On October 15, 2020, Institutional Shareholder Providers, Inc. (“ISS”) revealed preliminary FAQs1 offering common steerage as to how ISS might assess COVID-related govt compensation selections as a part of its common pay-for-performance qualitative analysis for the upcoming proxy season. Based mostly on suggestions obtained by ISS throughout investor roundtables and responses to ISS’ annual coverage survey, the FAQs are meant to tell traders, corporations, and their advisors on COVID-related govt compensation points, and have been launched forward of ISS’ common annual compensation FAQs, that are anticipated to be revealed in December 2020.
The FAQs reinforce the premise that ISS will proceed to scrutinize COVID-related modifications to each short-term and long-term incentive packages, whereas acknowledging that corporations are dealing with extraordinary circumstances within the midst of the pandemic and present financial downturn. Because of this, ISS might view COVID-related modifications to be cheap as long as the enterprise justifications and rationale are clearly disclosed, and the ensuing pay outcomes seem cheap. As well as, the FAQs verify that if ISS’ quantitative display leads to an elevated concern of a pay-for-performance disconnect, ISS will proceed to conduct a extra in-depth qualitative evaluation of an organization’s compensation packages and pay practices. Firms which have modified or adjusted govt pay packages and practices ought to start the proxy planning course of now, with a concentrate on getting ready clear and sturdy disclosure of the rationale, impression, magnitude, phrases, and circumstances of such modifications.
Beneath is a abstract of the preliminary FAQs in addition to compensation and governance-related takeaways from latest ISS and Glass Lewis2 updates.
COVID-Associated Modifications to Bonus/Annual Incentive Applications
ISS anticipates that many corporations will make changes to bonus/annual incentive packages, together with modifications to metrics, efficiency targets, and measurement durations. Different corporations might droop their bonus packages and make one-time discretionary awards as an alternative. Every of those actions would probably be thought-about problematic pay practices underneath regular circumstances, however ISS might decide such actions to be supportable as long as corporations absolutely and clearly disclose the justifications and rationale, and the ensuing outcomes seem cheap. Key disclosure gadgets that ISS and traders can be looking out for embrace:
Particular challenges ensuing from the pandemic and the way these challenges rendered the unique program design out of date or the unique efficiency targets not possible to realize. Disclosure ought to deal with how modifications aren’t reflective of poor administration efficiency.
Firms making mid-year modifications or one-time awards ought to clarify why the method was taken, different approaches thought-about, and the way such actions additional shareholder pursuits.
Discretionary awards ought to have some performance-based component, and firms ought to talk about the underlying standards for such awards. Generic descriptions needs to be averted (e.g., “sturdy management throughout difficult occasions”).
Firms ought to talk about how payouts appropriately replicate govt and firm efficiency, and make clear or estimate how the payouts examine with what would have been paid underneath the unique program design. Above-target payouts underneath revised packages can be intently scrutinized.
If monetary or operational targets are lowered under the prior yr’s efficiency ranges, dialogue of the pandemic’s impression on funds or operations can be anticipated, together with dialogue of how the compensation committee thought-about corresponding payout alternatives (significantly if such payout alternatives aren’t commensurately decreased).
If the next yr’s bonus program design has modified, ISS encourages disclosure of optimistic modifications, which can be a mitigating think about ISS’ qualitative analysis.
As well as, ISS might give some credit score to short-term wage reductions which lower complete pay total, however such reductions can be thought-about extra significant if goal incentive award alternatives are decreased in a corresponding method.
COVID-Associated Modifications to Lengthy-Time period Incentive Applications
Per ISS’ and Glass Lewis’ earlier steerage, ISS typically will not be supportive of modifications to in-flight long-term incentive awards that cowl multi-year efficiency durations (e.g., fiscal 2018-2020 or fiscal 2019-2021). As ISS views these packages as designed to easy efficiency over a long-term interval, ISS believes that such packages shouldn’t be altered after the beginning of a efficiency cycle resulting from “short-term market shocks.” Thus, any modifications to in-flight long-term awards will typically be seen negatively, significantly for corporations which have a quantitative pay-for-performance disconnect.
For long-term award cycles that started in fiscal 2020, ISS mentioned drastic modifications needs to be restricted to these corporations the place the underlying enterprise technique has basically modified. ISS has indicated it could be extra receptive to modest or incremental modifications, resembling pivoting to relative or qualitative metrics that could be extra cheap in mild of unsure long-term forecasting. Nevertheless, extra vital modifications, resembling a shift to predominantly time-vesting fairness or shorter measurement durations, will proceed to be seen negatively.
COVID-Associated Retention/One-Time/Substitute Awards
ISS will proceed to evaluate retention, one-time, or substitute awards with skepticism, however clear and fulsome disclosure of the rationale for the award, together with the magnitude and construction of the award, will assist mitigate ISS and investor concern. One-time award greatest practices embrace:
Demonstrating that the grant of such awards is an remoted apply—and never a substitute for forfeited awards as a result of failure to fulfill efficiency standards.
Making certain the awards are of cheap magnitude.
Attaching sturdy performance-based, long-term vesting circumstances which are clearly linked to the underlying issues the awards are meant to handle.
Together with shareholder-friendly guardrails to keep away from windfalls, together with limits on termination-related vesting.
Describing the particular points driving the choice to grant the awards, and the way the awards additional traders’ pursuits.
Avoiding boilerplate disclosure concerning “retention issues.”
Clear rationalization as to how such awards don’t insulate executives from decrease pay, if the awards are granted in consideration of forfeited awards, for equity concerns, or lowered realizable pay.
COVID-Associated Modifications to ISS’ Responsiveness Coverage
Firms receiving lower than 70% assist on their advisory say-on-vote proposals will proceed to be topic to ISS’ responsiveness coverage, which examines three components:
Disclosure of shareholder engagement efforts.
Disclosure of particular suggestions acquired from dissenting shareholders.
Any actions or modifications made to compensation packages and practices to handle shareholders’ issues.
Nevertheless, ISS has acknowledged that corporations could also be unable to implement modifications to pay packages and practices in response to shareholder issues amidst a pandemic, and expects particular disclosure as to how the pandemic has impeded the corporate’s potential to answer such issues. Moreover, if modifications are delayed, or don’t absolutely deal with shareholder suggestions, the corporate ought to disclose a longer-term plan on the way it intends to handle shareholder issues.
No Modifications to ISS’ Fairness Plan Scorecard (EPSC), Problematic Pay Practices (PPP), or Choice Repricing Insurance policies
ISS notes that there are not any COVID-related modifications to its EPSC, PPP or choice repricing insurance policies. For annual conferences held on or after February 1, 2021, nonetheless, the passing EPSC rating for S&P 500 corporations has elevated to 57 factors (up from 55 factors), and the passing rating for Russell 3000 corporations has elevated to 55 factors (up from 53 factors). For all different corporations, the passing rating stays 53 factors. ISS will proceed to oppose choice repricings which happen inside one yr following a drop in an organization’s inventory value. Moreover, if an choice repricing is undertaken with out prior shareholder approval, ISS might suggest votes towards members of the compensation committee who permitted the repricing.
Key Compensation Takeaways
Whereas ISS seems to be understanding of COVID-related modifications in pay packages and practices, together with using discretion and cheap changes to short- and long-term incentive packages, corporations needs to be ready to obviously and absolutely describe the rationale behind such modifications to garner ISS and investor assist.
Typically, ISS and shareholders could also be extra forgiving of modifications to short-term incentive packages, whereas changes to long-term incentive packages can be scrutinized extra intently.
Glass Lewis warns in earlier steerage, “making an attempt to make executives complete at even additional expense to shareholders and different staff is a certainty for proposals to be rejected and boards to get thrown out.” If pay and efficiency are misaligned, corporations ought to anticipate heightened scrutiny from ISS and Glass Lewis as to the reasonableness of compensation modifications and outcomes. Compensation modifications and outcomes needs to be constant and in proportion to the impression on shareholder pursuits.
Firms within the S&P 500 and Russell 3000 in search of shareholder approval of an fairness plan ought to put together for the next EPSC rating to acquire ISS’ suggestion for an fairness plan proposal.
We count on ISS to publish a abstract of its ultimate coverage updates in November and its detailed FAQs in mid-December.
Launch of U.S. Variety and Governance QualityScore Indices; ISS Foreshadows Benchmark Voting Coverage Modifications
On October 20, 2020, ISS’ accountable funding arm introduced the launch of two investable fairness indices.3 The ISS ESG U.S. Variety Index selects corporations with boards and named govt officers composed of people demonstrating broad racial, ethnic and gender illustration, and the ISS ESG Governance QualityScore Index is a set of sector-neutral indices of well-governed corporations and accountable market individuals primarily based on their ISS ESG Governance QualityScore in addition to ISS assessments.
The launch of those indices is in keeping with ISS’ concentrate on range and ESG issues. ISS proposes revisions to its benchmark voting coverage to additional board range and board oversight of fabric environmental and social dangers.4 Starting in 2022, for corporations the place there are not any recognized racial or ethnically-diverse board members, ISS proposes to suggest voting towards the chair of the nominating committee (or different related administrators on a case-by-case foundation) for corporations within the Russell 3000 and S&P 1500. As well as, ISS has proposed that vital danger oversight failures associated to environmental and social issues might, on a case-by-case foundation, set off vote suggestions towards board members. ISS’ ultimate benchmark voting coverage can be revealed later this yr.
1 ISS U.S. Compensation Insurance policies and the COVID-19 Pandemic Continuously Requested Questions (October 15, 2020), view right here.
2 Every thing in Governance is Affected by the Coronavirus Pandemic. That is Glass Lewis’ Strategy (March 2020), view right here.
3 First-of-its-Type Variety Index to Combine Ethnicity Alongside Gender for U.S. Firm Administrators and Executives (October 20, 2020), view right here.
4 Proposed ISS Benchmark Coverage Modifications for 2021 (October 14, 2020), view right here.
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