5 Pay Practices that Trigger ISS Attention

Because ISS reports and positions on executive pay are widely reviewed and considered by investors, comp managers need to be aware of the principal concerns ISS has, says Lifshey, managing director at the New York office of Pearl Meyer & Partners. She offered her executive pay tips at a recent webinar sponsored by BLR® and HR Hero®.

Problematic Pay Practices

Here are five pay practices that most concern ISS, says Lifshey.

1. Repricing/replacing underwater stock options without shareholder approval
2. Excessive perquisites or tax gross-ups
3. New or extended agreements that provide for:

• CIC (Change In Control) payments greater than three times base plus bonus
• Single-trigger CIC payments
• CIC payments with excise tax gross-ups

4. Incentives that may motivate excessive risk-taking:

• Multiyear guaranteed bonuses
• Single or common performance metric used for short- and long-term incentive plans
• Lucrative severance packages
• High pay opportunities relative to industry peers
• Disproportionate supplemental pensions
• Mega annual equity grants with unlimited upside and no downside risk

5. Options backdating

ISS’s quantitative and qualitative reviews, based on updated methodology for 2012, are the key analysis of pay and performance alignment, says Lifshey.

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Pay-for-Performance Quantitative review:

• Relative alignment to peer CEO pay and performance
• CEO pay multiple of peer median
• Absolute alignment between CEO pay and company TSR (Total Shareholder Return) over 5 years

Pay-for-Performance Qualitative review:

• Ratio of performance- to time-based equity awards
• Ratio of performance-based compensation to overall compensation
• Completeness of disclosure and rigor of performance goals
• Peer group benchmarking practices
• Actual results of financial/operational metrics
• Special circumstances related to, for example, a new CEO in the prior fiscal year or anomalous equity grant practices

Board Communications and Responsiveness

• Failure to respond to majority-supported shareholder proposals on executive pay topics
• Failure to adequately respond to the company’s previous say on pay proposal that received the support of less than 70% of votes cast

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ISS Potential Policy Changes

Pay-for-Performance
The current test involves:

• Peer Group: 14-24 companies that are selected based on size using market cap, revenue (or assets for financial firms), and GICS industry group
• Relative Alignment: CEO pay and TSR evaluated on a relative basis compared to a company’s peer group over 1 and 3 years, weighted 40% and 60%, respectively
• The weighted CEO relative pay rank compared to company’s weighted TSR rank
• The multiple of CEO total pay to the peer group median is quantified
• Absolute Alignment: CEO pay alignment will also be evaluated on an absolute basis against TSR over a 5-year period. Also checks the difference between the trend in annual pay changes and the trend in annualized TSR during the period.

In response to criticism, ISS is considering comparing “realizable” pay against performance but questions remain:

• What is the appropriate definition for “realizable” pay?
• Black-Scholes value of options at the end of the period or intrinsic value?
• Inclusion of only the performance plan cycles completed within the period or estimate of the value of “in progress” performance cycles using target?
• How should “realizable” pay be used—as part of ISS’s quantitative and/or qualitative review?
• ISS currently may consider realizable pay as part of its qualitative review.
• Should “realizable” pay be compared with performance on an absolute and/or relative basis?
• Potential for absolute comparison of realizable pay with grant value in the first year of implementation
• If ISS follows a two-step implementation process, they may wait to add peer group comparisons of realizable value in the second year.
• What is the appropriate time period for the “realizable” pay-for-performance assessment?
• The time period is likely to match ISS’s current 3-year TSR performance analyses.

ISS is also considering ways to incorporate the company’s disclosed peer group through an amalgamated approach.

• Start with the company’s peer group.
• Delete companies that do not match ISS’s criteria for GICS code and company size.
• Replace those peers with ones that ISS selects using their

methodology/criteria.

In tomorrow’s Advisor, some changes to Glass Lewis protocols, plus key considerations in designing executive pay, and an introduction to the comp and benefits manager’s trusted guide, Employee Compensation in [Your State].