Institutional Shareholder Services (ISS) released its 2012 policy updates on Nov. 17, 2011. These updates apply to shareholder meetings that will be held on or after Feb. 1, 2012.
ISS is the largest and most influential of the proxy advisory firms and it currently exercises a broad influence over institutional investors. While studies present varied conclusions, one study found that a negative ISS recommendation in uncontested director elections correlates to a 20.3 percent drop in favorable votes by shareholders. Other studies have found that ISS is able to influence shareholder votes by 6 percent to 19 percent. More recently, one study found that many institutional investors do not blindly follow ISS recommendations but do evaluate and consider them, and, according to this study, ISS swings only 6 percent to 10 percent of the vote in uncontested director elections. Nevertheless, ISS is still a powerful voice and companies should consider its policy updates when preparing for the upcoming proxy season. If there is a possibility of any "Against" recommendations, particularly as a result of ISS's more holistic review of problematic executive compensation practices, companies should start a dialogue with ISS to determine how to avoid an "Against" recommendation. Also, immediately after ISS issues its report on a company's proposals, the company should review it for factual errors and request any necessary corrections.
Policies on Executive Compensation
Executive compensation remains a hot button issue for many shareholders for the 2012 proxy season.
Board Response to Frequency of Advisory Vote on Pay Results
Under this new policy, ISS will recommend a vote of "Against" or "Withhold" from directors if the board implements a say-on-pay schedule that is less frequent than the frequency most recently preferred by shareholders. New director nominees will be evaluated on a "case-by-case" basis. Under the Dodd-Frank, the SEC not only required U.S. corporate issuers to present shareholders with an advisory say-on-pay vote (which ISS refers to as the Management Say-on-Pay proposal or MSOP) but also required them to provide shareholders with an advisory vote to select the preferred frequency of MSOP votes at the first annual shareholder meeting occurring on or after Jan. 21, 2011, and at least every six years thereafter. The resolution allowed shareholders to vote for a frequency of every year, every two years or every three years, or to abstain.
While the MSOP frequency vote is non-binding on the board, it is a means for shareholders to express their preference. ISS believes majority support for a particular frequency should be viewed as a mandate to a board and that boards should be responsive and implement the option preferred by shareholders, regardless of whether it is the same option recommended by the board. Where no particular frequency received a majority of votes cast, ISS will take a "case-by-case" approach to evaluating the issuer's say-on-pay schedule and recommending votes on director candidates.
ISS refined their methodology for determining pay-for-performance alignment after a survey of institutional investors found that those investors consider pay relative to peers and pay increases in light of company performance as very relevant to the evaluation. This methodology has quantitative and qualitative aspects. Since this methodology is very detailed, ISS provided additional guidance on the 2012 Pay-for-Performance methodology in a white paper published on Dec. 20, 2011. Under the new methodology, companies in the Russell 3000 index will be analyzed as follows:
1. Peer Group/Relative Alignment:
- The degree of alignment between the company's total shareholder returns (TSR) rank and the CEO's total pay rank within a peer group, as measured over one-year and three-year periods ending on the last day of the month closest to the company's fiscal-year end (weighted 40 percent/60 percent); and
- The multiple of the CEO's total pay relative to the peer group median, calculated by dividing the company's one-year CEO pay by the median pay for the peer group.
2. Absolute alignment: The absolute alignment between the trend in CEO pay and company TSR over the prior five fiscal years — i.e., the difference between the trend in annual pay changes and the trend in annualized TSR during the period.
If ISS believes that the above quantitative analysis demonstrates significant unsatisfactory long-term pay-for-performance alignment or, in the case of non-Russell 3000 index companies, ISS believes misaligned pay and performance are otherwise suggested, it will analyze the following qualitative factors to determine how various pay elements may work to encourage or to undermine long-term value creation and alignment with shareholder interests:
- The ratio of performance-based to time-based equity awards;
- The ratio of performance-based compensation to overall compensation;
- The completeness of disclosure and rigor of performance goals;
- The company's peer group benchmarking practices;
- Actual results of financial/operational metrics, such as growth in revenue, profit, cash flow, etc., both absolute and relative to peers;
- Special circumstances related to, for example, a new CEO in the prior fiscal year or anomalous equity grant practices (e.g., biennial awards); and
- Any other factors ISS deems relevant.
ISS has said that the peer group it will use is generally comprised of 14-24 companies that are selected using market cap, revenue (or assets for financial firms) and Global Industry Classification Standard (GICS) industry group, via a process designed to select peers that are closest to the subject company, and where the subject company is close to median in revenue/asset size. Peer groups for all Russell 3000 companies are constructed twice per year, based on data provided by an independent source as of Dec. 1 and June 1 for annual revenues, assets and market capitalization. ISS chooses companies in the same two-digit GICS universe as the subject company, each with between 0.45x and 2.1x the subject's company annual revenues and with market capitalizations of between 0.2x and 5x the subject company. Then ISS chooses companies from the above comparison universe that are in the subject company's six-digit GICS category (or four- or two-digit category if fewer than 14 companies exist in the six-digit category) to select the industryclose peer group. The goal is achieve a comparison group of at least 14 companies. If the methodology fails to identify at least 14 comparison companies, ISS will relax the revenue (but not market capitalization) parameters in the peer group selection process. Additionally, "super-mega" non-financial companies (about 25 non-financial companies within the Russell 3000 index) that are unique in being among the largest public companies and have very few industry peers close to their size will be compared to one another and any industry-specific performance will be considered in the qualitative review.
For more detailed information about this methodology, please refer to the ISS white paper entitled "Evaluating Pay for Performance Alignment" as it includes an explanation of how the above measures were back-tested and technical information on how the regressions for the absolute alignment test are calculated. The white paper can be found at: http://www.issgovernance.com/sites/default/files/EvaluatingPayForPerformance_20111219.pdf .
Board Response to High Levels of MSOP Opposition
ISS has updated its policy towards the Compensation Committee and the MSOP proposal to take a "case-by-case" approach to making a voting recommendation if the company's previous MSOP proposal received the support of less than 70 percent of the votes cast. ISS will consider the following in making its recommendation:
- The company's response, including:
- Disclosure of engagement efforts with major institutional investors regarding the issues that contributed to the low level of support;
- Specific actions taken to address the issues that contributed to the low level of support; and
- Other recent compensation actions taken by the company;
- Whether the issues raised are recurring or isolated;
- The company's ownership structure; and
- Whether the support level was less than 50 percent, which would warrant the highest degree of responsiveness.
ISS's rationale for the update is the overwhelming desire of shareholders to receive substantive and meaningful disclosure in determining whether the company has taken sufficient actions to address the compensation issues that contributed to the low level of support for the MSOP proposal.
Other Policy Updates
ISS updated its current "case-by-case" approach to recommending a vote on shareholder proposals asking for open or proxy access by expanding the factors examined in the evaluation. Now, ISS will not only look at the ownership threshold proposed in the resolution, but also the maximum proportion of directors that shareholders may nominate each year and the method of determining which nominations should appear on the ballot if multiple shareholders submit nominations. In addition, ISS will evaluate company-specific factors. This policy has also been expanded to cover management proposals on proxy access as well.
Board Accountability – Governance Failures
ISS has updated its current policy to recommend a vote of "Against" or "Withhold" from directors who fail on material governance issues by explicitly including a reference to risk oversight as a factor considered by ISS. This new factor is meant to highlight the boards that have had a material breakdown in risk oversight. ISS cites the recent well-publicized failures of board risk oversight, such as the BP Deepwater Horizon oil spill of 2010 and the scandals surrounding News Corporation's U.K. operations in 2011, as a rationale for including this new factor.
ISS has updated its policy on equity plans submitted for 162(m) shareholder approval. Now, the first time a company presents such a plan, it will be given the full equity plan evaluation. The purpose of this change is to provide shareholders with the opportunity to identify whether any problematic features exist under the proposed plan such that approval solely for Section 162(m) would not benefit shareholders.
ISS has decided to put its long-held policy of "one share-one vote" in writing through a recommendation to vote "Against" proposals to create a new class of common stock unless:
- The company discloses a compelling rationale for the dual-class capital structure, such as:
- The company's auditor has concluded that there is substantial doubt about the company's ability to continue as a going concern; or
- The new class of shares will be transitory;
- The new class is intended for financing purposes with minimal or no dilution to current shareholders in both the short term and long term; and
- The new class is not designed to preserve or increase the voting power of an insider or significant shareholder.
ISS has changed its policy on proposals requesting greater disclosure of a company's political contributions and trade association spending policies and activities from a "caseby- case" approach to recommending a vote "For" such proposals. ISS cites shareholder interest in greater transparency on this issue especially in light of the Citizens United decision by the U.S. Supreme Court.
ISS has expanded and updated its policy on proposals seeking information on a company's lobbying initiatives to include proposals seeking information on a company's lobbying activities generally and to clarify that its policy applies to proposals addressing broader efforts to inform or sway public opinion as well as to formalize political lobbying activities.
Exclusive Venue Management Proposals
ISS will take a "case-by-case" approach to recommending a vote on exclusive venue management proposals. These proposals for shareholder approval of exclusive venue charter provisions were new in 2011 after a court opinion suggested that exclusive venue bylaw provisions adopted solely by action of the board might not be enforceable.
ISS has created new and updated policies on the following environmental issues: hydraulic fracturing, recycling and water issues. ISS believes specific policies are warranted on each of these issues as environmental issues continue to gain attention by shareholders, the SEC and the public at large.
ISS adopted a new policy under which it would take a "case-by-case" approach to recommending a vote on requests for workplace safety reports, including reports on accident risk reduction efforts. This policy was motivated by recent requests by shareholders to have greater transparency and accountability regarding workplace safety after near fatal accidents at oil refineries and the BP Deepwater Horizon incident.
A copy of the 2012 ISS Policy Updates can be found at: http://www.issgovernance.com/files/ISS_2012US_Updates20111117.pdf .
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