Institutional Shareholder Services (ISS) recently released the results of its annual policy survey, which captures the views of investors and issuers and plays an important role in helping ISS formulate voting policy changes for the coming year. (For more on this year’s survey, see “ISS Launches 2014 Policy Survey,” Executive Pay Matters, August 2, 2013.)
Two headlines emerge from this year’s survey:
- There are no material pay-related changes (despite a potential shift in equity plan policies in the future).
- There’s the potential for greater scrutiny of directors.
In contrast to last year’s survey, which was heavily focused on compensation-related questions, this year’s survey had no questions directly related to say on pay. Instead the focus this year was on the criteria that ISS might use to evaluate directors and their responsiveness to nonbinding proposals, and on how ISS might evaluate equity compensation plans in the future.
While the results can signal potential ISS policy changes, they are also helpful in providing insights into investor views and the issues companies may face in the next proxy season. The investor views can serve as useful planning points as companies continue their shareholder outreach for the 2014 proxy season. We take a look at the key survey results below.
EQUITY PLAN EVALUATIONS
From the “be careful what you wish for” department, ISS signaled that there might be a shift in its equity plan evaluation methodology on the horizon. Specifically, the proxy advisor is considering a more holistic approach. The policy survey asked which factors would be most important under such a methodology. Three-quarters of the participating investors responded that performance conditions on awards are “very significant,” followed closely by plan cost (i.e., shareholder value transfer) and other plan features (e.g., repricing). Plan administration (e.g., burn rate) was of slightly lesser importance, rated “somewhat significant” by 57% of the responding investors. Conversely, issuers signaled that ISS should focus primarily on other plan features and plan administration, though their views weren’t as strong as those of investors.
ISS policy implications: As noted in our August 2 blog post when the 2014 policy survey was launched, a broader, more holistic approach to equity plan evaluations could be a welcome change from the strict application of the ISS Shareholder Value Transfer (i.e., equity plan cost) test and the resulting allowable cap. However, moving away from the more formulaic analysis might make it more difficult for companies to forecast potential ISS vote recommendations, depending on how the revised policy shakes out. Should ISS ultimately decide to update the equity plan evaluation methodology, we do not expect a formal update before the 2015 proxy season, although ISS may begin phasing in this approach sooner.
DIRECTORS IN THE SPOTLIGHT
Directors took center stage in this year’s policy survey. Questions relating to responsiveness, tenure and company performance, among others, were highlighted. In an indirect nod to say on pay, ISS asked for views on board responsiveness to nonbinding shareholder mandates. Not surprisingly, disagreement abounds on this issue, as 92% of the responding issuers believe boards should be free to exercise discretion (in the best interests the company) in response to such mandates. Conversely, investor support for use of board discretion, implementation of a specific action or “it depends on the circumstances” all fell just below majority level.
ISS policy implications: If ISS increases its focus on board responsiveness, it’s clear that boards will need to consider vote mandates as part of their shareholder outreach preparations. ISS may interpret these investor views as a minimum expectation that companies must address when material votes against management recommendations take place.
In a somewhat rare case of solidarity, both investors and issuers agreed that a director’s service on other public company boards should be strongly considered as part of the performance assessment. There was strong agreement that positive aspects such as breadth of experience and relevant expertise were important factors for consideration. There was less agreement on the negative aspects, such as governance concerns, among survey responses. Investors and issuers also agreed that company performance in the form of relative total shareholder return (TSR) and various financial metrics should be considered when evaluating directors, typically over a three- to five-year period.
ISS policy implications: Do the shared views of investors and issuers on this issue open the door for ISS to scrutinize directors based on say-on-pay votes and pay-for-performance issues at other boards that a given director sits on? Separately, while ISS currently considers relative TSR performance as part of director evaluations, the clear survey results may lead to inclusion of other financial metrics in the future.
ISS is targeting release of its draft policy updates in late October, which will be immediately followed by a 30-day comment period. Final policies are expected to be released in November or early December, and updates to the policies will be implemented as of February 1, 2014.
For the ISS description of the survey results, click here.
Jim Kroll is a director in New York who leads the firm’s executive compensation governance advisory practice and Brian Myers is an executive compensation consultant in the firm’s Arlington, Virginia office. Email firstname.lastname@example.org, email@example.com or firstname.lastname@example.org.