ISS Finalizes 2013 Corporate Governance Policy

by King & Spalding

[authors: James P. Cowles*, Atlanta, +1 404 572 3455,, Kenneth A. Raskin, New York, +1 212 556 2162, and Eleanor Banister, Atlanta, +1 404 572 4930,]

On November 16, 2012, Institutional Shareholder Services (ISS) finalized its 2013 U. S. Corporate Governance Policy. The changes in the policy are effective for shareholder meetings held on and after February 1, 2013. The significant changes made to the policy for 2013 that may affect executive pay are summarized below:

Pay-for-Performance Evaluation:
ISS conducts an annual pay-for-performance analysis to identify alignment of CEO pay and performance of the company. The analysis is based on the alignment of the CEO’s total pay within a peer group of 14 to 24 companies. If the analysis indicates significant unsatisfactory long-term pay-for-performance or, in the case of non-Russell 3000 companies, misaligned pay and performance, ISS’ analysis may include other qualitative factors, including the ratio of performance to time-based equity awards and the ratio of performance-based compensation to overall compensation. For 2013, the following revisions have been made to this evaluation:

  • Peer Group - Prior to 2013, the determination of the peer group was based primarily on the company's Global Industry Classification Standard (GICS). In 2013, information from the companies’ self-selected pay benchmarking peer group will be considered when identifying the peer group. The new policy will also include slightly relaxed size requirements and use revenue instead of assets in certain financial companies.

What is GICS ? An industry classification used by the global financial community. The GICS structure consists of 10 sectors, 24 industry groups, 68 industries and 154 sub-industries into which all major public companies have been categorized.

  • Realizable Pay - If the CEO pay analysis indicates significant unsatisfactory long-term pay-for-performance alignment or in the case of non-Russell 3000 companies, misaligned pay and performance, the qualitative factors will include a new factor for large cap companies in 2013–“realizable pay compared to grant date pay.”

    “Realizable pay" is the sum of relevant cash and equity-based grants and awards made during a specified performance period, based on equity award values for actual earned awards, or target values for ongoing awards, calculated using the stock price at the end of the specified performance period. Stock options and SARs will be re-valued using the remaining term, updated assumptions and the Black-Scholes option pricing model. ISS acknowledges that the inclusion of realizable pay in the analysis may mitigate or exacerbate CEO pay-for-performance concerns.

Hedging and Pledging of Company Stock - Beginning in 2013, ISS will consider any and all hedging and significant pledging of company stock by directors and/or executives a failure of risk oversight by the board. In extraordinary circumstances, ISS will advise an “against” or “withhold” vote on individual directors, committee members, or the entire board if the board is considered to have a material failure in risk oversight by allowing directors and/or executives to hedge or significantly pledge company stock.

ISS is concerned that the hedging of company stock could sever the alignment of shareholders’ interests with executive compensation and significant pledging of company stock could result in a negative impact on the stock price. For example, a director or executive may be forced to sell a significant amount of company stock that has been pledged due to a margin call. Additionally, the forced sale of pledged company stock may violate company insider trading policies. Further, the hedge or pledge enables a director or executive to insulate himself or herself from changes in stock value while retaining voting power with respect to the pledged/hedged stock.

In determining the vote recommendation, ISS will consider what policies are in place to prohibit the future pledging of company stock and the magnitude of pledged shares compared to outstanding shares or market value or trading volume.

Board Response to Majority-Supported Shareholder Proposals
ISS will recommend an “against” or “withhold” vote for individual directors, committee members or the entire board of directors (except new nominees) if the board failed to act on a shareholder proposal that received the support of a majority of shares cast (as opposed to shares outstanding) in the previous year (with some transition rules for 2013). Currently, ISS considers whether shareholder proposals received a majority of the shares outstanding in the previous year or a majority of the shares cast in the last year and one of two previous years. In the most recent ISS annual policy survey, 86% of institutional investor respondents indicated that a board should implement shareholder proposals if supported by a majority of the shares cast in the prior year and 47% of the issuer respondents agreed. The policy change will be effective for proposals appearing on ballots in 2013.

Golden Parachute Payments
In making a recommendation regarding a company’s golden parachute compensation, ISS will review all existing change-in-control arrangements with named executive officers and place additional scrutiny on multiple legacy problematic features in change-in-control arrangements. Prior to 2013, only severance packages that had been recently adopted or materially amended were reviewed. ISS identifies the features in change-in-control arrangements that may cause a recommendation for an "against" vote, including single-trigger cash severance; cash severance of more than three times base salary and single-trigger vesting of unvested equity awards.

ISS points out that its recent policy survey results show that the average support of shareholder votes on golden parachute payments was approximately 81%, while support for the underlying transaction averaged above 95%. Additionally, 74% of investor respondents surveyed believed that excessive golden parachute payments are a problem.

Linking Executive Pay to Environmental and Social Criteria
Prior to 2013, ISS generally recommended an “against” vote for proposals to link executive compensation to environmental and social criteria. The new 2013 policy is to review the link of executive compensation to sustainability related factors on a case-by-case basis. The rationale for the change is that companies are increasingly incorporating such non-performance metrics into executive compensation.

ISS plans to issue a list of frequently asked questions providing more guidance on these updated policies in December 2012. If you have any questions about the new ISS policies or if you would like assistance in drafting or amending your executive employment agreements, we would be glad to help.

*Non-lawyer Employee Benefits Consultant

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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