Prior to the holidays, the proxy advisory firm Institutional Shareholder Services (ISS) released updated Frequently Asked Questions (FAQ) on its policies on U.S. Compensation as well as U.S. Equity Compensation Plans. The updated guidance is effective for annual shareholder meetings occurring on or after February 1, 2019, which means that most calendar year filers will want to quickly get up to speed on these changes. The key updates are detailed below.
Updates to the U.S. Compensation Policies FAQ
ISS issues FAQs to help practitioners navigate the application of the proxy advisory firm’s Pay-for-Performance analyses as well as its general vote recommendation guidelines. The policies are updated each year, with additional guidance issued via the FAQs. The key updates to the U.S. Compensation Policies guidance for 2019 are as follows:
- Non-employee director pay – Beginning with annual shareholder meetings occurring on or after February 1, 2019, ISS will issue adverse vote recommendations for board members responsible for approving/setting non-employee director pay when ISS identifies a recurring pattern (i.e., two or more consecutive years) of excessive pay without a compelling rationale. ISS will consider pay excessive if it is above the top 2-3 percent of comparable directors. For purposes of this analysis, directors will be compared to other similarly situated directors (i.e., those serving in the same capacity/roles, such as committee chair, etc.) within the same industry and index grouping (i.e., S&P 500, Russell 3000, etc.).
- “Mega-Grants” – ISS is unlikely to support large equity awards intended to cover multiple years (i.e., a “mega-grant”) if the grant is intended to cover more than four years (grant year plus three future years). No adjustments will be made (i.e., annualizing the award) when incorporating the award into the Pay-for-Performance analysis, which can result in a negative Say-on-Pay recommendation if ISS deems the size of the CEO’s total compensation package to be unwarranted in light of company performance.
- Changes to compensation programs on account of the elimination of the “performance-based exception” to the deduction limitations under Internal Revenue Code (IRC) section 162(m), such as shifts in compensation program design away from performance-based compensation in favor of discretionary or fixed pay elements, will be viewed negatively.
- Quantitative Pay-for-Performance Analysis – There are no substantive changes to the quantitative component of the Pay-for-Performance Analysis for 2019.
Updates to the U.S. Equity Compensation Plans FAQ
When a public company within its purview puts an equity plan to a shareholder vote (usually due to a request for additional share authorization, an equity plan design change, or the adoption of a new equity plan), ISS conducts its Equity Plan Scorecard (EPSC) analysis to formulate its recommendation for the shareholder vote. The EPSC analysis focuses on the plan cost, plan features, and historic grant practices of the company. The EPSC analysis is periodically updated, with guidance for any changes issued via the FAQs. The key updates to the U.S. Equity Compensation Plan guidance for 2019 are as follows:
- Changes to the EPSC analysis – Effective for shareholder meetings on or after February 1, 2019, the following components of the EPSC analysis have been updated:
- Change in Control (CIC) vesting – Previously, under the Plan Features component of the EPSC analysis, points were awarded based on the type of accelerated vesting provided for on a CIC. Following the change, points for this component will now be awarded based on the quality of the disclosure surrounding CIC vesting provisions, rather than the actual vesting treatment of the award.
- Excessively dilutive equity plans – ISS will now consider an excessively dilutive equity compensation plan to be an overriding factor necessitating a negative recommendation, regardless of the company’s overall EPSC score. A plan will be considered excessively dilutive if it is estimated to dilute shareholders’ holdings by more than 20 percent-25 percent (depending on whether the company is in the S&P 500 or Russell 3000 indices). Note, this factor will not apply to non-Russell 3000 companies or companies considered to be “special cases” by ISS.
- IRC section 162(m) provisions – ISS will view plan changes removing references to section 162(m) qualification as administrative/neutral and by itself will not trigger review under the EPSC analysis. However, removal of provisions considered to be good governance best practices may be viewed negatively as part of a plan amendment evaluation.
Updates to the 2019 Americas Proxy Voting Guidelines
In addition to Compensation and Equity Compensation specific guidelines, ISS also issues more general guidance for board vote recommendations. Key among the changes for 2019 is a provision that ISS will recommend a vote against (or a withhold) the chair of the nominating committee (or other directors on a case-by-case basis) at companies where there are no women on the board. While there are mitigating factors, the specific parameters for this vote recommendation align with previous guidance promoting gender diversity on company boards.
Alvarez & Marsal Says:
It is always best to understand how proxy advisory firms are likely to vote in advance of a shareholder vote. Advanced understanding of the likely recommendation outcomes, in addition to avoiding any surprises, can help companies preemptively address potential shareholder concerns in the proxy Compensation Discussion & Analysis (CD&A). Further, a thorough understanding of the ISS guidelines can help companies design compensation programs and equity plans to maximize the potential for a positive vote recommendation. The Compensation & Benefits team at Alvarez & Marsal has vast experience conducting mock ISS analyses, including the EPSC tests for equity plan proposals, and can you help your company navigate the multitude of factors that can potentially influence the outcome. Additionally, our team has extensive experience with shareholder outreach to determine which proxy advisory firms (if any) hold influence over your key investors. Lastly, our team can assist in the drafting of the CD&A and related disclosures to provide you with a targeted, tailored, and effective compensation disclosure.