The Advisors' Blog

– Bimal Patel, ISS Governance Institute

Executive compensation is again the top area of focus for governance stakeholders globally, according to results from ISS’ recently concluded voting policy survey for 2013. Investor respondents collectively cite the issue of executive compensation as the top governance topic for the coming year, while issuer respondents also cited executive compensation as their top concern in North America and Europe, and as the second most important topic in both the Asia-Pacific region and in developing markets.

More than 370 total responses were received for this year’s survey of global governance practices. A total of 97 institutional investors responded. Approximately 71 percent of investor respondents were located in the United States, with the remainder divided between U.K., Europe, Canada, and Asia-Pacific. In addition, 273 corporate issuers responded, with 79 percent of them located in the United States and the remainder divided between U.K., Europe, and Canada.

Peer Groups
While ISS’ selection of peer groups for analysis of executive compensation invoked divergent views from investors and issuers, both agree that size matters when selecting peers. Eighty-four percent of investors and 74 percent of issuers indicated that an ISS-selected peer being within a specified size range of the target company (e.g., between 0.5 and 2 times the company’s revenue) is a “very” or “somewhat” relevant factor in selecting peers for a pay-for-performance comparison group.

Both the majority of investors and issuers also agreed that the target company’s size should be near the median of the selected peers (75 percent and 64 percent, respectively); the ISS-selected peer within the same GICS group as one or more of the target company’s published peers (79 percent and 51 percent, respectively); and the ISS-selected peer has chosen the target company as a peer (67 percent and 56 percent, respectively) as “somewhat” relevant or neutral factors.

It appears, however, that the ISS-selected peer being included in the target company’s published peer group(s) is only “somewhat” relevant or neutral in selecting peers for a pay-for-performance comparison group for 64 percent of investors while it is the “most” relevant factor for the majority of issuers (65 percent). Moreover, 74 percent of investors indicated the ISS-selected peer being in the same GICS group as the target company as a “very” or “somewhat” relevant factor, while 55 percent of issuers indicated that factor to be “somewhat” relevant or neutral.

A two-thirds majority of investor respondents said that ISS should continue to create its own peer group and provide the company’s peer group as an alternative view. For issuers, the responses varied with the most common response suggesting ISS use the company’s peer group without exception.

Measuring Pay
Investors are very likely to consider performance metrics other than total shareholder return when evaluating say-on-pay proposals. With respect to ISS’ pay-for-performance methodology, a slight majority (52 percent) of investor respondents indicated that they would be “very likely” to consider metrics other than total shareholder return as a factor when evaluating say-on-pay proposals. Common suggestions for such metrics included EPS and revenues as the alternative metrics.

Standardized calculations of realized/realizable pay or measures of such pay provided by the company are favored by both issuers and investors. One-half of investor respondents indicated that they would consider both granted and realized/realizable pay as an appropriate way to measure and analyze executive pay.

The other half of investor responses varied among other perspectives with 25 percent indicating that ISS should use granted pay in a quantitative evaluation but consider realized/realizable pay in a qualitative evaluation to determine overall pay-for-performance. For issuers, responses varied, with the least popular perspective to focus on “granted pay” (primarily cash and the grant-date value of equity awards).

A majority of investors indicated that both a standardized calculation of realized/realizable pay and measures of realized or realizable pay as provided by the company are appropriate ways to consider such pay in a pay-for-performance evaluation. Issuer responses varied, with 36 percent citing a standardized calculation of realized/realizable pay and 29 percent citing measures of realized or realizable pay as provided by the company as the appropriate way to consider such pay.

Pay for Failure
Regarding pay-for-failure scenarios, cash severance exceeding three times base salary and target bonus and new severance agreements entered immediately prior to a CEO’s departure are considered problematic: both issuers and investors agree. Over 80 percent of investor respondents consider all of the following actions as problematic in a scenario where a CEO receives a sizable termination package concurrent to significantly lagging shareholder returns: a severance settlement when the executive is slated to be retiring or resigning, immediate acceleration of all unvested equity upon termination without cause, cash severance exceeding three times base salary and target bonus, a new severance agreement entered into immediately prior to departure, and large pension/SERP payouts.

A majority of issuer respondents, on the other hand, do not consider any of these actions to be problematic with the exception of cash severance exceeding three times base salary and target bonus and a new severance agreement entered immediately prior to departure.

Canada
Guaranteed pay elicits mixed views among investors with respect to voting against the management say-on-pay proposal. Investor respondent views were split with 51 percent indicating that any form of guaranteed pay set out in employment agreements should not trigger a vote against a voluntarily adopted advisory vote on executive compensation, while 49 percent indicated that it should trigger a vote against the proposal.

Factors that received a majority response as warranting a vote against the proposal include an unreasonable payout range for incentive compensation (i.e., where the range does not start at zero for no achievement to an upper payout potential of 400-500 percent generally of base salary), lack of any performance based long-term incentive compensation, interest-free or forgivable loans to executives to exercise options or purchase shares, and a single trigger change in control provision in an employment agreement.

Europe
Investors and issuers generally support deferred bonus shares. Many European banks have been required to adjust their compensation practices in light of a new EU-level directive on remuneration at financial institutions. The most significant resulting trend has been a movement away from the traditional short-term/long-term variable pay mix and toward a deferred bonus model, in which all variable pay is measured based on performance in a single year and then deferred for a multi-year period. Oftentimes, the deferred pay is converted into share units and settled in shares.

A significant majority of both investor and issuer respondents, 69 percent and 78 percent, respectively, indicated that they would either generally support time-vesting deferred bonus shares or support them as long as clawback features are present. Most investors (49 percent) indicated that they would generally support these types of bonus shares as long as clawback features are present. By comparison, most issuers (50 percent) would generally support them outright.