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Global Governance Advisors

ISS Releases its 2020 Policy Guidelines for the United States

Posted by Peter Landers on Nov 25, 2019 9:15:00 AM
Peter Landers
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On November 12, 2019 Institutional Shareholder Services (“ISS”) published their Americas Proxy Voting Guidelines Updates for 2020 for the Americas region, which includes the United States and Canada. While GGA has summarized updates directly affecting Canadian-listed companies in a separate blog post, we are summarizing the key updates affecting U.S.-listed companies as it relates to compensation and governance below. These updates will impact any shareholder meetings held on or after February 1, 2020.

The updates are generally split into six separate categories:

  1. Voting on Director Nominees in Uncontested Elections (several updates)
  2. Independent Board Chair Proposals
  3. Share Repurchase Programs
  4. Equity-Based Compensation Plans – Evergreen Provision
  5. Diversity – Gender Pay Gap
  6. Pay-for-Performance Analysis

GGA’s summary of each change is provided below.

  1. Voting on Director Nominees in Uncontested Elections

Exemptions for New Nominees

ISS clarified that they will now consider new director nominees on a case-by-case basis with a “new nominee” being a director who is being presented for election by shareholders for the first time. Vote recommendations for “new nominees” will generally depend on the timing of their appointment to the board and the problematic governance issue in question. This will include whether a director has been on the board long enough to be held responsible for a problematic governance issue at the company. On a related note, this “new nominee” exemption is being moved to the beginning of the Director Election section from Accountability, as it may be applied to other policies in the other ISS evaluation pillars of Independence, Responsiveness, and Composition.

Board Composition – Attendance

ISS also clarified its policy for director nominees who served only for part of the fiscal year. This includes nominees who may have been appointed to the board a few months prior to the first annual meeting that they are to be elected by shareholders at. In these cases, it is to be expected that a nominee would not have attended all meetings throughout the fiscal year and therefore ISS’ 75% attendance threshold should not apply.

Board Composition – Diversity (Russell 3000 or S&P 1500 Companies)

ISS has stated that they will generally vote “Against” or “Withhold” for the Nominating Committee Chair (or other directors on a case-by-case basis) at companies where there are no women on the company’s board. Mitigating factors that could lead to a For vote recommendation include:

  • Until February 1, 2021, a firm commitment within the proxy statement to appoint at least one woman to the board within a year;
  • The presence of a woman on the board at the preceding annual meeting and a firm commitment to appoint at least one woman to the board within a year; or
  • Other relevant factors, as applicable.

The one-year transition period to appoint a female director provided by ISS has now passed, so even making a commitment to appoint at least one woman to the board within the next year will only act as a mitigating factor for 2020 for those companies who have had no women on their board previously.

In addition, for those companies that had at least one woman on their board in previous year, but not the current year, the company will clearly have to acknowledge the current lack of diversity on their board and provide a clear commitment to re-achieve a level of board gender diversity within the next year.

A “firm commitment” is defined by ISS as a plan, with measurable goals, outlining the way in which the board will achieve gender diversity.

Board Accountability – Problematic Governance Structure at Newly Public Companies

ISS has clarified its policy in two areas for newly public companies. One update states that ISS will generally vote “Against” or “Withhold” from directors individually, committee members or the entire board (except for new nominees who should be considered on a case-by-case basis), if prior to or in connection with a company’s public offering, the company or its board adopted the following by-law or charter provisions considered materially adverse to shareholder rights:

  • Supermajority vote requirements to amend the by-laws or charter;
  • A classified board structure; or
  • Other egregious provisions.

ISS has noted that a reasonable sunset provision (7 or less years at the most) will be considered a mitigating factor when making their vote recommendation. In subsequent years, unless the adverse provision is reversed or removed, ISS will vote case-by-case on director nominees.

ISS’ second update states that for newly public companies, they will generally vote “Against” or “Withhold” for the entire board (except new nominees, who will be considered on a case-by-case basis) if, prior to or in connection with the company's public offering, the company or its board:

  • Implemented a multi-class capital structure in which the classes have unequal voting rights without subjecting the multi-class capital structure to a reasonable time-based sunset.

They clarify that in assessing the reasonableness of a time-based sunset provision, consideration will be given to the company’s lifespan, its post-IPO ownership structure and the board’s disclosed rationale for the sunset period selected. A sunset period of more than seven years from the date of the IPO will not be considered reasonable.

In subsequent years, unless the problematic capital structure is reversed or removed, ISS will continue to recommend a vote “Against” or “Withhold” their vote from incumbent directors.  

Board Accountability – Restrictions on Shareholders’ Rights

ISS clarified its policy around restricting binding shareholder proposals to state that they will generally vote “Against” or “Withhold” its vote for Governance Committee members if the company’s governing documents impose undue restrictions on shareholders’ ability to amend by-laws. Undue restrictions include, but are not limited to:

  • Outright prohibition on the submission of binding shareholder proposals or share ownership requirements, subject matter restrictions or time holding requirements in excess of SEC Rule 14a-8.

If this restriction is not amended or removed, ISS will recommend an “Against” or “Withhold” vote on an ongoing basis.

ISS has also clarified that submission of management proposals to approve or ratify requirements in excess of SEC Rule 14a-8 for the submission of binding bylaw amendments will generally be viewed as an insufficient restoration of shareholders' rights. Therefore, ISS will continue to recommend a vote of  “Against” or “Withhold” for Governance Committee members on an ongoing basis until shareholders are provided with an unfettered ability to amend the by-laws or a proposal providing for such unfettered right is submitted for shareholder approval.

  1. Independent Board Chair

ISS has stated that they will generally vote For on shareholder proposals requiring that the Board Chair position be filled by an independent director when the scope and appropriate rationale for the proposal is provided, in addition to other considerations. They have also clarified that the following factors will increase the likelihood of a For recommendation on the proposal:

  • A majority non-independent board and/or the presence of non-independent directors on key board committees;
  • A weak or poorly-defined lead independent director role that fails to serve as an appropriate counterbalance to a combined CEO/chair role;
  • The presence of an executive or non-independent chair in addition to the CEO;
  • A recent recombination of the role of CEO and chair; and/or departure from a structure with an independent chair;
  • Evidence that the board has failed to oversee and address material risks facing the company;
  • A material governance failure, particularly if the board has failed to adequately respond to shareholder concerns or if the board has materially diminished shareholder rights; or
  • Evidence that the board has failed to intervene when management’s interests are contrary to shareholders' interests.

This view continues the evolution in North America thinking towards separating the Board Chair and CEO roles, which GGA has observed in recent years.

  1. Share Repurchase Programs

ISS has added new language relating to share repurchase programs stating that for U.S.-incorporated companies, and foreign-incorporated U.S. Domestic Issuers that are traded solely on U.S. exchanges, ISS will recommend shareholders vote “For” on management proposals to institute open-market share repurchase plans in which all shareholders may participate on equal terms, or to grant the board authority to conduct open-market repurchases, in the absence of company-specific concerns regarding:

  • Greenmail;
  • The use of buybacks to inappropriately manipulate incentive compensation metrics;
  • Threats to the company's long-term viability; or
  • Other company-specific factors as warranted.

ISS will also vote case-by-case on proposals to repurchase shares directly from specified shareholders, balancing the stated rationale of the company against the possibility for the repurchasing authority to be misused, such as to repurchase shares from insiders at a premium to market price.

  1. Equity-Based Compensation Plans – Evergreen Provision

ISS has updated its list of overriding factors that will apply under the Equity Plan Scorecard analysis to include plans that contain an evergreen (automatic share replenishment) feature. This means that for those U.S.-listed companies that have historically had an automatic share replenishment feature in their formal plan documents, if that feature is not removed then ISS will recommend a vote “Against” the equity plan proposal.

GGA notes that this could lead to a lot more “Against” vote recommendations from ISS than in the past as we have noted many U.S. companies that include these automatic share replenishment features within their plans, so is something for U.S. companies to be mindful of when putting their equity compensation plans up for a shareholder vote at the annual meeting.  

  1. Diversity – Gender Pay Gap

ISS has stated that it will generally vote on a case-by-case basis on requests for reports on a company’s pay data by gender, race or ethnicity, or a report on a company’s policies and goals to reduce any gender, race or ethnicity pay gap. While gender was included in this policy before, race and ethnicity have been added for 2020 within the policy.

ISS has also included whether the company has been the subject of recent controversy, litigation, or regulatory actions related to race or ethnicity pay gap issues; and whether the company's reporting regarding race or ethnicity pay gap policies or initiatives is lagging its peers. This is in addition to ISS’ historical inclusion of gender pay gap issues in its considerations as well.

  1. Pay-for-Performance Analysis

Use of EVA as New Executive Compensation Metric to Replace GAAP-Based Metrics

Starting in 2020, ISS plans on incorporating a new performance metric (EVA) into the financial performance assessment, replacing the GAAP-based metrics used in 2019. Accordingly, EVA performance will now affect the quantitative pay-for-performance analysis and Say on Pay recommendations for the 2020 proxy season. GAAP-based metrics will continue to displayed within ISS reports for information purposes.

As a reminder, EVA will be calculated as follows by ISS:

EVA = Net Operating Profit after Taxes – (Cost of Capital * Capital)

ISS will look at EVA in four different ways as part of its analysis:

1) EVA Margin – EVA as a Percentage of Sales
2) EVA Spread – EVA as a Percentage of Capital
3) EVA Momentum (Sales) – Annual change in EVA Margin
4) EVA Momentum (Capital) – Annual change in EVA Spread

These four measures will then be weighted and compared to the same overall performance of the selected peer group for an issuer.

Further clarification of these calculations are expected from ISS in the months ahead leading up to the adoption of these changes for issuers with meetings falling on or after February 1, 2020.

Changes to Quantitative Pay-for-Performance Thresholds

ISS has also updated its pay-for-performance thresholds relating to their Relative Degree of Alignment (RDA) and Pay-TSR Alignment test as follows:

 

 

2019 vs. 2020 Quantitative Pay-for-Performance Thresholds: All U.S. Companies

Measure

Policy Year

Eligible for FPA Adjustment

Medium Concern

High Concern

RDA

2019

-28

-40

-50

2020

-38

-50

-60

Pay-TSR Alignment

2019

-13%

-20%

-35%

2020

-22%

-30%

-45%

The Multiple of Median (MoM) thresholds will not change in 2020.

Addition of 3-Year Multiple of Median View of CEO Pay for Information Purposes

ISS has also indicated that their research reports will now feature a 3-year MoM view of CEO pay as a measure of long-term pay on a relative basis against an issuer’s ISS peer group. The 3-year MoM analysis will not be a part of the ISS quantitative screen methodology, but will be displayed in ISS reports for informational purposes only.

GGA continues to monitor the evolving proxy voting guidelines on a regular basis and will be reporting on any further developments as they are confirmed. Companies should be reviewing their compensation and governance practices against these updated guidelines to ensure that their current designs align to the updated guidelines as we move into the 2020 proxy season.

For more details on the ISS 2020 Proxy Voting Guideline Updates for the United States, please click on the following link:  https://www.issgovernance.com/file/policy/latest/updates/Americas-Policy-Updates.pdf

Further information on preliminary changes to ISS’ U.S. compensation policies for 2020 can also be found here: https://www.issgovernance.com/file/policy/latest/americas/US-Preliminary-Compensation-FAQ.pdf