ISS has provided some early guidance regarding how it will view pandemic-related changes to executive compensation as part of its pay-for-performance qualitative evaluation. According to ISS, the guidance was informed by direct discussions with investors as well as the results of its annual policy survey. The guidance is summarized below:
- Salary reductions. Because salary tends to be a relatively small component of total comp, ISS will give temporary salary reductions only “mitigating weight,” but will attribute more significance to the reduction “if targeted incentive payout opportunities are decreased to reflect the reduced salary.”
- Changes to bonus/annual incentives. ISS expects that there may well be adjustments to these programs in light of COVID-19, especially among companies severely impacted. Adjustments may even include, in some cases, substitution of one-time discretionary payments in lieu of entire programs. Although normally these practices would be frowned on, in view of the pandemic, ISS may view these actions as reasonable “so long as the justifications and rationale are clearly disclosed, and the resulting outcomes appear reasonable.”
- Disclosure of changes. Key disclosures advocated by ISS include:
- “The specific challenges that were incurred as a result of the pandemic and how those challenges rendered the original program design obsolete or the original performance targets impossible to achieve. The disclosure should address how changes are not reflective of poor management performance.
- For companies making mid-year changes vs. one-time discretionary awards, the company should explain why that approach was taken (as opposed to the alternative approach) and how such actions further investors’ interests.
- One-time discretionary awards should still carry performance-based considerations and companies should disclose the underlying criteria, even if not based on the original metrics or targets. Investors are likely to find generic descriptions (i.e. ‘strong leadership during challenging times’) to be insufficient.
- The company should discuss how the resulting payouts appropriately reflect both executive and company annual performance. The disclosure should clarify (or estimate) how the resulting payouts compare with what would have been paid under the original program design. Above-target payouts under changed programs will be closely scrutinized.
- Companies that have designed the following year’s (2021) annual incentive program are encouraged to disclose information about positive changes, which may carry mitigating weight in ISS’ qualitative evaluation.”
- Reduced bonus/annual incentive plan targets. Reductions in financial or operational targets below the levels of the prior year might be reasonably explained as the result of the impact of COVID-19, but boards will need to explain in the disclosure how they considered the corresponding payout opportunities, especially if they were not similarly reduced.
- Changes to equity/long-term incentive programs. Because these programs are designed for the long term, ISS believes that current in-progress cycles should not be modified “based on a short-term market shock.” ISS will generally view these types of changes “negatively, particularly for companies that exhibit a quantitative pay-for-performance misalignment.” However, “modest” changes to long-term incentives awarded in 2020 looking forward may be viewed as reasonable (e.g., changes to relative or qualitative metrics) in the event of “unclear long-term financial forecasting.” In the absence of fundamental changes to the basic business strategy, “drastic changes,” such as “shifts to predominantly time-vesting equity or short-term measurement periods,” would be viewed negatively. All changes should be explained in the disclosure.
- One-time awards. Companies that, to address challenges created by COVID-19, grant retention or other one-time awards should disclose, avoiding boilerplate, the rationale for the award (including magnitude and structure) and how the award furthers investors’ interests. ISS advises that the practice should be “isolated” and that the awards should be:
- reasonable in magnitude;
- contain long-term, strong performance-based vesting conditions tied to the underlying concerns; and
- contain “shareholder-friendly guardrails to avoid windfall scenarios, including limitations on termination-related vesting.”
- Forfeited awards. ISS does not favor the grant of one-time awards in replacement of forfeited performance-based awards. Companies that grant one-time awards in the same year or year following forfeiture of incentive awards will need to describe “the specific issues driving the decision” and how the awards further investors’ interests. If one-time awards were granted as a result of forfeited incentives (fairness, lower pay, etc.), companies will need to explain how the awards “do not merely insulate executives from lower pay.”
- Say-on-pay responsiveness policy. If a say-on-pay proposal receives support below 70%, consistent with current practice, ISS will still consider, COVID-19 notwithstanding, the company’s disclosure of (i) the board’s shareholder engagement efforts and (ii) the specific feedback received from dissenting investors. Typically, ISS also takes into account the company’s actions taken to address investors’ concerns. However, if a company is unable to implement changes due to the pandemic, the company should disclose, in its proxy statement, how the pandemic has impeded the company’s ability to address shareholders’ concerns, and, if changes are delayed or incomplete, a longer term plan to address those concerns.
- Other ISS policy changes. ISS is not changing its Equity Plan Scorecard (EPSC) in light of COVID-19; however, it is increasing the 2021 passing scores for the S&P 500 EPSC model to 57 points and for the Russell 3000 EPSC model to 55 points. For all other EPSC models, the passing score will remain 53 points. There are no changes to ISS policies on Problematic Pay Practices (which identify problematic contractual provisions in executive agreements) or option repricing policies (which generally oppose repricings that occur within one year of a precipitous drop in the company’s stock price).
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