June 18, 2018
Parsing ISS’ Peer Group & Pay-for-Performance Methodologies
– Broc Romanek
Recently, a member posted this query in our “Q&A Forum” (#1241):
Having read about ISS’s “wisdom of the crowd” approach to the construction of company-selected peer groups, my thoughts have once again turned to something that has always puzzled me concerning how ISS determines pay-for- performance alignment for the most recent performance year. I’m leaving to one side the issue of how closely the ISS peer group resembles the company’s proxy peer group, as that has improved significantly since 2012. (In any event, some years ago ISS said that its peer group is intended to serve a different purpose than the peer group selected by a compensation committee to benchmark executive pay, and that ISS’s pay-for-performance analysis is not intended to benchmark pay directly, nor is it intended to evaluate the effectiveness of a compensation program in attracting and retaining executives. I’m unclear as to whether that is still the case, but if it is, it argues against compensation committees trying to mirror the ISS peer group, since each peer group group is intended to serve a different purpose.)
Even assuming that a company’s peer group is identical to that constructed by ISS, the compensation and performance data available for each member of the peer group may vary widely, depending on when 10-Ks and final proxy materials are filed. In our case, fully 65% of our ISS peer group files proxy materials after us. In such cases, ISS says that it uses “…the latest compensation data available for the peer companies, some of which may be from the previous year.” U.S. Compensation Policies FAQs, at 33. (Dec. 14, 2017). Of course, due to the one-year lag in reporting equity grants in the Summary Compensation Table, some of the information ISS is using is two years old. That is, a 2017 Summary Compensation Table will show equity grants made in 2016 for 2015 performance.
Furthermore, even assuming that members of a peer group file at the same time, the information they provide will vary based on whether they provide a supplemental table that corrects for the one-year lag in reporting equity awards in order to better tie compensation to the most recent performance year. If Company A provides a supplemental table, it is providing ISS with an advance look at what will be in next year’s Summary Compensation Table. If Company B does not provide a supplemental table, ISS will rely on the Summary Compensation Table, which will show Total compensation that is distorted by the one-year lag in reporting equity awards.
Considering all of this, what is your opinion of the validity of ISS’s pay-for-performance methodology when analyzing the most recent performance year for members of its peer group?
Here’s the response that I posted from Carol Bowie of Teneo Governance:
As you note, the purpose of ISS’ peer groups does differ somewhat from that of the company, which is generally looking to benchmark pay to whatever market its management and board believe is appropriate to attract and retain talent.
According to its policy, ISS’ aim is to compile a peer group of companies that have specific similarities (primarily in size and industry) to the company being reviewed, as the first step in evaluating whether CEO pay and company performance are reasonably aligned. If that initial step indicates potential misalignment, what follows is a more in-depth (than normal) analysis and evaluation of the components and decisions related to the compensation program, with the ultimate recommendation based on whether the company’s disclosures indicate a robust pay process that clearly links pay outcomes to long-term company performance.
In working with our clients, we’ve found that there is no perfect peer group for such an analysis for many reasons, including the primary one the writer notes – i.e., various timing discrepancies. ISS may aim to utilize data as consistently as possible in the quantitative portion of their analysis, but there will almost always be anomalies to some degree, which is why it is critical that the company’s proxy disclosure – which ISS and other advisors rely on for their analyses — be as clear, comprehensive, and compelling as possible to support its pay programs and the decision-making underlying them.