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Article | Executive Pay Memo North America

Trick or treat: ISS releases preliminary FAQs 

Governance Advisory Services |Executive Compensation
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By Brian Myers | October 22, 2020

Guidance covers U.S. policies around compensation decisions related to coronavirus (COVID-19)

Institutional Shareholder Services (ISS) released a preliminary version of its annual compensation FAQs (U.S.) with a focus on how its Research team may approach COVID-19-related pay decisions under qualitative reviews. Additionally, a few notable changes around the Equity Plan Scorecard (EPSC) methodology are in store for 2021. The guidance is in part based on input ISS received from investors through roundtables and its annual policy survey. A more comprehensive release will follow in the typical timing of mid-December. ISS cautions that the FAQs are not to be considered guarantees of policy application, as all analyses will be completed on a case-by-case basis. As always, detailed disclosure in the Compensation, Discussion & Analysis (CD&A) will be paramount. Key items are highlighted below:

Qualitative review of compensation-related decisions

  • Temporary salary reductions — While fixed pay components are generally smaller in nature, reductions to base salaries will help mitigate pay-performance concerns to the extent they reduce overall pay. Those that also include a corresponding decrease to target incentive opportunities will be considered even more meaningful.
  • Changes to annual incentive programs — Under normal circumstances, changes to metrics, performance targets, measurement periods and/or suspension of programs would be considered problematic; however, depending on detailed disclosure including rationale and justification, such moves may be viewed as acceptable during COVID-19-related times. Pay outcomes resulting from the changes will be scrutinized for reasonableness.
    • Proxy advisors and investors alike have indicated that additional disclosure will be extremely important when reviewing COVID-19-related decisions.
    • Key items should include, at minimum, challenges to the original program design as a result of the pandemic (making clear that poor management performance was not a factor); clarification of midyear changes versus one-time discretionary awards and why this was done (and how all stakeholders benefit); underlying performance measures of one-time discretionary awards, resulting payouts and how they are reflective of performance (both of the executives and the company, and relative to what would have otherwise been paid under original terms); and any forward-looking decisions made for the 2021 program.
  • Lowered annual incentive performance targets — Targets lowered below prior year actual results may be considered reasonable but will be highly incumbent upon detailed disclosure of the board’s considerations of payout opportunities (e.g., to reduce or not reduce, and why).
  • Changes to in-cycle long-term incentives — Investors strongly believe that long-term incentives should not be adjusted after the beginning of the cycle to respond to temporary market disruptions. Any changes to in-progress cycles will generally be received with a negative view, particularly when pay and performance are not aligned quantitatively.
  • 2020 long-term incentive awards — Generally, it is expected that material changes (e.g., shift to largely time-based from performance-based) will not be made to the most recent awards, unless there have been fundamental changes to the business. Minor alterations may be acceptable, such as changing to relative or qualitative metrics given cloudiness of the long-term picture. Again, any changes should be clearly disclosed in the CD&A.
  • Retention or other one-time awards — Similar to such awards being made in non-COVID-19-related times, clear and detailed disclosure providing rationale for the awards will be extremely important. Such disclosure should not only include award details (e.g., size, structure) but also describe the impact to shareholders. These awards should be strongly performance-based, with clear linkage to the underlying concerns, and should maintain “guardrails” to protect against windfall scenarios.
  • One-time awards replacing forfeited awards — Similar to “normal” times, such actions will generally not be viewed positively. Nonetheless, companies should provide disclosure and rationale, to include discussion that the awards were not simply made to artificially support executive pay levels.
  • Say-on-pay responsiveness — ISS requires companies and boards to demonstrate responsiveness when the prior year’s say-on-pay vote receives support below 70%. Typically, this would include shareholder engagement, disclosure of feedback received during engagement and actions taken to address this feedback. Given COVID-19 issues, if companies are not able to implement changes in a reasonable time, the disclosure should focus on why this is the case and what the long-term plan to implement will be.

Equity Plan Scorecard (EPSC) -related decisions

  • Threshold scoring changes — Though not COVID-19 related, ISS has announced pending changes for the vote recommendation scoring thresholds around equity plan proposals. S&P 500 companies will be required to achieve 57 points (up from 55 points); Russell 3000 companies will need to achieve 55 points (up from 53), and all others will remain at 53 points. These changes will be effective for policy year 2021, beginning February 1, 2021.
  • Option repricing — No changes will be made to the current policy, but the FAQs gave emphasis to the point that option repricing is generally not favored when occurring within one year of the market event causing the drop in stock price.

Overall, Willis Towers Watson believes the key takeaways are:

  • Relative to “normal” years, ISS appears more open to considering reasonable adjustments or use of discretion for incentive plan payouts — but there will be no free passes.
  • CD&A disclosure providing a sound rationale will be essential to support incentive plan modifications and special awards.
  • Generally speaking, there is a greater openness to annual incentive/bonus “interventions” as opposed to those involving long-term plans.
  • Equity plan share requests will see tighter scrutiny for approval.

ISS is expected to release its final policy updates in November and its annual detailed FAQs document in mid-December.

Author

Governance Team Lead, North America & Director, Executive Compensation (Arlington)

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