two recognizable changes to the EPSC.
First, ISS added an evaluation of the payment of dividends on unvested awards to the “Plan Features” pillar of the EPSC. In ISS’ view, dividends on unvested awards should be paid only after the underlying awards have been earned and not during the performance/service vesting period. Under this new factor, full points will be earned if the equity plan expressly prohibits, for all award types, the payment of dividends before the vesting of the underlying award (however, accrual of dividends payable upon vesting is acceptable). No points will be earned if this prohibition is absent or incomplete (i.e., not applicable to all award types). A company’s general practice (not enumerated in the plan document) of not paying dividends until vesting will not suffice.
Second, ISS made two modifications to the minimum vesting factor of the EPSC. For 2017, an equity plan must specify a minimum vesting period of one year for all award types under the plan in order to receive full points for this factor. No points will be earned if the plan allows for individual award agreements that reduce or eliminate the one-year vesting requirement.
ISS promises to include additional information about updates to the EPSC policy in its Equity Compensation Plans FAQ document to be updated and published in December 2016.
Amending Cash and Equity Plans (including Approval for Tax Deductibility (162(m))
ISS renamed and reorganized its policy formerly known as “Incentive Bonus Plans and Tax Deductibility Proposals” to more clearly differentiate the evaluation framework ISS applies to the various types of cash and equity plan amendment proposals. The policy sets forth a separate evaluation framework applicable to proposals to amend:
- Executive cash, stock, or cash and stock incentive plans that addresses administrative features only or seeks approval for Section 162(m) purposes only.
- Cash incentive plans, including plans presented to shareholders for the first time after the company's IPO and/or proposals that bundle material amendment(s) other than those for Section 162(m) purposes.
- Equity incentive plans, where the proposal requests additional shares and/or the amendments may potentially increase the transfer of shareholder value to employees.
- Equity incentive plans where the plan is being presented to shareholders for the first time after the company's IPO, whether or not additional shares are being requested.
- Equity incentive plans where there is no request for additional shares and the amendments are not deemed to potentially increase the transfer of shareholder value to employees.
Director Pay Programs
As readers know, there has been a surge in lawsuits alleging excessive non-employee director compensation and many companies have responded by seeking shareholder ratification of their non-employee director compensation programs. ISS indicates that it expects to see more non-employee director pay proposals submitted to a shareholder vote. Since ISS had no generally applicable voting policy on non-employee director pay programs, it decided that “a policy framework to evaluate such proposals is necessary.” According to ISS, the new policy incorporates the same qualitative factors that ISS will use under its updated policy to evaluate non-employee director equity plans.
In its new voting guidelines, ISS announces that it will vote on a case-by-case basis on management proposals seeking ratification of non-employee director compensation. If the equity plan under which non-employee director grants are made is on the ballot, ISS will evaluate whether or not it warrants support in general, and perform an assessment of the following qualitative factors:
- Equity award vesting schedules;
- The mix of cash and equity-based compensation;
- The availability of retirement benefits or perquisites;
- The quality of disclosure surrounding director compensation.
- Director stock ownership guidelines and holding requirements;
- Meaningful limits on director compensation;
- The presence of problematic pay practices relating to director compensation; and
- The relative magnitude of director compensation as compared to companies of a similar profile.
For 2017, ISS adds specifically highlights option repricing and liberal change in control vesting provisions as among the “egregious” plan features that will affect its evaluation.
Most companies’ director stock plans set aside a relatively small number of shares. However, when combined with the company’s employee or executive stock compensation plans, these plans can occasionally exceed the plan cost or burn rate benchmark. Currently, ISS would only recommend a vote for a plan that exceeds the plan cost or burn rate benchmarks if all of the five qualitative factors listed above were met and disclosed in the proxy statement. In 2017, ISS will recommend a vote for a plan that exceeds the plan cost or burn rate benchmarks on a case-by-case, taking into consideration all of the factors noted above, including the last three.