Earlier this week, I posted on the ISS FAQs on Equity Compensation Plans. Today, we discuss the ISS U.S. Compensation Policies, FAQs, Updated December 20, 2018. New or changed information in these general compensation FAQs included the following:
Use of TSR. Regarding ISS’ use of TSR in its quantitative screen, the FAQs declare that “ISS does not endorse or prefer the use of TSR or any specific metric in executive incentive programs,” as it “believes that the board and compensation committee are generally best qualified to determine the incentive plan metrics that will encourage executive decision-making that promotes long-term shareholder value creation.”
Problematic Practices. ISS again lists the problematic practices that are “most likely” result in adverse vote recommendations, which include:
- Repricing or replacing of underwater stock options/SARS without prior shareholder approval (including cash buyouts and voluntary surrender of underwater options);
- Extraordinary perquisites or tax gross-ups;
- New or materially amended agreements that provide for:
- Excessive termination or CIC severance payments (generally exceeding 3 times base salary and average/target/most recent bonus);
- CIC severance payments without involuntary job loss or substantial diminution of duties (“single” or “modified single” triggers) or in connection with a problematic Good Reason definition;
- CIC excise tax gross-up entitlements (including “modified” gross-ups);
- Multi-year guaranteed awards that are not at risk due to rigorous performance conditions;
- Liberal CIC definition combined with any single-trigger CIC benefits;
- The vague “Any other provision or practice deemed to be egregious and present a significant risk to investors.”
“Good Reason” Termination Definitions. ISS adds to its list of problematic practices, “Good Reason” termination definitions that present windfall risks, such as definitions triggered by potential performance failures. The FAQs state that companies should limit change-in-control severance payable in connection with a “Good Reason” termination to circumstances that are reasonably viewed as an adverse constructive termination, such as employer actions that result in a material negative change to the executive’s title/role, function or compensation. ISS considers as problematic definitions that are triggered by circumstances reflecting potential performance failures, such as a company bankruptcy or delisting.
“Front-Loaded” Equity Awards. ISS states that it is unlikely to support equity grants that cover more than four years (i.e., the grant year plus three future years), because such awards limit the board’s ability to meaningfully adjust future pay opportunities in the event of unforeseen events or changes in either performance or strategic focus. ISS will more closely scrutinize pay-for-performance considerations, including completeness of disclosure, emphasis on transparent and rigorous performance criteria, and stringent vesting provisions that limit windfall risk. In situations where the company commits not to grant additional awards over the covered period, the company should make that commitment explicit and firm.
Use of EVA. Readers may recall that two years ago, ISS announced that it would be featuring Economic Value Added (EVA) measures in its research reports. The FAQs confirm that ISS will continue to use GAAP/accounting performance measures in it Financial Performance Assessment screen. ISS indicates that it will display EVA measures in its research reports on a “phased-in basis over the 2019 proxy season,” although not as part of the quantitative pay-for-performance screen, and will continue to explore the potential for future use of EVA measures.
Excessive Non-Employee Director (“NED”) Pay. ISS had also announced a policy to potentially issue adverse vote recommendations for board members responsible for approving/setting a recurring pattern of “excessive” NED pay without a compelling rationale. Following additional investor feedback, ISS updated the methodology to identify NED pay outliers and, in consideration of the methodology change, ISS announced that it will not issue adverse recommendations under this policy until meetings occurring on or after February 1, 2020 (i.e., for companies where ISS has identified excessive NED pay without compelling rationale in both 2019 and 2020).