On November 21, 2013, Institutional Shareholder Services (ISS) released its final 2014 voting policy updates . Consistent with the draft policies previously released, the key changes relate to ISS's quantitative CEO pay-for-performance analysis and its evaluation of board responsiveness to majority-supported shareholder proposals. Other changes were to modify the factors considered in evaluating shareholder proposals requesting details on a company's lobbying activities and to establish a policy regarding proposals requesting that a company conduct an assessment of the human rights risks in its supply chain or operations or publish a report on its risk assessment process. These new policies will be effective for companies holding their annual shareholder meetings on or after February 1, 2014. ISS anticipates posting FAQs in December 2013 covering any open questions relating to the revised policies.
QUANTITATIVE ANALYSIS FOR CEO PAY-FOR-PERFORMANCE
ISS uses a number of pay-for-performance metrics to evaluate the alignment between executive compensation and performance. Among them is the quantitative relative degree of alignment (RDA) measurement, which compares a company's total shareholder return (TSR) rank with its CEO total pay rank within the company's peer group over the previous one- and three-year periods (weighted at 40 percent and 60 percent, respectively). If the RDA and the absolute alignment test, another quantitative measure, indicate CEO pay-shareholder return misalignment, ISS then looks to a factor-based qualitative analysis to finalize its position on a company's pay-for-performance policies.
The final 2014 voting policy does away with the previously used prior one-year period comparison. Accordingly, ISS will limit the analysis to the preceding three-year period (or shorter period if pay and performance data are not available for all three years), weighting each of the three years equally. ISS credits the revision to feedback from investors and other constituents and its view that a single three-year measurement period will smooth the impact of periods of market volatility and the timing of equity award grants, and provide a more accurate assessment of long-term pay and performance alignment.
According to the proposed policy updates released in late October, ISS does not expect the revision to change materially the number of companies that raise concerns under the RDA test, noting that back-testing indicates that less than 7 percent of U.S. companies would show significant differences in RDA test results as a result of the change.
ISS also modified the substantial changes it set forth in its 2013 policy update regarding board responsiveness to majority-supported shareholder proposals. In its 2013 policies, ISS made three key changes to its approach in this area:
- Starting in 2014, ISS will initiate a review of boards failing to act on shareholder proposals that receive one year of a majority of votes cast, rather than the prior, less aggressive, triggers of either two years of a majority of votes cast in a three-year period, or one year of a majority of shares outstanding;
- Adopted a case-by-case approach, including a list of factors for analysts to consider, for assessing whether a board acted appropriately on a shareholder proposal; and
- Provided analysts with broader discretion when determining which directors to hold accountable if the degree of responsiveness is found to be insufficient.
The 2014 update substantially implements the 2013 policies with a couple of changes. First, the 2014 policy softens the 2013 revision recommending a vote against directors, committee members or the entire board for a failure to act on a majority-supported proposal by instead assessing recommendation of a vote against on a case-by-case basis. Further, ISS will now also consider "the board's rationale as provided in the proxy statement" as one of the factors in its case-by-case analysis of whether the board failed to act appropriately. This addition effectively introduces a "comply or explain" framework. ISS predicted in the proposed policy updates that this updated case-by-case evaluation could affect approximately 80 U.S. companies in 2014.
LOBBYING AND HUMAN RIGHTS
Finally, the 2014 update addresses ISS's analysis of two specific subject-matter proposals: (1) requests for information on lobbying activities and (2) requests for assessments of or reports on human rights risks. The lobbying revision slightly updates the factors to be considered in the case-by-case analysis of lobbying disclosure proposals. New for 2014, the human rights risk policy recommends a factor-supported, case-by-case vote on human rights risk assessment or reporting proposals.
NEW BENCHMARK POLICY CONSULTATION PERIOD
In conjunction with the release of the 2014 policy updates, ISS also opened a first-ever policy consultation period, through which ISS is inviting comment on various ISS policies for consideration of long-term policy adjustments. Through this consultation period, ISS explains, it is "seeking market feedback with the goal of shifting [its] process from a seasonal to a continual focus on policy development." The following topics evaluated in ISS's U.S. company analysis are open for comment: director tenure, director independence, independent chair shareholder proposals, auditor ratification and equity-based compensation plans. The consultation period closes in February 2014. Further information on the topics open for consultation and the commenting process may be accessed here.
The 2014 updates generally seek to afford companies a broader and more flexible assessment of their pay-for-performance and shareholder proposal practices. The pay-for-performance analysis revisions could result in a more consistent evaluation, avoiding arbitrary swings in a company's rank among its peers. Similarly, companies facing majority-supported shareholder proposals may be able to mitigate an adverse result under the revised qualitative board responsiveness test by carefully evaluating and articulating their rationales for less than full proposal implementation in their proxy statements. Issuers, investors and other constituents should also consider taking advantage of the new opportunity to guide ISS's long-term policy approaches by providing feedback on the topics opened for comment during the consultation period.