Spotlight on Pay For Performance Intensifies as ISS Releases New Evaluation Methodology for 2012 Proxy Season

by Sheppard Mullin Richter & Hampton LLP
Contact

The arrival of a new year means that another proxy season is not that far off.  A highlight of the 2011 proxy season was that it marked the first year in which shareholder advisory votes on executive compensation ("Say on Pay") were conducted in accordance with the Dodd-Frank Act.

While it is true that the vast majority of companies received favorable Say on Pay votes in 2011, even those companies who garnered a large percentage of affirmative votes will not want to become complacent particularly since most companies opted for annual frequency of Say on Pay votes meaning that they will again be holding Say on Pay votes in 2012.  In this regard, aligning executive pay with company performance appears to increasingly be a major focal point with respect to Say on Pay votes.  Moreover, the Dodd-Frank Act specifically will require companies to disclose and report on the relationship between CEO compensation and the company's performance including stock price changes.  The Securities and Exchange Commission ("SEC") has stated on its website that it expects to propose regulations to implement this statutory requirement in the first half of 2012.  Note though that this disclosure requirement has been the subject of several comment letters to the SEC and there have been efforts to entirely repeal this disclosure requirement (see for example H.R. 1062: Burdensome Data Collection Relief Act).

While the SEC's pay for performance regulations may not be effective in time for the 2012 proxy season, it does not mean that the alignment between executive pay and company performance is not being scrutinized.  In December 2011, Institutional Shareholder Services Inc. ("ISS"), a proxy advisory firm, released a comprehensive white paper ("Evaluating Pay for Performance Alignment") detailing its new pay for performance evaluation processes that will be effective for the 2012 proxy season and which ISS will utilize to evaluate whether or not a company's executive compensation practices are in proper alignment with its performance.  In its white paper, ISS noted that 94% of the institutional respondents to one of its policy surveys indicated that pay for performance is a critical/important consideration with respect to their Say on Pay vote determination.

ISS Evaluating Pay for Performance Alignment White Paper

The ISS white paper is detailed and contains a fair amount of complexity.  The discussion below is necessarily just a brief overview and the white paper provides much more details and rationale for the ISS methodology.  In a nutshell, the ISS methodology focuses on CEO pay and quantitatively compares it to long term total shareholder return ("TSR").  If the quantitative analysis indicates that there may be misalignment, then ISS will perform an in-depth qualitative review to determine either the likely cause of a perceived long-term disconnect between pay and performance, or factors that mitigate the initial quantitative assessment.  If after these evaluations have been completed, ISS believes that the company's executive compensation pay practices are an outlier then this, in their view, means that shareholders of such company may want to communicate their concern to the company about its pay-setting and could potentially cause ISS to recommend voting against the company's Say on Pay proposal.

In performing its quantitative assessment, ISS looks at the following three measures:

  • Relative Degree of Alignment ("RDA") – Comparison of CEO pay and TSR, relative to an ISS selected peer group, over one and three year periods
  • Multiple of Median – Relative comparison of the CEO's pay to the peer group median pay for the same time periods
  • Pay to TSR Alignment – An absolute comparison of the trends of the CEO's annual pay and the Company's TSR over prior five year period

The ISS generally uses the Company's publicly disclosed compensation data in SEC filings with respect to CEO pay numbers.  The peer comparison group is selected by ISS and generally consists of 14 to 24 companies which are intended to be similar in terms of size, industry and market capitalization over one and three year periods.  The ISS constructs peer groups for all Russell 3000 companies twice per year utilizing Global Industry Classification Standard ("GICS") classifications and revenue/total assets and market value data.

ISS back-tested their pay alignment methodology using historical data.  The white paper states that the three quantitative measures were statistically significant predictors of Say on Pay votes, especially the RDA measure.  The white paper also states that companies whose quantitative assessments indicated that there was high concern for potential misalignment between pay and performance received fewer affirmative Say on Pay votes than companies which ISS determined were low concern companies.

After computing the three quantitative measures, ISS evaluates the results to see if there is a concern that the company's pay for performance practices are not in alignment.  If the quantitative analysis indicates significant misalignment, then ISS will perform a qualitative analysis on some or all of the following:

  • Strength of Performance - Review of the ratio of performance to time based awards along with the overall ratio of performance based compensation to total compensation
  • Company's Peer Group Benchmarking – Review the company's selected peer group to see if the company is benchmarking to larger companies that are resulting in inflated compensation
  • Financial/Operational Metrics – Evaluate the rigor of the company's performance goals upon which the compensatory payouts are based
  • Special Circumstances – Assess any special circumstances (e.g., the hiring of a new CEO in the prior fiscal year) that could distort the quantitative analysis

Summary

Pay for performance will continue to be the mantra of corporate governance advocates and the subject of scrutiny by proxy advisory firms and institutional investors.  Therefore, among other things, companies may wish to examine the ISS white paper and assess how their pay for performance practices would be measured under the white paper's methodology.

If you have any questions regarding this information, please contact Greg Schick at (415) 774-2988.

 

Written by:

Sheppard Mullin Richter & Hampton LLP
Contact
more
less

Sheppard Mullin Richter & Hampton LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.